As real estate investors, we recognize that we need to take risk in order to reap any rewards. But how should you go about dealing with this risk? What’s too risky, what’s an educated risk, and when are we not taking enough risk? In this article I give you my thoughts on how I deal with risk.
I approach risk in three ways:
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3 Ways to Deal With Real Estate Risk Without Letting it Paralyze You
#1: Ignorance is Bliss
I have to be honest: I approach many new ventures from a perspective of pure and utter ignorance. I just don’t know what I don’t know. Sure, I educate myself, ask questions and consult past experience. But if I were fully aware upfront of what COULD happen, I might never have started in the first place.
If I had known I could be sued by a homeowner three years after I had sold the house to her, maybe I wouldn’t have flipped houses.
If I had known that a single tenant could bankrupt the entire apartment building by incessantly calling the authorities and suing me, perhaps I would have never started with apartment buildings.
If I had known that owning restaurants could result in significant losses, I would have never gotten into restaurants.
My point is this: Sometimes ignorance is in fact bliss. If we knew of every possible risk that could happen, it might be so overwhelming that we would never start with anything.
The reality is, while these things DID happen and they WERE bad, the overall venture was decidedly positive, both in monetary terms and experience gained.
Sometimes ignorance is good because it keeps you moving forward.
#2: Manage the Risk
Of course, we try to manage the risk. When we ARE aware of a risk, we try to assess its probability and impact. We think about what we can do to decrease the odds of it happening in the first place. And we consider what we would do if it were to happen.
We put all of this together, and we decide to take a calculated and educated risk because we know we can’t avoid risk; we can only mitigate it.
There is certainly a science to managing risk. That’s why large companies have “Chief Risk Officers.” Their job is to quantify and assess risk.
The challenge is that very few deals are no-brainers. The vast majority of deals are somewhere in the gray zone: they’re likely to work, but there’s always some doubt.
“Is this a good idea or not? Should I move forward with this deal or not?”
I’ve come to the conclusion that assessing risk is more art than science. It’s really about gut-feel. Sure, you can put pen to paper, lay out scenarios. And you should. But at the end of the day, at least for me, it’s a gut-check.
It’s not about avoiding risk, it’s about managing it.
#3: Always Expand Your Comfort Zone
Risk is a funny thin, because it’s relative. What I might consider risky, you might find completely not risky. I might find a mobile home park investment risky, and that might be your specialty. I might only offer $1.5M for an apartment building, and the next guy buys it for $1.8M. Why? Many times it’s an owner who owns the building next door. He’s familiar with the area, the market, and has a local team in place. His perceived risk is lower than mine, and that’s why he pays more.
When I visited my first 12-unit property, I was overwhelmed. Sure, I had flipped a couple of dozen of houses up to this point, but this was giant 3-level brick building. I could feel my stomach tightening at the thought of owning it.
Ten days into my due diligence, my comfort zone must have expanded because not only was I no longer anxious, I wished it was a bigger building! I learned that it’s the same amount of work to purchase a 12-unit as buying a building two or even three times that size.
Your bigger risk is someone else’s lesser risk.
And what you thought risky today, you might not consider nearly as risky as you did a year ago.
The reason is that some people have a bigger comfort zone than others. The lesson here is to constantly expand your comfort zone.
I recommend that you consistently operate just outside your comfort zone. If you do, your risk tolerance will grow and grow and grow. Over time you will look back and wonder why you got so stressed about a particular deal or situation a couple of years ago.
As real estate investors, we need to take risks to have a shot at success. While a good defense may work well for a football team, it’s a good offense that is required by an entrepreneur. If you accept the fact that you might not be completely prepared, do your best to anticipate and manage the risk, and constantly expand your definition of risk, you will be amazed at how your investing career will continue to grow.
What do you do to manage risk without letting it paralyze you?
Share in the comments below!