Mitigating Risk, a point of view discussion

General Real Estate Investing
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Mitigating Risk, a point of view discussion

Will BarnardPro Member
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Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes

In a recent thread, one member asked the other member the following:

"I'm curious as to how you mitigate your risks? I totally understand using your own money has far less headaches than dealing with the banks or private lenders and gives you higher returns when things go right, but what about if things go wrong? I'm not saying you're wrong, clearly you have been very successful, but to me the risk mitigation factor alone necessitates having some kind of money partner."

Here is my take on this, the risk does not change for me if I use private lenders as no matter if it is my money or theirs, even in a loss situation, I am going to pay back that lender (or lenders) no matter what so taking on debt does nothing to mitigate my risk in that scenario. However, if I take on an equity partner that brings capital to the table, than surely they also share in the downside, thus, a portion of my risk is diversified between us.

Things can and do go wrong (ask me how I know that!) but for me, risk is mostly mitigated by proper due diligence and buying at the right price. If I lock a deal with a large enough spread to cover everything that can go wrong (in a rehab flip scenario, exit price drops, rehab estimate goes up, holding time is longer, etc), then I have mitigated most of my risk, regardless if I use my money or that of OPM (other people's money).

Please feel free to chime in.

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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
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I think there are two categories of risk: That which you can foresee and mitigate, and that which you can't foresee and mitigate. The second category would include the types of catastrophic events in which it's unlikely that I'll be my investor's first phone call.  Since there's nothing I can do about that type of risk, I'll focus on what I CAN influence.

  • Diversifying geographically and amongst asset classes
  • Offering multiple investment opportunities with differing strategies
  • Encouraging investors to invest in multiple offerings instead of putting their entire allocation into one (and to invest with other sponsors too)
  • Understanding that risk increases when I stray further from my core competencies, which means I need to bring in expertise or take the risk myself with my own funds before accepting investor funds
  • Recognize that properties have flaws, and don't ignore them to make the deal work...if the flaws make the deal un-doable, don't do the deal
  • Watch economic indicators to seek clues to future market conditions and react before everyone else figures out what is going on
  • Exercise discipline, don't get caught up in bidding wars that put your successful execution at risk
  • Don't accept unsuitable investors--they must be utilizing risk capital.  A little ol' lady's life savings isn't worth it

Real estate investing is risky, and those who are new to the business and haven't been injured yet fail to appreciate the reality of that risk.  Does using OPM mitigate our risk as real estate investors by dividing the risk amongst more participants?  Yes, it does, but it also adds to our risk because of fiduciary responsibilities, regulatory compliance and liability.  In the end we are just trading one risk for another.  I don't take investor capital to mitigate risk, I take it to facilitate growth. And growth breeds risk...

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  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
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    @Will Barnard - You left out the part about getting the previous inhabitants to move out of the property ;-)

    I share the view that private lenders are to be made whole even if it would mean selling a property outside of the troubled deal to make them whole.

    We also tend to put the capital of our equity partners before our own.  We usually operate within a corporation where our preference is to issue a preferred series of shares to equity partners which gives them priority of capital return, but no or limited voting on day-to-day matters.

    Since we are buy-and-hold types, we mitigate risk through taking a rather dour look on future performance when evaluating a deal.  If the property will produce a satisfactory cash-flow under our doom-and-gloom scenario, then most of our surprises should be pleasant.

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  • Karen MargraveBusiness Member
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    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
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    @Will Barnard thanks for starting this, after it being brought up in another thread. I didn't want to get that thread off course, and answered through a private message. 

    When I was asked about mitigating risk, we, like you, have the same plan. We mitigate risk to everyone by doing good due diligence, and choosing projects wisely. 

    • Developing projects with healthy profit margins is the number one way to mitigate risk. How? 
    • We buy properties in high demand areas, 
    • Work in areas where there's a strong economy (more qualified buyers/investors) 
    • Buy land priced at or below market value, 
    • Design as cost effective of a project as possible,
    • Shop everything for the best price and highest workmanship
    • List our own properties (and sometimes sell ourselves)
    • Act as our own general and electrical contractors, 
    • Do all preliminary architectural and site design in house
    • Stay involved with engineers, architect, planners, etc.
    • Understand the entire permitting process, and build relationships. 

    Risk cannot be eliminated, but mitigated. As Will said, things do go wrong even with the most well planned projects, but staying with it, doing what needs to be done to finish the job and cover your lenders, etc. has to be THE priority. For us, because we do so much of the job ourselves, we can get hit pretty hard and still have enough profit to cover lenders.  

    2Reply
  • Cal C.
    Investor · Peachtree Corners, GA · Member since 2014 · 1k+ posts · 1k+ votes
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    @Will Barnard and @Karen Margrave  I absolutely agree careful research and large margins  are great ways to mitigate risk.   In most instances they will work.  But from personal experience, I know there are totally unexpected things that can happen.  For instance, I went to work early one morning in September 2001 and was not able to return to my apartment for two weeks and then with only a military escort.   A plane had hit a building three blocks away and another one four blocks away.  Fortunately, I was a renter at the time, so I wasn't affected investmentwise.  

    Yes, of course 9/11 is an extreme example, but crazy things do happen as I attested.  

    As everyone pointed out paying off lenders and or partners first is vitally important.  However, I look at it this way, having multiple projects in slightly different areas going on at the same time is better than having one major project.  Even if one of the projects goes bad, then profit on the other projects will increase the chances of lenders being made whole on the bad project. It will also give you a much better chance of rising from the ashes, if a deal goes spectacularly bad. 

    My takeaway from this thread is there are three (at least) things to look for/do to mitigate your risk.  1) Careful research, 2) wide margins/conservative estimates 3) diversification

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
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    You may have an advantage of using your money, but you may not too.

    Using OPM is a contingent liability above that of the project, just as a lender may seek a deficiency judgment, so can a partner. Your reputation is more at risk working with investors than some bank, banks don't describe failures to others like investors might in the grapevine.

    While anyone using OPM will swear up and down as to good intentions, the investor needs to do their due diligence, can your partner pay you back as agreed, can they eat a loss personally or are the borrowing from Peter to pay Paul? What if there is no Peter to bail them out? Good intentions are fine, keep in mind, people are mortal, things can happen, your key man running a project may not be able to finish up, then what? A bank will be there!

    In some ways, your risks are increased dealing privately than with an institution. the end result can be worse dealing privately. That's why greater care should be taken with OPM. :) 

    0Reply
  • Cal C.
    Investor · Peachtree Corners, GA · Member since 2014 · 1k+ posts · 1k+ votes
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    @Will Barnard @Karen Margrave @Roy N. 

    I just wanted to bring this thread back to life since I think it is an extremely interesting one.  

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  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    11y

    @Cal C. I'm not sure what else there is to say, though if you have any thoughts or questions, post them, and I know people will be happy to chime in! 

    0Reply
  • Andy Mirza
    Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
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    My last fix and flip deal went south and I'm in the position of owing a couple of friend/investors money. Fortunately, I have equity in other buy and hold properties which I can use to pay them back when they eventually get sold, I still have good earning capacity from my "day" job, and my friend/investors are understanding and willing to work with me since they know I'll make things right.

    It was a high end fix and flip and I was focused on doing the deal myself and maximizing the profit. I wanted/needed the deal to work because it would've gone a long way toward helping me get out of the rat race. The submarket softened and I missed a big flaw in the property (it backed up to a relatively busy street which turned out to be a BIG deal to buyers in that area and at that price point.)

    I never even considered wholesaling the property or giving an equity position to my gap lenders because I was so focused on what I needed and I though I had a good plan that was going to work the way I envisioned it. In retrospect, I should have wholesaled the deal or found an experienced investor to put up the down payment and shared things 50/50. My due diligence could have been better but even if it were perfect, there are unforeseen things that could go wrong and cause you to lose money. Until I can withstand the shocks to my capital for a deal that goes wrong, I'm planning to share risk and be happy even though I'll make less. The stress to me and family isn't worth it.

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    11y

    I think there are two categories of risk: That which you can foresee and mitigate, and that which you can't foresee and mitigate. The second category would include the types of catastrophic events in which it's unlikely that I'll be my investor's first phone call.  Since there's nothing I can do about that type of risk, I'll focus on what I CAN influence.

    • Diversifying geographically and amongst asset classes
    • Offering multiple investment opportunities with differing strategies
    • Encouraging investors to invest in multiple offerings instead of putting their entire allocation into one (and to invest with other sponsors too)
    • Understanding that risk increases when I stray further from my core competencies, which means I need to bring in expertise or take the risk myself with my own funds before accepting investor funds
    • Recognize that properties have flaws, and don't ignore them to make the deal work...if the flaws make the deal un-doable, don't do the deal
    • Watch economic indicators to seek clues to future market conditions and react before everyone else figures out what is going on
    • Exercise discipline, don't get caught up in bidding wars that put your successful execution at risk
    • Don't accept unsuitable investors--they must be utilizing risk capital.  A little ol' lady's life savings isn't worth it

    Real estate investing is risky, and those who are new to the business and haven't been injured yet fail to appreciate the reality of that risk.  Does using OPM mitigate our risk as real estate investors by dividing the risk amongst more participants?  Yes, it does, but it also adds to our risk because of fiduciary responsibilities, regulatory compliance and liability.  In the end we are just trading one risk for another.  I don't take investor capital to mitigate risk, I take it to facilitate growth. And growth breeds risk...

    Podcast Guest on Show #2024
    4Reply
  • Jeff Greenberg
    Real Estate Consultant · Camarillo, CA · Member since 2010 · 2k+ posts · 1k+ votes
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    @Brian Burke as always, very eloquently said.

    0Reply
  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
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    Perfectly explained Brian, props to your explanation and descriptions. You explained my point much better than I could myself.

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  • JT Spangler
    Buy and Hold Investor · Nashville, TN · Member since 2013 · 264 posts · 102 votes
    11y

    As a beginner, I am hoping to minimize risk where I can and mitigate risk where I can't. So far, the best way I've figured out to minimize and mitigate is (1) learn everything I can, and (2) invest only my own money (and the lender's) until I have proof of concept and can verify my actual returns with my projected returns.

    Only when I'm reasonably sure I'm evaluating deals correctly can I think about using OPM to fund them.

    0Reply
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