By Derek Kartchner | Gila Insurance
Starting with the end in mind, creating a plan, breaking the plan down into digestible steps, and doggedly working on the plan is how anything real is accomplished. Moreover, it’s how we reach the unreachable. Any dream worth striving for also creates some risk. We might fail. The plan might blow up in our face or we might simply fall short of what we set out to do. Some might say that this is a limiting belief, and ought to be avoided. But there is a difference between reaching for the stars with everything we have and having a safety net or a plan and not fully extending our hand. Risk management should be a pillar of any plan. In fact, any worthy vision will involve some risk, but what is acceptable, and how we manage these risks is very much an individual question. The key is identifying the risk in our plan, analyzing what we plan to do, and setting controls to ensure our vision stays on track.
Risk identification will look different for each real estate investor. For example, someone flipping homes has to consider the interest rate environment, hold time, cost of materials, labor, etc, and what might happen if those things suddenly change. Conversely, a long-term rental operator wouldn’t have the same risk. They would have tenant risk e.g. will the tenant pay, will the tenant trash the property, and is there enough cash flow to cover the vacancy and repairs when the property needs to be turned? Notes, wholesaling, multi-family, and every investment vehicle will carry its own risk and can be compounded or minimized as we scale. Think of a rehabber that has several properties. Increased inputs can compound very quickly. Conversely operating long-term rentals with narrow margins can be catastrophic with vacancy, decreased rents, or increased expense lines. The point is, that identifying the risk is the first step in the process.
Once you have identified the risk – does it bother you? Do you have enough margin to withstand a bump in the road? I had a real estate investment that I lost many nights of sleep over, and another that was literally a dream. The difference? One drained my bank account and the other filled it. The difference was how I went about preparing for the risk beforehand. Both properties had hiccups and unexpected expenses. One I looked at with rose-colored glasses. We found a deal at 0% interest on an owner carryback. I was so in love with the interest rate I failed to analyze the risk of the investment. Once the novelty wore off I saw it for what it was; a dog with fleas and A LOT of them! In the end, I sold it at a loss and was glad to be rid of it (spit). The other I was prepared for the bump, paid the bill, and wished I had 10 more of that property. The thought exercise of analyzing your risk can help along the way and is worth the effort.
Each of us knows a friend who is crazy. You know the one. They are the adrenaline junky, the risk taker. We also know the guy who can barely leave the house because the asteroid might hit him, the risk petrified. Investment risk is no different. You can avoid risk altogether by not investing. You can prevent or reduce risk by having a partner, taking steps to control costs, or investing in education to help you avoid the pitfalls (Thank you AZREIA). You can segregate risk by putting different assets into different LLCs. You can transfer risk by buying insurance. It really depends on the risk and your appetite for it. Obviously, this is surface analysis at best but “it won’t happen to me” is not a risk management plan, nor a pillar of a good vision, not if you want to arrive at the top. I have found preparing for the storm helps me get through it.
As an insurance guy, you might think that I would simply plug insurance as the one-size-fits-all solution. Not at all. Insurance is a small piece of risk management and is simply a risk transfer mechanism. Frankly, I think far too many investors have too low of deductibles, and expect insurance to solve far too many problems. Conversely, risk management is a holistic look at what’s out there and what the plan is. As we consider what our vision of the future looks like, I encourage each of us to consider the risk in our plan and get a plan to control it. As I have long said to many an investor and AZREIA member, investment decisions should not be made based on insurance, but risk management should certainly color the decision. As Gary Cohen (VP of IBM) once said, “ If you don’t invest in risk management, it doesn’t matter what business you’re in, it’s a risky business.”