Tools and Strategies for Risk Mitigation and Management
by Andy Bates
Even in times of certainty, the wise real estate investor understands that there is risk involved in any deal. Awareness of risk and the ability to identify it, prepare for it, and strategize around it are skills at the core of what it takes to be successful in any business, not just real estate.
Regardless of the state of the industry, risk isn’t going anywhere, and every investor who has ever succeeded has done so despite the risks. For real estate investors looking to face the risks of the industry and find a way to win, here is an assemblage of tools, concepts, and strategies for risk mitigation and management.
Location and Diversity
Integral to the formula of risk is location and diversity of assets. Diversity not only speaks to where subject properties are located across markets, but also the mix of asset classes in which an investor deals. The real estate market tends to be cyclical. In some seasons, rental assets are heavily impacted by rent rolls, with the monthly costs of maintaining the property coming up against rent figures, otherwise known as the debt-service-coverage-ratio (DSCR). In other cycles, affordable flips may be hard to come by, or it may be difficult to determine a path to profit due to the cost of goods and services. Investors should keep abreast of key market indicators and leverage that data to inform their investment strategy.
Business Partners
For newer investors especially, it can be risky to go it all alone. This is where a business partner can come in to help mitigate that risk. Newer investors are less likely to have the capital, credit, or experience to stand on their own two feet, not to mention the knowhow that comes from experience in real estate with what can go wrong in a big way. With two investors sharing capital, resources, brainpower, and the risks of real estate investing, they are more likely to also share in the rewards.
It can be worthwhile for experienced investors to team up as well. This is especially true when it comes to larger holdings and developments. Investors may partner on the acquisition of a several-hundred-unit property to hold and maintain as a rental asset or to conquer larger builds such as track developments or build-to-rent communities.
It’s important to remember that arrangements with investment partners can be subject to change. Partners can buy in at different percentages or can be bought out of their holdings. Discussing strategy and working in concert rather than opposition can ensure that no additional risks are incurred in the partner relationship.
Broker Professionals
Real estate brokers are industry professionals that specialize in helping their clients achieve success. A good broker can help an investor vet a property and advise them on the strength of the investment. Brokers also manage process documentation on behalf of the investor, ensuring that paperwork is completed accurately and in accordance with the needs of any third party whether that be lenders, appraisers, title companies, general contractors and more.
Entity Establishment
Regardless of whether an investor is just stepping into real estate or if they are looking to expand their business, leveraging legal defense is essential. One way that investors can protect themselves is through the establishment of entities for business purposes.
When something goes wrong with an investment, the investor can be liable for major losses. If the investor did not establish an entity for their investment, then they are solely responsible for any fallout, and in these situations their personal assets are at risk. With a properly established business entity, such as a Limited Liability Corporation (LLC), an investor working through an entity is significantly more protected than one who is not.
Investors can set up multiple entities. Each entity can be used for its own specific investment. In this way, if an investor has trouble with one of their investments, not only are their personal assets protected, but their additional investments, once separated by distinct business entities, are protected from one another as well. Leveraging business entities for appropriate investment purposes is a tested and effective method of risk mitigation that does not hinder business development. Investors working through multiple entities can still establish and manage a portfolio of their properties.
Portfolio Management
Professional portfolio management is another proven means of mitigating risk. Portfolio management firms can assist investors in a variety of ways at the front and back end of the deals and projects they pursue. Portfolio managers maintain and assess the portfolio and all its variables (asset classes, locations, project types, etc.) and combine these with data, both new and historical, to determine and mitigate risk.
Excellent portfolio management can also provide for acquisitions and vetting deals that are in line with the strategy of the investor. They can also support strategic planning with discussions of diversification, financing options, market activity, and performance optimization all personalized to the goals a given investor may have for their business.
Legal Counsel
Legal counsel can be considered a cornerstone of risk mitigation in any industry. For investors, counsel can be used to ensure compliance and due diligence. They can review contracts, resolve disputes with partners and institutions, and offer litigation support in the worst of cases. While legal representatives are there to rely on when things are at their worst, leveraging them for legal opinions when making major decisions can help prevent investors from even finding themselves in such situations in the first place.
Managing Risk
The risk/reward aspect of real estate investing is something that prospective buyers should always have in the back of their minds. By implementing the suggestions laid out in this article, investors can minimize their risks and protect themselves in the process.
Relying on talent and expertise where it is required is a hallmark of the resourceful investor. Combining industry data with savvy counsel helps investors make the best decisions for their goals and for their business. Investors will want to ensure their strategy is complete in order to prepare for and mitigate risk as effectively as possible.
