Risk Management in Real Estate Investing

How to Reduce the Risk of Doing Your First Deal…

I’ve been polling my readers for a while now about how many deals you’ve done and not surprisingly the vast majority of you are yet to do your first real estate deal – which is no problem at all.  We’re going to fix that soon enough.

It is exactly these people I want to help most because I think the bulk of the information online is quite advanced and there are few resources aimed at helping you with that internal struggle with doubt, confusion, lack of confidence and of course risks.

To help you overcome these issues and start making offers, with confidence, I am trying to go back and put myself in the shoes of a beginner again by recalling the concerns and emotions that held me up when I was getting started.

An insight I’ve gained from doing so, is that two major barriers to entry are:

risk outweighing risk tolerance (ie. being driven by anxiety or fear)
a lack of answers to many detailed little questions that stem from having no experience (which increases the risk or perceived risk)

Examples of the myriad of questions that bother beginners and prevent them from acting include:

where should I start my property search?
how do I know if it’s a good deal?
what kind of insurance do I need?
what do I do next?

What should you do about all these questions? Ask someone. Don’t worry how embarrassing it may be. Ask me or find someone at your local REI club or association. But ask someone.

But now, I want to focus on this issue of reducing the risk involved in doing your first deal. We want to reduce the risk and remove this barrier to entry for you sufficiently that you feel much more comfortable pulling the trigger.


Risk Reduction Tools and Techniques

1. Education

As I have discussed previously (Education in Real Estate Investing: the best risk mitigator) the first step in risk management is getting a thorough education. Playing a game when you don’t know the rules is just plain stupid and getting educated about the laws and possibilities surrounding your business is absolutely essential. This is by far the most effective risk reduction technique.

2. Financial Analysis

Knowing your profit BEFORE you make an offer is the key to investing with confidence. I strongly suggest you go and read my post about the financial analysis of a deal if you haven’t already done so. I believe this to be the most important skill of any real estate investor and it will make all the difference in giving you the confidence to act.

3. Due Diligence

The rest of your due diligence is also critically important and yet, it’s often overlooked by smaller investors. I have found a very comprehensive due diligence checklist which should be a great primer for you. You probably won’t need to use this list in full when starting out but it would be smart to create your own sub-set of items for your own use. I bet there’s some things on here you hadn’t thought of.

4. Start Small

In order to minimize your exposure I always encourage people to start with at least a couple of deals that you consider to be “training deals”. The point of this is to get started quickly since the learning that comes from action and making mistakes far outweighs any book-learning. But then we want to keep your potential losses to a minimum by starting with small deals and applying the rest of our risk management techniques.

5. Contingency Planning

Your next level of protection should be to preempt any potential problems you are likely to run in to and have a plan B in mind. When you are getting started this might include things like:

“What if I have trouble financing the deal?”
“What if I can’t find tenants for the property?”

If you have accounted for worst case scenarios then any surprises that come along will always be in your favor.

6. Contracts and Agreements

As I mentioned above, knowing the rules of the game is an absolute fundamental of doing business, especially in real estate. And having contracts and agreements that use those rules to your advantage is a great way to manage your risk.

This might be as simple as using a letter of intent to purchase rather than submitting your offer as a signed contract. Perhaps you can use “subject-to clauses” on your contracts to allow you to only proceed with deals that are working out. This is not to be confused with sub-to deals but that’s another example. And you can also use “option contracts” very cleverly both when buying and selling real estate to achieve various desired results.

There’s two things I think need to be added here:
a) Just because you write something in a signed contract does not make it so. You cannot write a contract outside the bounds of the law. eg. laws governing tenants rights must be adhered to even if you have had a tenant sign a contract with different guidelines
b) You should not use these tools for trickery and you should always treat customers and business associates with the utmost respect. If you wish to be in business for the long-term, just do the right thing.

7. Insurances

Other than property insurance there are other things you can do as a form of insurance such as get a property inspection and get an appraisal. All these things should be covered in your due diligence checklist.

Well, that’s about it for this week. I hope this gives you a solid plan for managing risk in real estate investing and hopefully it will reduce that barrier to entry and we’ll have some brand new investors doing their first deals in the near future.

If you think of anything I’ve missed here or have any questions please add them in the comment area below.

To Your Success,

Scott Roemermann.

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