What you don’t know can hurt you.
In 2005, when house flipping reached record levels, many investors believed they could make a fortune taking out loans, buying properties, and selling them for a profit. While some noticed the high levels of speculation and retreated to the sidelines, others got swept up in the hysteria and missed the warning signs. They profited for a while.
But it all came crashing down in 2008.
The Housing Crisis should serve as a reminder to always have your eyes open. You can’t control external risks like internal risks, but you can navigate through difficult times and come out ahead.
In real estate investing, you must be constantly on the lookout for external real estate investment risk factors, from market conditions and trends to the competitive landscape.. Here’s what you should know and how you can reduce external risk.
Understand Market Risks
If there is anything 2008 taught us, real estate investments aren’t immune to the ups and downs of the economy. However, with focus and decisive action, you can reduce your real estate investment risks and weather hard times.
For instance, multi-family housing declined less during the 2001 recession and held up better than others during the 2008-09 recession. Investing in multi-family assets can give your business the economy of scale without the significant downside risk from a market correction.
While the Dow Jones dropped more than 50% during the 2008-09 recession, multi-family housing rents held up well. Rent declined 7.9%, the lowest of any real estate investment. Even the recovery of multi-family housing was better, with rents rising nearly 26% since then.
Investors also must boost their personal knowledge of a market and asset class in which to invest.. As Warren Buffett says, invest in what you know.
Therefore, take time to build your knowledge base on your market conditions, on the specific asset class you want to purchase in that market, and your experience and ability to execute a clear improvement strategy on the property. Analyze the following external risks:
- Price: Are you buying at current market value? Above? Below?? What’s the price per square foot versus a few years ago? Have property values been rising too fast or too slow?
- Property risk: Are there any risk factors specific to the property, such as construction or environmental risks? How much will repairs and updates cost you?
- Cash flow estimates: Can the property rent at 1% of the purchase price per month? This would generate solid cash flow.
- Market conditions: Examine median sale price-to-household income ratios, average loan-to-value ratios, price volatility, diversity of local employment, the share of homes sales that are flips, etc. If numbers don’t add up, the market could pose more risk than you want.
- Liquidity risk: How difficult would it be to cash out your investment? For example, an investment in a retail mall in a tertiary market may be attractive, but will buyers be there if you need to liquidate?
As a real estate investor, ensure detailed due diligence and analysis with each deal. Consider all the real estate indicators and conditions, even the credit risk of your potential tenants. Think short- as well as long-term here. The desirable anchor tenants from the last decade have changed drastically over the years. Remember when landlords loved having JCPenney anchor the mall?
Doing all this research and analyzing every possible scenario ensures you don’t jump into the wrong investment. It enables you to choose the projects that have the strongest potential for success.
“You have to be thorough. At DLP, we review hundreds of multi-family deals a month. We do a deep dive into the due diligence process on 50 or 60 deals and decide to make offers on 5-10. This is all in the hopes of getting one offer accepted and closing one deal,” states Brion Yarnell, Vice President of Business Development at Direct Lending Partners, a leading provider of private loans for real estate investors.
Know Your Real Estate Competition
Gaining a competitive advantage makes yourself more appealing to sellers, investment partners, and creditors. You have to understand the competitive landscape deeply. Examine:
- Who the leading real estate investors in your market are
- Where your real estate competition is spending their marketing money
- What those investors offer that sets them apart from other buyers in the seller’s eyes
- How those competitors structure deals (this provides insight into how you can make better offers)
After you do this research, see whether you’re adequately prepared to win deals against your top real estate competition. Can you offer more attractive terms to sellers? What differentiates you?
For example, if a competitor makes an offer higher than you’re willing to go, you could make a slightly lower offer with a large upfront deposit. Or you can make an offer with a shorter due diligence period and more hard money. This would make your offer more attractive to the seller. Your offer would enable a faster close and provide them security that funds for purchase are there.
When you find the right deal—one where external risks are minimal and opportunities are great—identify where you have competitive advantages or see how you can make yourself stand out as an investor. This is how you beat the real estate competition.
Master Real Estate Risk Management and Scale Your Operation
Real estate investing, like any other investment, carries risk. Whether it’s differentiating yourself from the real estate competition or understanding market risks, you have a lot to manage. By reducing external risks, you can put yourself in a better position for success.
Create a strategy for identifying these external risks and processes for taking action. Get ahead of potential risks before they surprise you (so you don’t get trapped).
Finally, make sure you have adequate capital. This way, you can manage your real estate investments as best as you can. If you’re concerned about money for your next deal, know Sign out private loans for real estate investors are out there. If you’d like to learn more, contact the team at Direct Lending Partners. We’re ready to help you meet your investment goals.