I get asked a lot about what investors should consider when assessing the risk of real estate? It's a good question, because you should never evaluate any investment without taking into account the risks associated with it - which includes real property.

When investing in stocks, investors can take a look at the volatility of a company's shares in order to gauge the risk. In the case of bonds, investors are able to examine the credit rating of the particular offering to get the same evaluation.

However, when it comes to real estate, the same universal standard for risk assessment isn't in place. Therefore, investors have to know the various types of risks - as well as how to reduce the risk.

The article below will talk about the different kinds of risk factors that investors are faced with and the actions they can use to reduce them.

DIFFERENT INVESTMENT STRATEGIES, DIFFERENT RISKS

The risk levels in real estate investment are directly related to the kind of investment in real estate. That is, various investment strategies involve different types of risk.

In this case the investor who purchases the property subject to conditions could be at risk of lenders using due-on-sale clauses as investors choosing between the BRRR and flip option have to consider their own risk factors.

So, I'm not able to give an answer that is simple on the issue about assessing the risk involved in real estate since each sector of the huge real estate market has distinct advantages and disadvantages, as well as risks and benefits.

Realizing this We'll explore risk in relation to two of the most common investing strategies we employ in Do Hard Money in the following article - flipping and wholesaling.

Wholesaling – Low Risk Real Estate Investment Strategy

Investors usually think of buying and selling real estate as as a low-risk investment option due to the inherent risk of hedging it entails. In general, the method involves purchasing with the intention to sell it immediately, and follows the following four steps:

• Find the house: The broker locates an extremely discounted property that meets the requirements of an effective flip of a house.
• Find buyers The wholesaler is then able to find an interested buyer who is who is interested in buying the property and then carrying out the remodel and then selling it.
• Negotiating the agreement: The wholesaler then has to negotiate with the seller and buyer to come to an agreement on conditions.
• Closing the agreement: The wholesaler assigns this contract over to buyers and both parties conclude the transaction and the wholesaler receives the commission for locating and taking over the property on the buyer's behalf.

As mentioned, wholesaling comes with an inherent hedge mechanism in other words, in the event that you aren't able to find buyers, you decide not to purchase the property, thereby significantly less risk is associated by this method.

House Flipping – A Higher Risk Strategy

Although wholesaling is less risky but it also offers less rewards. House flipping On the other hand, involves greater risk, but also a greater chance to earn a profit if it is done right.

Each house flip has its own distinct characteristics, however generally the process comprises some of the steps below:

• Purchase an undervalued property The majority of investors will not find these types of bargains on the market but instead will have to locate off-market properties which are overvalued due to substantial repairs needed.
• Renovation of the house The next step is to improve the property so that it is at an extent that it A) appraises for a greater value than the cost of the purchase and rehabilitation and) attracts prospective buyers.
• The property is sold Finally House flippers can are able to sell their renovated properties. If they do it correctly the proceeds from sale will yield a substantial return for the investor.

Through this method the investors are taking on greater risk than wholesalers since they are assuming both the risk of making the required repairs as well as having to sell the house.

The six risk categories listed below involve house flipping and each mitigation method gives investors a tested approach to tackling the inherent risks.

RISK 1: OVERESTIMATING VALUATION PROJECTIONS

When investors create plans for flipping houses that they plan an after repair value or ARV. This is the budgeted price for exit which is the amount of cash that investors can expect to get when they sell their property after the rehab process.

Most homeowners who flip houses, and especially novices, greatly underestimate their ARVs. This is a huge risk.

In this case, for example the scenario where an investor buys the house for $50,000, and budgets an additional $50,000 to cover rehab/holding costs, and anticipates an ARV of $150,000, they will earn an estimated profits of $50,000. In this case investors assume the risk of the ARV being less than the forecast which is the property will ultimately sell for under $150,000. If, for example, the rehab/holding costs budgeted remain exact, but the property is sold for $90,000or less, the sale changes from a profit of $50,000 to a loss of $10,000.

Although this might seem radical, overestimating ARVs can be the biggest danger for those investing.

Risk Mitigation Technique

On a fundamental level investors reduce the above risks by conducting thorough market research. With years of experience and an understanding of sales and the local market, you can make sure that that your projected ARVs are the closest to what is feasible.

But, there are times when ARVs aren't as high as projections due to reasons beyond the investor's control, such as the effects of a recession (e.g. Great Recession collapsing valuations). In these extreme situations investors use time to reduce the impact of their projections that are too high.

Investors don't notice losses until they actually have to sell. If, however, you are in the middle of rehabilitation, prices plummet investors may change their strategies in favor of a long-term, buy-and-hold method. In this way, tenant's rent will cover the cost of holding and the investor is able to sell the property later after the value has recovered.

RISK 2: UNDERESTIMATING REHAB COSTS

On the other side of this coin investors also confront the danger of underestimating the cost of rehab by assuming that the whole renovation process and the holding period will be more expensive than what it actually costs.

Let's consider the previous example. Consider a $50,000 purchase, and an the plan of $150,000 ARV. However, this time the buyer blew his rehabilitation plan by $60,000. In this instance the $50,000 projected profit also was shattered into a loss of $10,000, however, this time due to an inadequately planned budget for rehab.

These risks cannot be distinguished from human nature. In general the case of investors, they tend to be too confident about the amount they'll get from the sale (i.e. selling a house) and the amount they'll be spending during the transaction (i.e. actually renovating the house). TV shows create a worse situation. When investors first start watching one of the seemingly endless number of television shows about flipping homes, they are often tempted to think that it's simple.

In the real world, a 30-minute TV show isn't able to show all the process involved in the process of a successful home flip. The typical viewers will only glimpse the purchase as well as a short glimpse of repairs and then a sparkling finished product. This model - while entertaining, it can set new investors in a position of risk because it drastically limits the amount of work is required to complete an effective rehab. This results in overestimated rehab costs.

Risk Mitigation Technique 2

However, new investors probably will not be able to mitigate the risk by themselves (unless they're general contractors with years of experience).

Instead, flippers of houses are able to reduce the risk of a low rehab budget by having a deal's construction manager review the plans in depth with the general contractor who will be working on the rehab. In particular, these key stakeholders should discuss the guidelines for renovations in the industry and the specific challenges associated with the particular property, and not just putting together a few "back-of-the-napkin" numbers.

This means in the case of a property instead of inspecting a home and making a quick estimation - we're going to require about $2,000 in electrical work - general contractors and project managers will actually come up with a definitive industry-standard estimate of the projected electrical cost for a particular property.

With this kind of planning investors can look at how their budgets for renovation are in good hands, removing the biggest risk related in flipping.

RISK 3: NEW OR PREVIOUSLY UNDISCOVERED DAMAGE

However even the best budgets and plans may fail in the face of unexpected obstacles.

If a project manager or general contractor design a rehab budget, they design it to reflect the current conditions. Sadly, in the rehabilitation process, new damages could be discovered or brought to their notice (e.g. water heater breaks or an attic ceiling falls and the contractor discovers an electrical issue that wasn't initially recognized and budgeted for etc.).

Any of these scenarios could result in an unsustainable rehab budget and reduced profits is a risk that investors must take into consideration.

Risk Mitigation Technique 3

A new hazard can't be prevented regardless of how meticulously an investor and his team have planned the project. Two basic tools can be a big help to reducing the danger:

• A thorough inspection Prior to buying a home the buyer should carry out an extensive examination on the house. Even when inventory is moving quickly in a market investors should are aware of what kind of work their property really requires. If they don't have this knowledge even the most knowledgeable investor won't be able to come up with a realistic budget for rehab.
• insurance: No one likes to pay for insurance but flippers require this security to limit the possibility of damage occurring in the process of rehab. If a home is destroyed during the hold period insurance can help investors recover some of their cost. If they don't have insurance, the investors are forced to roll the dice, with hoping that nothing happens wrong, while taking on a huge risk.

RISK 4: A LONGER THAN EXPECTED REHAB PERIOD

This is due to the underestimation of rehab costs. When investors contract third-party general contractors to remodel the property, they have their own priorities and often result in blown rehabilitation timelines.

In a flip investors face massive holding costs. That is, expenses that are incurred by the mere possession of a property and without actually doing any renovation. These are the costs for utilities and taxes on the property and the cost of insurance and loan rates, etc and will add up fast.

If the general contractor isn't able to meet the timeline that was set investors take on the risk of these increasing cost of holding cutting into the company's margin of profit.

Risk Mitigation Technique 4

I've spoken about it several occasions, yet the secret to ensuring that you stay on time is based on a well-trained Project manager (PM). This may be the investor, who is experienced, or in the absence of (or already busy) or even a designated person from the team of the investor.

In the end, a great project manager manages the day-to-day relationships with contractors, and ensures that the renovations are completed within the timeframe and budget. Therefore, investors who are new have to identify dependable PMs in order to avoid the possibility of a schedule that is not met.

RISK 5: USING EMOTION INSTEAD OF LOGIC

The combination of emotion and investing is a the risk of all investments, and especially in the real estate industry.

If you buy a house you will have a tangible record of the money you spent, that is, the house. Therefore, when an investment goes wrong investors can feel a resentment towards this tangible object and say that they would like to sell this property and never look at it ever again.

However, this method can lead to losses due to an emotional motive while a rational one could effectively solve your issue.

Risk Mitigation Technique 5

How do you deal with the issue of investing based on emotion? Although I'm not able to tell you how to eliminate your emotions, I can tell you that you can minimize the negative effects of investing through a set of guidelines.

If you create and implement an action plan, you can be sure that, regardless of the unexpected challenges that occur during rehab you take decisions with a solid understanding of the situation and an in-depth study of the best method to achieve the return from investment.

If you don't have a plan in place without a plan in place, you'll eventually fall to the risk of impulsive rather than profit-maximizing decisions.

RISK 6: LIQUIDITY SHORTFALLS

Last but not least, I want to talk about the financial aspects of real estate and investment risk. In particular, I'm referring to the possibility of cash flow shortfalls or, in simpler terms the possibility of running out of cash in the course of a rehabilitation.

As a result of these scenarios, investors have to take on the risk of being short of money prior to completing the rehab.

Consider, for instance, that after buying the property, the investor gets a $100,000 money loan to fund repairs. If any number of negative scenarios arise (new damage, longer-than-expected holding period, previously-undiscovered damage, etc), the investor can blow through that $100,000 budget.

If an investor is running short of money, two options are available (both likely to be bad):

• Sell the property as it is and you will likely receive far lower than the estimated ARV.
• Take out a second hard money loan which will increase the costs of your interest-related holding and the overall budget.

Risk Mitigation Technique 6

What steps can new investors take to ensure they don't be unable to pay?

Like basic personal finances homeowners must create a reserve within their budgets. It doesn't matter if you call it a contingency line item , or a reserve, investors have to reserve a portion of their total liquid assets (either the cash option or an obtainable line credit) to cover unexpected events.

With this buffer in place investors can feel secure in knowing that they've lowered the risk to liquidity inherent in flipping houses.

FINAL THOUGHTS

In any investment you are able to reduce risk, but never completely eliminate risk.

In addition, as we've already explained, although wholesaling could lower the risk for investors but it also restricts the profits potential of a particular deal.

If investors are considering the risks mentioned above and decide to pursue a house flipping strategy, reducing risk along with the strategies mentioned above - mostly relies on following tried and tested strategies.

It is believed that the Do Hard Money team has personally completed, funded or guided new buyers through plenty of fix-and-flip transactions as well as proven methods. Therefore check out the entire collection of excellent information for real property investors.

Investors might not be able to completely eliminate risk from real estate, however by learning from the mistakes made from others, you will be sure to avoid the mistakes of others.

Whatever route you choose to take as an investor in real estate finance is the most important factor. Without access to dependable funding that is reliable, the best deals are only a wishful thought. Therefore among the most crucial relationships you can make for yourself as an investment professional is one with an honest, reliable lender.