RULE #1 - Don’t Lose Money: Let’s Talk About Evaluating and Minimizing Risk…

“Successful investment is about managing risk, not avoiding it.” - Benjamin Graham

Recently, I've found myself talking about risk with a lot of people.

Most of it is because of our previous articles -- Navigating the Market Cycles, Due Diligence, and Underwriting Bad Debt, just to name a few.  People believe that investing in real estate is much riskier than investing in the stock market.

These discussions triggered an immediate reflection on how we evaluate and manage risk in our property investments.

There's a lot you can do to reduce the chance, it turns out.

First Things First: Put the Property in an LLC (see our post about syndications)

Having rental properties exposes us to the risk of being sued, just like any other company.

The trick is to keep our property investments apart from one another and from our personal finances (i.e. the CF Capital team, our co-sponsors, our property managers, and most importantly, our investors).  You accomplish this by forming a separate LLC for each property (or in a series LLC).  Then you treat each LLC as if it were its own business. EIN numbers are assigned to each of you separately. 

You'll get your own bank accounts.

Is it a decent amount of effort on our end? Yes, but it is more than necessary to protect ourselves and our investors legally.

More Legal Protection: Get the Proper Insurance (get in touch with us about our e-book covering more of this topic)

While the LLC provides some security, you should still have adequate insurance coverage.

Not only should you have adequate coverage for the property, but you should also be covered by umbrella insurance to cover something that the property insurance doesn't cover.

Downside Protection: Buy the Properties that People Live in During a Recession (see our post on Navigating the Market Cycle)

We don't typically seek to purchase "A" assets as a part of our core acquisition criteria.

What does it mean to have a class A property?  Picture a glass-enclosed modern apartment building with a dog park or pool, or a charming Tudor house with a backyard in a neighborhood.  These are the apartments that rent for $2,000 or more a month.  

These aren't our rentals.

We purchase properties in the “B” and “C” range.  What is the reason for this?

Consider what will happen if an individual who is living beyond their means in a "A" property loses their job during the next economic downturn.

What happens to that person?  They'll be relocating to our B or C rated property.

Similarly, if the economy improves and everyone has a job, people in the D and C classes move up to the B class.

The sweet spot for rentals, we assume, is somewhere in the center.  You'll be able to profit from an upswing while still weathering a storm during a downturn.

Protection We Can Manage: Cover Our Bases in Our Due Diligence, Underwriting, and Business Plan (see our posts on Due Diligence, Underwriting Bad Debt, Cap Rates, Rent Growth, and Vacancy, as well as our Business Plan)

When it comes to research, underwriting, and crafting our business plan, it is all about the grunt work -- we are not afraid of the tremendous amount of work it takes to be thorough and thoughtful.  

We wouldn’t be able to sleep at night knowing our investors’ (and our own) capital is at risk because we took a shortcut.

Formally, it is our fiduciary duty to be excellent stewards of capital.  How we see it, the only way to do that is for us to do everything we can to protect our investors’ money with our “blood, sweat, and tears” (particularly, deep research, thorough and conservative underwriting, as well as thoughtful creation of our business plan).

Actions, Not Just Words: Execute in Asset Management (see our post on Asset Management)

Building off the previous section above, let’s make things simple here: if you put your investors, the community, and the residents' interests above all else, you maximize your chances of success.

Having PURPOSE for what we are doing makes things so much better; probably one of the main reasons it is one of our core values.  Not only is it a driver, but this (perhaps counterintuitive) approach actually puts us in a better position to “win.”

The funny thing about this world is that “the more you give, the more you receive.”  And this is speaking in terms of receiving both tangible and intangible benefits.

That is why we choose to do everything humanly possible to make sure every party is pleased with the outcome.  

In the area of asset management, WE EXECUTE.

Asset Repositioning: The Little Things Count (see our previous post)

Vacancies tend to rise during a downturn, and housing options expand dramatically.

So, how can you make sure your apartment complex isn't one of those that sits empty during a downturn?  Aim to make it the “nicest property on the block.”

The benefit of making your property the nicest on the block is that you can charge premium rentals during good economic times.

I'm not suggesting you go overboard with stainless steel appliances and granite countertops. However, a little maintenance and slightly higher finishes than the group average are a perfect way to reduce danger in the long run.  

CF Capital’s value-add strategy focuses on the “numbers” in our models as well as our cost-benefit analysis to determine the appropriate measures to take in order to reposition our asset, the property.

In essence, when you have a desirable property that is in high demand, your risk goes down.

The Bottom Line: Cash Flow, Cash Flow, Cash Flow (again, read more about this in our e-book)

Be sure to “buy it right” when purchasing investment properties.

What exactly does this imply? It means that you have pre-defined requirements for buying a property and only buy properties that meet those criteria.  Never, ever compromise.

The cash flow generated by a property is one of the most important criteria.

We like to use a cash-on-cash return threshold of 7%, as stated in previous articles.  We normally won't acquire an asset unless we can hit this minimum average threshold over the hold period.  Of course, there are exceptions to this law if a property has a significant amount of untapped secret value, for example.

You will reduce the risk by maintaining a certain minimum amount of cash flow.  And if rents fall marginally during the next downturn, you'll be able to bear the loss.

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