Risk is a fundamental characteristic of investing and it is precisely risk that rewards investors. But not all risks are created equally. Knowing these two types of risks are useful to both operators and passive investors and can help limit unnecessary trouble or difficulty down the road.
1️⃣ Controllable Risks
These types of risks are manageable with competent operators and solid teams. Using real estate investing as an example, risks that can be controlled are those that have to do with the property. Below are a few examples:
- Vacancy
- Rent delinquency
- Expenses
- Property upkeep
- Curb appeal
- Marketing and awareness
Any good operator and team can control and mitigate risks associated with any of the above and more. It is these types of risks that bring rewards for owners, because they are problems that allow for improvements and efficiencies which lead to value creation.
2️⃣ Uncontrollable Risks
Unfortunately, in real estate investing, there are some risks that cannot be controlled. These are the risks to especially look out for before the decision is made to acquire the asset. The primary risks that cannot be controlled have to do with location or overall market. Whereas we investors can control operational risks that have to do with the property itself, they cannot control risks associated with buying in a bad location or in a bad market.
Let’s think about it.
- Location: Even the most highly-skilled operator and property manager with experience in turning around properties by improving living conditions, rent collections, loss-to-lease as well as physical and economic vacancy cannot mitigate the effects of buying in an undesirable or bad location. If an investor buys in a high-crime area, there are limitations to what can be done to improve crime or safety on the property.
- Market: In a similar way, there are limitations to what can be done to mitigate the impact of buying in an undesirable market altogether. If the population is decreasing in a city and jobs are declining, there will be limitations to the ability to manage rent collections, occupancy and net operating income growth at a property in that declining area.
Know the difference
While this seems fairly straightforward, taking a step back and considering these fundamentals can save any deal sponsor and passive investor from a headache in the future. Sticking to your fundamentals (growing markets, population growth, B and A areas, for example) helps mitigate the uncontrollable risks so that your operating team can focus on creating value with the property itself.
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– How To Use Your 401k To Invest In Real Estate
