Life is full of surprises, and sometimes they are not always pleasant. This is as true of business as it is of personal matters. Understanding and preventing these unpleasant surprises is the basis for risk management. When you own real estate, it is necessary to act preemptively to mitigate risk.
Real estate ownership comes with a lot of risks—overestimation of a property’s potential to generate income, liability or other legal issues involving tenants, damage to the property, natural disasters, disagreements among partners, and poor management can have a catastrophic impact on investment returns. Because of the diverse nature of these risks, managing them is a complex task, requiring a number of simultaneous approaches.
It is important for an investor to understand the various types of risk when making any investment. Proper vetting (due diligence) can prevent a lot of problems. This is particularly true with regard to projected profitability, which is likely to be presented as a major selling point, and legal liabilities, such as liens, which might go unmentioned by the seller.
In the case of multifamily housing, the greatest risk is associated with property management. Nearly every interaction a property manager has—and there are always many—entails a certain amount of risk. While the level of risk may be low for each interaction, which might include maintaining safety standards, hiring contractors to make repairs, interviewing future tenants, collecting rent, and many other activities, the cumulative risk level may be significant.
There are three basic strategies for managing risk, and an effective risk management plan will combine all three.
The first of these is to avoid it. This is generally achieved through a combination of due diligence and timely remediation—building fences and keeping them mended, so to speak. But, while this may seem straightforward, that is to some degree illusory. Some risks, such as structural issues in a building, are only identifiable by a specialist and this makes them harder to react to. Some risks cannot be avoided. No one can prevent an earthquake or hurricane. Sooner or later, some disagreement with a tenant is inevitable as well. Similarly, we will assume that you only come into open conflict with a partner if it is unavoidable.
It is important to acknowledge that not all risk can or should be avoided. A balance must be reached between potential risk and potential profit. Risks that are deemed acceptable nonetheless must be limited. An example of this might be requiring that children be supervised in playgrounds. Adding a playground to a property might add value to the community, but an effort should be made to avoid liability for any injuries that occur there. For instance, limiting access to the property by outsiders could be an effective security measure.
The third strategy is to transfer or redistribute risk. This often means taking out insurance. There are other steps that can be taken, however. One is to turn the management of a property and some of the responsibility that comes with it over to a professional management company. Professional management is likely to address risk in the best manner possible. As we have noted, risk is a complex package, and a specialized team is most likely to be able to muster the diverse skills required to handle it effectively.
Another way to limit exposure to risk is through the form of ownership. Using a 1031 exchange, you may not only reposition your equity in a property that will outperform your previous property, you can dilute your risk by holding a share in a larger property than the one you owned before.
The optimal choice is to combine the functions of identifying and managing your real estate investments. CWS Capital Partners has a great deal of experience in the multifamily housing market, with strategic teams dedicated to risk management and due diligence. We can help you find a solution with a level of risk that is acceptable to you. Contact us today to find out more.
The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.
Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.