Doing Your Investing Homework

Over the past few years I have been working more with real estate investors while continuing to serve licensed agents and offices with branding and marketing. Investors often shed a different light on marketing themselves and their properties, especially when it comes to seeking their "next" property investment.

Quite often, the properties with the most investment potential over the subsequent 10+ years are ones in which there is also an increased risk. Even the most reputable experts have no guarantees that the market will go as they expect or predict.

Recently an investor client told me, "The greater the risk, the greater the reward!" as one of his reasons for seriously considering purchasing an investment property. He and his group saw the potential for some serious rental income upon completion of major renovation which could take close to one year to complete to their liking.

However, this investor was surprised at my response to his comment, which was to ask him to show me the market trend numbers instead. When he replied that he "already looked" and concluded that "Other investors are not willing to take this risk", I gave him my standard example in response.

If you are in your first floor office and jump out of the window, chances are you only drop a couple of feet and would land safely and ready to continue on. However, jumping out of your fifth floor office is a bigger risk. Yet, the consequences of such a jump would be far worse than jumping out from ground level.

Consequently, the "reward" is far worse than the greater risk in the fifth floor scenario. Or is it?

As is usually the case in real estate, more information is needed. Suppose the fifth floor office fed into a rooftop garden. In that instance, jumping out would likely produce the same result as doing so from the first floor. 

The point of the discussion is that the need is there to more thoroughly compare the risk to the reward. 

Although my marketing client "saw" the reward and realized there is a risk, he was closer to a form of gambling than he was to making an important business decision.

One of the questions I asked him was about the amount of time this property had been on the market. To me it was clear that if this property had been available for months it would mean there would be more problems than needing a lot of renovation. Very few real estate opportunities go unexplored once they hit the market.

There were more questions, including researching of local rental comps over the past couple of years with an eye toward showing growth trends.

The whole idea was to get my marketing client to make this property he was so interested in become his "fifth floor" in considering his risk.

Next, I suggested that he ask the broker he works with to come up with other investment possibilities on the market which are available and fit his group's criteria. If his broker could find one or more opportunities which are as or more likely to become profitable in less than one year, it would be more financially feasible to go that route. 

He told me that he had already looked at other opportunities before targeting this "risky" one. That meant I had to put it a different way.

"Suppose you find something that could bring you $50,000 six months from now. This opportunity could bring you $90,000 a year from now. Which opportunity would really be your best investment?

The idea is that it is important to compare the risk to the reward with every possible real estate decision. 

What happened? My client is still looking for his next investment deal. His group wants something more rewarding.