Real estate holds indisputable potential for profit. However, there’s also an inherent risk to any form of real estate investment. Real estate risk management involves carefully weighing the various risk factors in order to maximize potential for profit and minimize potential loss. This can be most easily done by first categorizing your options into specific strategies.
There’s no single form of risk management within the real estate market. After all, competition is built into the system as a whole. If everyone were working through the same checklist, then it’d be easy to predict a competitor’s choices and beat him to it. Rather, strategies are typically set within loosely defined banners that can be further organized as needed. Variations of the NIST’s policies, in particular, are often used in this way within the industry.
Table of Contents
Strategies
According to the National Institute of Standards and Technology (NIST), strategies for risk management can be loosely fit into one of these four categories.
Risk Avoidance
Risk avoidance involves judging the potential risk of an individual real estate option and then deciding against it. This generally involves considering specific metrics, personally aligned to your own definition of risk, and stacking them to create a larger scale value.
Geographic avoidance is one of the classic examples of risk avoidance. Consider a property located in an area prone to tornadoes or even wildfires. The land might seem perfect and competitively priced at first glance. It can seem like you’ve found a hidden gem ready for acquisition. However, it’s wise to step back and consider why what seems like prime real estate would sell so cheaply.
If you researched the history of this theoretical area, you’d often see stories of natural disasters and the economic issues that go hand in hand with them. This concept also extends to social issues inherent to the area and properties that exist within markets that you lack experience with.
Risk Mitigation
This is the process of recognizing risk factors but taking steps to reduce their impact. With the prior example, you wouldn’t be able to do much about the environmental impact of a tornado. But if the risk avoidance centered around mold, then you could introduce inspections, treatment procedures, and even education designed to treat the problem.
Or consider a property that is judged risky due to operating far under tenant capacity. You might track the reason for low tenant capacity down to a lack of reliability in the property’s utilities. Problems with the utilities might be mitigated through building upgrades, which would in turn see increased interest from renters.
Diversifying your portfolio can also help mitigate risk. Consider investing in multiple properties with varying levels of risk or entering into a real estate partnership to reduce your financial liability.
Risk Transfer
Risk transfer involves transferring a property’s risk to a third party. The concept of risk transfer might seem unethical at first glance. However, the process of risk transfer fits into standard insurance policies. Of course, there are some tradeoffs when using risk transfer. The cost of insurance scales with the risk shouldered by the insurance company. However, you can carefully strategize around the various forms of insurance to help balance the scales.
Risk Acceptance
The final strategic category centers around deciding whether the potential risk factors have been properly weighed and balanced. This might not seem like a strategic move in and of itself, but in many ways, it’s the most important of all of these strategies. This is the point where you evaluate the real estate investment again with the newly modified odds in place. In this step, you consider the endpoint where all mitigation options are in place and how this would change the nature of the property itself. And, with all that settled, you decide whether the investment is worth the risk.
