Real Estate Investing: Weighing The Risks & Rewards

Woman holding a lot of money

Every investor is looking for their next home run deal. Often times, this means finding gem properties that nobody else wants. This could mean foreclosure properties that need extensive work, or auctions where you are buying sight unseen. What is common among these properties is that they are risky in nature. Once you take ownership there is no telling what you may find. The upside can be big but there is also potential to lose money. Before you get involved in any deal you need to know exactly what you are getting in to. The reward has to justify the risk.

Instead of thinking about dollar signs and the potential of the property think about the worst case scenario. There is nothing worse than losing money on a deal. While making money is obviously the goal you need to always consider the downside. This means looking at realistic comparable sales and listings. It means using a budget that is in line with reality instead of how you hope it will go. If you prepare for the worst you will be ready for the inevitable obstacles that come your way. There seem to always be unexpected items on every property. What you want to do and what you can do are often two different things. Always consider everything that realistically can go wrong with a property before making an offer.

In a perfect world you will have more reserves than you need. Most risky properties need more cash than you anticipate. Without these reserves you will be left with a property that you end up doing halfway. This will cause you to make less profit than you originally thought. If you knew this would be the case when you made an offer you probably wouldn’t have moved forward. Once you commit to a property you need to do it wholeheartedly. This means having the funds to make the proper improvements. If you don’t have the cash to do it right try to find a partner that does. To get the full benefit of fully revamping a property you need cash to make it happen.

The goal of most rehab investors is to get in and out of a property as quickly as possible. While this is certainly the case with risky properties you need to know your timeline. It doesn’t make sense to get into a property if you are not willing to wait for the maximum return. This may mean having to rent for a year to clear inventory in a neighborhood. It could also mean taking a few extra weeks or even months to make sure any work is done properly. Time is money with every rehab but you also need to think about the big picture. By putting anything less than a quality property back on the market you won’t get the return you desire. Most buyers aren’t aware of the condition of the property when you took ownership. You may have put in a massive amount of time and effort but buyers don’t really care. All they will look at is the finished product and if it isn’t top quality they will move on to a property that is. Hurrying up to finish a property is great but never at the expense of quality.

Properties with greater risk usually require greater time, assets and resources. Because of this it is important to surround yourself with the right team. If you have a cash partner you need to set up realistic timeframes and goals. It is also critical to have a solid contractor help in the process. Your contractor is directly responsible for handling the budget you give them and making sure the work is where it needs to be. The minute that you exceed your initial budget you bottom line decreases. You also don’t want to have to look over their shoulder with everything they do. This may be an important project for you but you can’t put all your eggs in one basket. You need to still be able to find new deals and run your business. A good team around you will help you do this.

What is your realistic reward on the property? Different investors are willing to get smaller returns based on time, ease of transaction and contacts made. Just like you need to know the downside on a property you also need to know the upside. Never rely on someone else to do your work for you. Just because your realtor or a fellow investor gives you a number doesn’t mean it will happen. Do your own due diligence and look at market trends and data. At the end of your work you need to be completely comfortable with your reward. After all this is the reason you are in real estate. Be aware of the risks but also know the rewards as well.

In theory the bigger the risk the bigger the reward. Risk can be that the property will need more work or take longer than you originally anticipate. There is also no telling what your property will sell for after you are done. Past sales are an indicator of the market but never a guarantee. The bottom line is that as long as you know exactly what you are getting into and are comfortable with the possible outcomes you should be able to accept whatever happens. Before doing anything in real estate you need to know the risk and the reward.