Many people are asking us how we’re confident buying in today’s real estate market. So this month we’ll discuss how we manage and reduce the risks of real estate investing.
How We Manage And Reduce Risk
There are always risks in investing, whether that is in stocks, real estate, or commodities. Our goal is to provide the highest risk-adjusted returns to our investors. While we err on the side of caution and usually shoot for 15% returns, we’ve been able to achieve annual returns of 23%-50% on our projects.
There are many ways that we reduce risks in our projects. This month, we’ll touch on three of the ways we do that. If you’d like to learn more, you can always reach out to us.
1) In-House Construction Company
Our business model is based on renovating units with high-quality finishes in a timely manner. Sometimes we renovate 20 units at once. Originally, we had hired contractors through the property management company to complete the renovations. This led to longer timelines and higher costs. Instead of renovations taking 2-3 weeks, it took 6-10 weeks. The bigger impact of this was the opportunity cost of longer vacancies.
In 2019, the interior renovations were brought in-house. The job of our employees is to renovate our properties only. They are on the payroll as full-time employees and are offered health benefits. This allows us to control the costs and timeline of the interior renovations, which helps us quickly achieve the business plan.
2) We assume the market gets worse
One of the conservative assumptions in our underwriting is that we anticipate the market to get worse when we sell. This is called cap rate expansion.
The lower the cap rate, the higher multiplier the property will sell for. We assume the cap rate gets higher each year, which lowers the sale price of our properties.
If the cap rate stays the same or increases slower than what we anticipate, then that boosts our sales price and returns for our investors.
3) Adjustable-rate loan
The interest rates are at all-time lows, yet we use an adjustable-rate loan. We often get asked why we don’t get a fixed-rate loan.
While a fixed-rate loan sounds great, it often comes with a hefty 7-figure prepayment penalty. We are opportunistic investors and want to have the option to sell when we receive strong offers.
An adjustable-rate loan still has prepayment penalties but at a significant fraction of the cost. This allows us to remain flexible in any market cycle. If we’re halfway through the renovations and we receive a very strong offer to sell, we’d like the option to make that decision.
The risk of an adjustable-rate loan is rising interest rates. We purchase an interest rate cap from a third-party insurance company. If the interest rate rises above that cap, the insurance company will pay the difference. This helps us keep our costs fixed while having the freedom to sell whenever it makes sense.
