Moving Up the 'Risk Curve' | Think Realty | A Real Estate of Mind
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Moving Up the ‘Risk Curve’

A strong lender relationship is as important as a line of credit for an investor expanding his or her portfolio.

Real estate investors often start small—a single-family home investment or a small apartment, office or retail building—before leveraging that early experience into multiple properties and a larger portfolio. The move up from new property investor to a seasoned property investor level can require training in the “school of hard knocks.” But experience demonstrates there are tried-and-true tips and tactics for success.

Build From Initial Success, Make a Plan

The single most consistent trait of successful property investors we’ve seen over the years is that their early successes were the foundation of next-step and ongoing investments. Nurture and develop a property’s ability to produce income. It’s a simple truth that challenges every investor, because lenders rely on a borrower’s history and ability to repay, as much as on the property itself. A conservative and market-proven approach is what most experts recommend—building confidence and experience as one moves up the risk curve.

New investors are well advised to do extensive research up front and even work with a partner or a highly experienced broker or consultant to minimize potential missteps.

Real estate markets and economic fluctuation are always part of the risk equation, but solid advice and experience can help avoid a lot of pain. By the same token, it’s important for a property investor to develop a sound strategy that works and stick to it, with reasonable flexibility. Build a real estate portfolio upon the knowledge that one has acquired rather than constantly learning new things.

Solidify One Great Lender Relationship, Then Several

Early-stage investors utilize a variety of sources for investment capital—saved funds or inheritance, stock market proceeds, home equity and other credit—but in practically every scenario, a crucial part of the business plan is a lending partner, whether the property investor needs to borrow or not. An existing banking or lending relationship is, of course, the best start. Even if the source is not strong in real estate, it can be a part of the mix in establishing new credit with other sources. Investors with a lending partner who knows them, has experience with their credit history and has an interest in developing a relationship will be in the best position to execute a transaction or secure additional help when needed. Beyond that initial relationship, it’s important to develop secondary sources, too, such as when a specialty investment or need arises.

Beware the Irrational Exuberance Syndrome

Early successes are key, but can also create overconfidence. Whether it’s an initial purchase or a subsequent investment, each real estate investment must stand on its own fundamentals, local market conditions and the overall market demand and economics.

Occasionally, we see investors who establish a business plan that reaps success, then get “trapped” in that mind-set and are surprised by factors that hadn’t arisen before or may even be out of their control. Follow-on deals are hardly ever the same, and it’s not uncommon that a series of successes is undone by a single misstep or an economic downturn, which many pundits are predicting in coming months or years.

For example, one misstep is when an investor begins to look at his or her portfolio as a whole or in aggregate rather than individually performing properties, thinking that “temporary” challenges are made up via strong cash flow from other properties. Sometimes exiting a worrying or time-consuming deal is best, as it enables the property investor to focus on other, more successful endeavors.

Hit a Snag? Everyone Does. Here’s a Road Map

What’s an investor to do if headwinds or major surprises arise? Backup plans and contingencies are critical to long-term success, and a strong lender relationship is as important as a line of credit. Among the tips and tactics are:

• Create an investment plan, every year. It may not be crucial to a first-time investor, but documenting an investment strategy is extremely helpful for working with lenders and other co-investors, enabling them to see your approach, the highlights of success and your contingencies. Update it every year to reflect new market conditions, perceived opportunities and objectives.

• Even all-cash investors should borrow to establish a track record. It’s the same as an individual who’s establishing credit for the first time: Investors should create a lending relationship when they don’t need it, even in modest amounts, so that they have a relationship in place if borrowing becomes necessary.

• Keep the business fundamentals of property investing in mind for each deal.

• Do not overleverage the properties. While this can be easy to do during the good times, keep in mind that down times can occur, vacancies can increase and rental rates can go down.

• Define a property management plan (self or contracted) and remember that different property types have different turnover and lease-up timelines. Further to that, some properties require tenant improvements to lease up, some do not. All factor into the “total cost of ownership” equation. In more than 35 years of assisting real estate investors from simple transactions to multiple and complex deals, Redwood Mortgage has seen hundreds of property investors grow in their skill and success, across economic cycles. While no business plan is bulletproof, investors who practice solid property investment fundamentals, maintain appropriately conservative and flexible approaches, and seek out strong lender relationships are well positioned to thrive in good times and survive the difficult ones.

 

About the Author

Steve Belleville, MBA, is director of sales and marketing for Redwood Mortgage in San Mateo, California. Founded in 1978, Redwood Mortgage is an established financial organization with 35 years of experience in arranging and funding mortgage loans in California. Redwood Mortgage and its affiliates have arranged around $2 billion in loans and currently manage a loan portfolio of over $275 million. Contact him at 650-365-5341 or steve@redwoodmortgage.com.