Winning in Real Estate with Risk Mitigation
Since COVID-19 has necessitated social distancing and closing non-essential businesses, it has slowed the economy and caused concern amongst Wall Street and the capital markets. Investment banks like Goldman Sachs have predicted the U.S. GDP will shrink by 34 percent in the second quarter.
Now, major housing lenders have updated lending terms that reflect concern and risk mitigation. In April 2020, for instance, JPMorgan Chase raised mortgage borrowing standards. To qualify for a home loan, borrowers now need a credit score of at least 700 and a down payment of 20 percent or more.
As you can see, the real estate landscape has changed, and the future is unpredictable. But this disruption doesn’t necessarily equate to destruction. You’re still in control. And you can still win. But you must mitigate risk going forward in this new norm.
More than ever, now is the time for focused action. Given the uncertainty and panic that COVID-19 has created, it is imperative real estate investors are more conservative in their investment strategies and analysis. By focusing on what you can control, such as market research and finding the right lender, you can set yourself up for success over the short- and long-term.
Let’s go over a playbook for mitigating risk in these turbulent times.
Build a Conservative Capital Plan
Each time I work with real estate entrepreneurs, I stress the need to plan for every phase of the investment. That’s because undercapitalization is one of the main reasons why deals fail.
First, I advise investors to use conservative numbers when analyzing deals and developing their respective investment strategies, especially during times of uncertainty. You shouldn’t use the best sales comp, nor should you expect appreciation. It’s more likely you will experience a decrease in property values – both in its current state, and after any proposed renovations.
Remember: We went into 2020 quite optimistic, with CoreLogic predicting a rise in home prices of 3.7 percent over the year.
However, by early April, Bloomberg predicted a housing slump as a result of rising unemployment. And Veros Real Estate Solutions projected an appreciation rate of 1.9 percent through the first quarter of 2021—roughly 50 percent lower than original projections.
To put it bluntly, don’t rely on the market to improve. We certainly hope it will rebound and that the impacts on housing values will be minimal, but this is not the time to look at deals with these types of assumptions.
With the changes in the lending market, you must prepare by having additional capital. Because cash is king, it’s the best way to hedge against fluctuations that may impact an investment. Because home values and leverage are expected to be lower, you need to bring more to the table and have more in reserve in order to see a deal through from start to finish.
Additionally, pay attention to the financial metrics. You have to avoid common mistakes, such as underestimating the renovation budget and assuming a higher-end home will fit into a lower-end neighborhood.
Other common mistakes include:
- Not having enough cash reserves (prioritize this!)
- Spending all your money on the acquisition
- Mis-analyzing your as-is and after repair values (this stems from trusting real estate brokers and wholesalers)
- Only obtaining one bid for renovations
- Expecting quick dispositions and few days-on-market
- Underestimating the money needed to buy, re-position, and exit
Furthermore, focus on value creation with your investment properties. Don’t use best-case scenario estimates and do not expect to get more than a 2x return on your investment in renovations.
Before entering any real estate deal, know exactly what you’ll need to hold in your reserve in addition to your hard project costs. Accurately calculate the capital you need to buy, renovate, and hold the property. It’s wise to pad these numbers to ensure ample capital is available to complete your business plan.
Finally, when forecasting projected costs and ROI, use conservative numbers to mitigate risk! For the deal to succeed, you have to be well-funded at every phase. Real Estate investing deals are unpredictable, so if you’re not prepared from a capital perspective, your deals could easily go awry.
Do Your Market Research
Peter Lynch, the famous Fidelity mutual fund manager, says to “buy what you know” and know why you own it.
In today’s uncertain environment, you must understand trends, especially supply and demand. And you must follow the data to the opportunities.
For large strategic decisions, and for decisions about what markets to invest in, you must analyze macro data at the national and regional level, such as:
- Market growth
- Trends in investment segments
- Homeownership versus rentership
- Housing affordability and employment and income levels
For deal-level decisions, analyze micro data, such as the local market’s:
- Rent versus homeownership rates
- Available inventory
- Home price trends
- Number of cash or investor transactions, number of foreclosure listings, and home flipping activity
Now, you may be asking yourself: Where can I obtain solid real estate market data?
My recommendation is to read reports from CoreLogic, House Canary, Collateral Analytics, ATTOM Data Solutions, and other reputable real estate data firms. Their research will give you accurate valuations, investment trends, and detail on what strategies will be most successful (fix-and-flip, buy-and-hold, new construction, etc).
Partner with a Reliable Lender
Things have changed in the lending world. Similar to real estate investors, lenders too are mitigating risk by being conservative in their terms and guidelines. Due to the shift in the real estate market, you can expect lower leverage, a little higher cost of capital, stronger experience requirements, and a need for more cash reserves.
All this means you must understand the lender’s loan structures and your available leverage options. Since identifying deals has become more difficult, you must know these granular details about your lender in order to develop a good relationship with them. That relationship will enable you to better handle capital risks and navigate through the investment.
With any deal you do, I recommend always having a backup lender. Get pre-qualified with the following two lenders:
- The lender that can offer you the best terms.
- The lender you know can execute and help you close the deal.
This strategy ensures you can close the deal quickly and/or get great rates and terms. For instance, if time is on your side, traditional banks may be your best option. But note that they can take four weeks or more to close the loan, which means you could miss out on a potentially lucrative deal. If you need to close a deal quickly, consider a loan from a private real estate lender.
The Path to Victory in Turbulent Times
Opportunities still abound for real estate investors. More than ever, locating those deals depends on your discipline, execution and willingness to pass on certain deals if they don’t meet your need to be conservative.
With strong in-house management, resourcefulness, and effective risk mitigation, you’ll not only endure this turbulence, but you’ll also prevail. And when the good times start rolling again, you’ll be in as good of a position as anybody.