Risk, The Final Part

It seems like people have this fear of going into real estate because they look at it like my casino example. Remember the one where you have a 99% chance to win $1,000 and 1% chance to lose $100,000? The problem is that they haven’t taken the time to evaluate the deal, and so instantly say it is a bad one. What they are doing is dropping the responsibility for working the numbers, looking at the place, negotiating, figuring out exit strategies, and making the deal work.

It is extremely unlikely that your $100,000 house purchase will collapse into a Superfund sink hole and you will lose it all. What is the probability of that? According to Wikipedia (https://en.wikipedia.org/wiki/List_of_Superfund_sites) there were 1,322 sites as of 2014. Contrast this with the millions of parcels of land and the probability is vanishingly small.

More likely is that the value of the property will go down for some reason, whether by damage, loss of property values, decreased rents, or something else. That is a loss, but not a total loss.

http://observationsandnotes.blogspot.com/2011/07/housing-prices-inflation-since-1900.html

Just look at the Inflation-Adjusted U.S. Home Prices graph. Two times in the last 120 or so years has the price dropped >15%. You can see that we had a bubble around 2005 and then we had the crash. At that time, you would have lost about 40%. That is a very big loss, don’t get me wrong, but that wasn’t a loss of everything. Many people were hurt really bad, but the loss wasn’t 100%. The people who lost most (by percentage) were those retail homeowners who lost their down payments and the principal they had paid down. They did lose 100% of what they put in, which was those down payments and principal. They weren’t investors, they were homeowners. You are different. You will evaluate the risk of that happening again (it very well could) and you will plan for it. Your $100,000 investment is something you would hate to lose but it is not something that by losing will sink you. It better not be, or you shouldn’t be investing that amount.

And that brings us back to risk tolerance. There might be a 1% chance of losing 40% of your $100,000 versus a 10% chance of getting your investment back plus $10,000. That has been our year over year property value increase in Sioux Falls in the last 5 or so years. I pretty much made up the other numbers, but you will need to get a feel for the risk and ask what is reasonably the worst that can happen that you can plan for? Probably not the superfund site. I would argue that in a residential area, you shouldn’t worry about that. And while it is a risk, it is a very small one and not worth your time.

IF you do worry about the Superfund problem, then you probably have a low-risk tolerance and should avoid investing right now. You can find people who feel the same way just by talking about investing. They are the ones who immediately dismiss investing by telling you about that bad tenant their cousin had who peed on the carpets or started a grease fire and they would never in a million years invest and you must be out of your mind to even suggest doing so. “Go back to your investment advisor” will be the next bit of advice from them.

I totally disagree with them, but if I didn’t I wouldn’t be writing.

And even if the real estate market drops 40% next year, that will be a huge opportunity for you to acquire more properties for cheap. You just need to tolerate the risk that the prices take a long time to come up again. And if you have taken time to plan your deal, you will have no problem.

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