Investors have a hard life. Rising insurance rates, legal liability, security concerns and increasing interest rates may not be actually conspiring to give them early heart attacks, but it can seem that way. Managing risk is in large part about how to lower uncertainty by dealing appropriately with those and other stress factors.
Start by exercising common sense and gathering as much information about the local market and the general economy in addition to the specifics on an interesting property. Study the numbers on rates of new home construction and the ratio of new to existing property sales. Narrow down to your local market(s) by looking online at existing comparables, but also talk with other local property owners about their concerns and plans.
When building new structures, manage risk by reviewing trade area demand — by demographic and daytime population for commercial structures, for example. Look also at site characteristics and examine local competition and contrast with regional differences. Take some time to find out about upcoming environmental regulations.
Be sure to set aside the needed amount for insurance, and err on the side of too much insurance rather than too little, if minimizing risk is an important goal.
Go into a deal with the maximum available capital by not spreading your resources too thin. Keep borrowing low and avoid ARMs (Adjustable Rate Mortgages) unless they’re longer than three years and you expect to sell well within that period. ARMs are inherently higher risk, and the ‘interest only’ type even more so. Rates tend to rise more quickly than they fall, over the long term.
If you have an ARM and rising monthly payments occur, due to interest rate increases, while the market price is dropping (as may soon be the case), consider selling. Even stocks have to be sold sometimes during a period of declining prices. Capital preservation is important for long term investing, and part of that involves keeping liquid during a ‘market correction’.
Some lenders allow borrowing more than 100% of the value of the property. Unless you can use the extra cash in a way that more than compensates for interest and other charges, that’s burdensome debt.
Take the time to seek out trustworthy and competent people — don’t settle for an uncooperative or arrogant Title company or an unreliable contractor because you’re busy. Think in terms of long term relationships. Otherwise, the long term will involve counting financial losses.
Risk can be spread by forming partnerships and, in come cases, by incorporation. Incorporation can allow you to separate personal from business assets, protecting you in case of severe decline. But there are limits — you don’t automatically get to walk away from debts by being incorporated. Partnerships though, if you can find reliable and compatible individuals with whom you’ll feel comfortable over the long haul, can strengthen your position.
Partners can help fill in gaps in your knowledge and experience, provide additional capital and someone to bounce ideas off of. But choose carefully. Differences of outlook can lead to stagnation when it comes time to take action. Remember, risk can never be reduced to zero.
Filed under Real Estate by on Dec 5th, 2008. Comment. 
First, some statistics. In the summer of 2005, the median price of a home rose nearly 15 percent from the year earlier, in some markets, much more. Lenders lowered required credits scores (FICOs), waived some documentation requirements, and raised the debt allowance to 45 percent of income. Some reports estimate that interest-only loans now make up 30 percent of all new mortgages. Nearly 35 percent of mortgages are now ARMs (Adjustable Rate Mortgages). Since June 2004, the U.S. Federal reserve has raised rates 11 times.
What all these numbers suggest is that real estate investments have seen phenomenal growth in recent years. But with rapid increase in prices always comes increased risk. The higher the value of an asset the greater the potential for loss. Fortunately, for every form of risk there’s now an accompanying type of insurance.
The most common forms that benefit the investor/owner are title insurance and liability insurance.
Title insurance is designed to cover any lapses that may have occurred during the title search, prior to closing. Title companies search databases of public record and other sources to ensure a property is legally free of encumbrances. I.e. title can be legally passed to the new owner.
But like any human research effort, time and resources are limited and errors can be made. Public records databases are imperfect and title companies, though rarely, can fail to uncover a past tax lien or miss the fact that the adjoining strip of land is actually part of the adjacent property.
Title insurance covers any potential economic loss that results of these errors, up to a specified limit.
Liability insurance is intended to cover injuries to another party occurring on or as a result of using the property. When a salesperson or visitor steps onto the property and falls from a front deck because of a loose board, or any of a thousand other causes, liability insurance pays for medical bills, settlement of suits, etc. Again, up to a contractually specified limit and for a normal range of events. What constitutes ‘normal’ is what lawsuits are all about.
More extensive, and more expensive, forms of insurance are available for the dizzying variety of risks possible. Hazard insurance covers earthquake, tornado and hurricane, flooding, fire (natural), and dozens of other disasters outside human control. Damage from wind or freezing can be covered, too.
Alongside ‘natural disaster’ insurance are policies to cover man-made events: chemical spills, human caused fires, electrical failures, and on and on, endlessly. Insurance can cover damage or loss from vandalism or theft, faulty plumbing or wiring, even large appliance failure.
For landlords there are additional policies to cover the risk of rent interruption from non-payment, damage making the property unhabitable, or abandonment.
Naturally, all these insurance policies come with a price, which varies according to amount covered and deductible desired. They’re also invariably accompanied by limitations that restrict payment — for zoning variances, environmental conditions, negligence, and a host of other circumstances. As with any investment, shop around — you’re not required to use any particular company the agent or title company recommends.
You are required, though, to get one form of insurance that doesn’t benefit you at all. If you acquire a loan to finance a property purchase, the lender will require mortgage insurance — which pays the lender, not you, in the case of default or disaster.
Filed under Real Estate by on Dec 2nd, 2008. Comment.
