You are currently viewing Flipping America 559, Risk Management

Flipping America 559, Risk Management

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Life is full of risks. We subconsciously deal with them all day every day. But when it comes to business, we often love the idea of the income but don’t always bring risk analysis into our consciousness. 

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Quote of the Day

If you haven’t taken the time to understand the risks, EVERY business is a risky business.

Expected Air Date: Wednesday 10/5/2022

Guest: None

Transcript

[0:00] Music.

[0:15] Show that teaches you how to make money in real estate wherever you are, whatever your situation, there is an opportunity for you and now, here’s that flipping America guy, Roger Blankenship. Thank you, Kathy Curtis. Hello, America.

Life.

We subconsciously deal with them all day every day but when it comes to business, we often love the idea of the income but we don’t always bring that subconscious risk analysis of mitigation into our conscious brain,

We have to do something about that and that’s what we’re gonna do today.

Coming up right now is a talk that I did recently for the Philippine America Rhea on risk management for real estate investors,

Let’s see the hands I don’t know if we can see the hands.

[1:10] Just say so and chat. I’m looking at chat right now.

I actually looked around a little bit for a picture of my motorcycle. I just slept about doing that about 45 minutes before we started today.

And it was great. I love motorcycling.

And you know, I know the risk of motorcycling. I knew them long time ago. I I rode an old motorcycle back and forth to graduate school,

Got rid of that bike in the interest of protecting myself because of the risks involved in having young children but once the children got to a certain age and i had enough money to buy good insurance including disability insurance,

And the the truth is my ex wife, my wife who is now my ex wife. At that time, she really no longer cared. So, she’s like, yeah, get a motorcycle. Who cares?

So, I got another motorcycle and I fixed it up and rode it around, rode it. I wrote it with a group friends all the way up to Maine and we took camping gear at a tent on the back of a motorcycle,

Rolled up in a bag and we can’t.

Next to the Atlantic Ocean in Maine and Road through a bunch of states on the way we’re going for a couple of weeks and some interesting things happen.

[2:31] While we’re on the trip but I gained a lot of confidence about you know and renewed some of my skills in writing. I came back felt,

You know, we retired from long rides on the motorcycle. I don’t know if you know this but if you put 500 mi on a motorcycle in a day.

It’s grueling. It’s it’s rough on your body. And so we’ve all like conquering heroes when we got back home.

Couple weeks later I’m riding around town in McDonald Georgia where I live it’s a suburb south of Atlanta and.

[3:01] I I was coming up to an intersection just kinda the lighter just turned and I was just kinda cruising through about 2030 mi an hour and a woman.

She swears she never saw me she turn left right in front of me.

[3:15] And it was T bone time and you know thing about motorcycles is if you get in a tangle with anything else on the road you’re gonna lose because of tonage.

So I grabbed a handful of front brake and then attempted to stir out of the way and everybody that owns a motorcycle knows exactly what will happen if you do that I didn’t.

But what happens if you grab the front brake and steer you’re going down.

It it’s just there’s a lot of physics involved. So, I hit the road. My motorcycle hit the road. The lady scooted out of the way so I could slide on past,

On my side, on my arm, on my helmet right here and my leg and everything and we got through the intersection. That, I probably slid 50 or 80 feet.

On the asphalt wearing nothing but a T shirt and some jeans.

Full of asphalt bits and rocks and broken rib I think Naomi’s on the car I don’t know Naomi do you remember that happening now he’s known me a long time well she was here a little while ago.

After i got myself and my bike fixed.

[4:43] The first thing I did was I went and took a skills class. You see, here’s the lesson from that. I knew that there were wrists involved in a motorcycle and owning a motorcycle and riding motorcycle but I’d really done nothing to mitigate those risks,

So, from that day on, I, when I got my motorcycle back, I put one of those annoying flashy headlights on it. It’s just, it just flashes like that back and forth.

The entire time and man if one of those in your review mirror it’s really annoying but

I didn’t care because no one ever pulled out in front of me again and then i got a full helmet

Because I remember exactly what it’s like to be skitting long at 30 mi an hour on the pavement with your face that far from the asphalt in this thin little bit of helmet right here I just wore one of those little hats and it’s wearing out grinding away,

I tried to lift my head up and I couldn’t,

During the few seconds that it lasted so full face helmet then I got AA Kevlar line motorcycle jacket that I wore no matter how hot it was from then on,

The point of all of this is that in life.

[5:55] Motorcycle riding is one of them but just about anything you do in in a given day involve some level of risk.

Those risks and get them either avoid them or get them to and acceptable level. There are four things that you can do with risk and we do them,

When we come into a new situation like getting a motorcycle. Well, some of us don’t. Some of you are a little bit more careful and sensible than i am. Alright. So, here are the four responses that you could have to risk. Number one is to avoid it,

That’s why some people never fly on planes which is crazy to me because they’ll get in the car but.

[6:44] The second thing that we do is share risk the third thing we do is mitigate risk and the fourth thing that we do is finally accept it when we get risk to an acceptable level

Alright. Now, just to let you know, I have the Q&A tab open so as we’re going through this, if you have questions,

Feel free to put them in here. I’m gonna talk a little bit about some of the things that,

I’ve learned about risk mitigation now I I’m not gonna tell you everything that I know about risk mitigation,

And be honest with you I’ve forgotten a bunch of the things that I learned about risk mitigation because it don’t really use all of it.

I’m gonna give you the the parts about risk mitigation that I really use and where does risk come from in a real estate deal.

Well, it comes from uncertainties about the outcome,

How hard is it gonna be to get that property sold or get that property rented? How long will it be on the market not producing the income you expected? But there are other risks also.

Such as.

[8:03] Or bodily harm due to slip and fall accidents are slip and fall con artists,

You know, they’re around and that happens. So, how do you, what do you do with those risks? Well, the risk I’m talking about about destruction and about injury,

Those are the types of risk that you share you share them with an insurance company,

And using the the live large numbers and industry averages the insurance companies charge you a little bit to share that risk,

Because they know that over a large number of properties that they ensure they know that the actual claims will be small enough that they can still make money even if they ensure this risk for you so that’s

That’s one thing that you can do is risk and share it and that’s how you share risk in real estate.

To mitigate risk in real estate you just need data.

[8:59] And,

No one has a perfectly clear crystal ball to see into the future when you’re projecting what you’re gonna sell a property for in 3 months there’s no way to know for sure but there are certain things that you can do,

To try to make sure that you’re as close to accurate as possible,

One thing of course is to understand the market prices right where they are right now,

As they exist right now

Whether it’s 1 month, 2 months, or 3 months getting it in shape market ready for your exist strategy whether that’s going to be selling or renting.

You probably really can’t say for absolute certainty what the price is going to be in the in in 3 months but you can know with a reasonable amount of certainty and that’s how you get to acceptable risk.

Alright.

[10:12] One one thing to do is to study the comparable sales or the comparable rents. I know the thing to do is to look at which direction the market is going. What’s happening the overall in the overall real estate market? What’s happening in happening in this community,

And because real estate is hyper local what’s happening in this neighborhood.

[10:32] If you understand those trends and what the current data shows you’ve done a lot to mitigate the risk of the future pricing issues,

The only thing that you can do is take a look at occupancy of similar properties right in the area and that’s a little bit difficult to do with single family homes I understand that.

I would suggest that.

[11:02] I told you I was gonna talk about some of the mistakes I made. The first two rental properties that I made at that that I bought.

I bought them from a member of my church. Who is getting into real estate investing himself?

And I I knew the mask well enough do you know somebody said one% rule okay the one% rule for those of you that may not be familiar with it is you want your rents to be at least one% of your total acquisition,

So if you,

Are all in on a property let’s say you buy a property for $90 thousand and I’m gonna use round numbers here to make the math easier and the renovation cost you $10 thousand that initial

Renovation to make it rent ready is a part of your acquisition for this purpose,

So you’re all in price here is $100 thousand and you want that rent to be $1000,

If you find one of those and.

This gentleman in my congregation brought these two properties to me cuz he knew I was interested and they fit the criteria.

[12:15] And guess what.

The reason for one it was in a terrible neighborhood.

I was new to this whole thing. I didn’t know any better. The numbers looked okay but what I did not realize is i would never keep anybody in there past their 1 year and a lot of people wouldn’t even stay for a full year,

And so,

And a lot of times I had to put a new carpet and all of the money that I made on the spreads between the difference between.

[13:05] While I was charging in rent and what my payments were every bit of it got sucked into turning the house around the next time,

And hey, I just didn’t see any point and it got to a point where it was

Was in a little bit better area

I didn’t I didn’t I didn’t love it. I didn’t I didn’t even like it. But I didn’t care because I thought it didn’t matter because the numbers worked. But here’s the thing it was difficult to rent out. If you’re looking at a street full of houses

Or a neighborhood full of houses to rent and you got cute.

[13:57] Which one are you gonna do,

People would look at it and then they would I think they would say themselves.

Let’s just keep looking. See if we can find something else. Anything but this.

I don’t know what happened but that house burned down it was a few years after i got rid of it but it burned down and,

I took a picture of the charge remains and that’s in my book and I said this is the best that house ever looked,

That’s what needed to happen to it. So, in both of those,

The situations the numbers appeared to work but i had not mitigated all of the risk because I didn’t think about the neighborhood and I didn’t think about the rentability of the property,

If if you’re hearing anything and I say, number one, don’t buy a rental property in a bad neighborhood no matter what.

Because anybody who can avoid to live there is going to avoid it and the same goes with really ugly houses.

[15:18] Okay. Alright. So.

[15:23] Another thing that I do with the data and I don’t wanna overwhelm you with formulas and stuff like that. I don’t wanna get down into the weeds and get too much into the math here. But I will tell you

Of all of the formulas that I’ve used to analyze rental properties over the years,

These are the three that I stick with and,

I’m just gonna tell you what they are. You can look them up or we can talk about them later on. You can schedule a free strategy call with me if you wanna go deeper on this and and I’ll be happy too. Number one,

Is i look at the yield spread difference between the capitalization rate.

The capitalization rate is the rate of return on the capital and it’s the net return let’s go back to that $100 thousand,

That’s $12 thousand a year your grocery turn then is 12%,

See that that’s why I use these numbers the math is easy to do.

[16:30] In every rental property that ever exists,

Your groceries do not equal your net rents do you have expenses they’re unavoidable you have to pay taxes you have to buy insurance you’re gonna have some management,

And you don’t have to have management. You can, you know, manage yourself but you’re gonna have maintenance and you’re gonna have repairs.

Taxes insurance maintenance management and repairs all of those things in a typical single family home in a decent neighborhood.

Notice I qualified a little bit. Those things are going to typically add up to about 25%. Your cost ratio is gonna be 25% in single family home,

I get that number really from the banks my experiences always been a little bit higher but since that’s the bank number we’ll just use that for the purpose of this discussion.

[17:18] So if you have $12 thousand in groceries,

Subtract 25% from that and you end up with $9000 in net rents that gives you a nine% net yield on your investment so that is a nine% capitalization rate.

Okay.

I I know that there are some that would poo poos in ocean of using cap rate on a single family home and I I’m one of those because caporate is,

Income producing property. However, it’s useful in single family to understand what that rate of return is and then simply compare that to the loan content. What is the loan constant? The loan constant is the true cost of the money.

[18:10] If you think that you if you’ve got a an amortized loan like a 30 year loan on a property that is six%.

[18:19] Do not make the mistake of believing that the cost of that money is six% it’s not.

[18:26] The way you figure out the true cost of the money at advertise loans are tricky and look we could get into the deep weeds here and I’m not gonna do that but just do this.

Out.

[18:37] If you if you have $100 thousand loan at six% and I pick these numbers on purpose because at six or six. 000.

You’re.

Now we’re just focusing on principal and interest here. $600 a month to 30 years. Well, if you pay that $600 a month for 1 year, you’ve paid $7200. So, what is the cost of that money in year one,

The seven. Two%.

[19:10] If you have an Ambertized loan.

If you made that a 15 year loan, your loan concept would even be higher but that I’m going far enough. You could you can look up loan cost, do a lot of reading about it.

But what you wanna do here is you wanna look at your nine% cap rate and subtract your seven. Two%.

Long constant and if the result is a positive number then maybe you got something that’s going to work.

In a typical situation and you might even have some positive cash flow. The next thing to do is to calculate what’s known as the debt service coverage ratio.

DSCR and rather than getting into that too much I would encourage you just look up DSCR their calculators online that will calculate it for you but,

It’s basically that service ratio takes really it’s your capitalization rate.

[20:17] What amounts do the loan concept that cost the cost of the money in a given year and so.

When you make that division you want to see that result equal one. Two or better,

Because.

On the property.

And the reason we wanna see one. Two is that extra. Two will be used for those extra expenses that happen when the property turns over after 12 months.

Ok

And then the third thing that I look at is breakeven ratio and you can again you can look up this you could find it formulas for breaking ratio and a lot of places and what what were,

Calculating here is.

[21:11] Okay,

And we can talk about a little bit later but those those three things are built into my spreadsheet model that I use when I analyze a formula. Now, those numbers are not the only thing that concerned me,

Because as I’ve mentioned before there are other factors involved in a rental property of where you can just throw the numbers right out the window.

So

[21:44] I would urge you to look for a small.

[21:48] Low maintenance that would be brick or vinyl siding. You know, we all love the look of hardy plank but it has to be painted every 15 years.

Vinyl. Now, maybe you’re gonna end up replacing it one of these days because it does dry out and crack and so forth but brick is best. It lasts, it lasts, you know, my lifetime and maybe.

My kids and grandkids too some sort of brick or stone or masonry exterior is ideal. Something you have to paint, not ideal. I want low maintenance and,

I want it small so that when I had to turn the house over my cost per square foot is gonna be on my cost per square foot is gonna be the same no matter what but if I have a smaller house my ultimate cost is gonna be less,

I wanted to also be in a good neighborhood with decent schools,

Where hopefully a family with young children will move in and make up their mind to stay there till the kids are grown at out of school.

[22:43] Because in truth the only houses single family houses that truly cash flow and I know I’m gonna catch a little flag from this,

But the only single family houses that truly cash flow are houses where people move in and stay for years and years at least 3 years.

If you have turnover after 1 year in a single family house you’re never gonna make any money now there are some tax advantages that give you a reason for holding us plus your building equity,

And so that’s another reason for doing it. And if you could at least break even, it’s not a loss until therefore, there’s no reason not to do it,

Just don’t think that you’re going to.

When you have a duplex triplex or a quad or any small multifamily like that.

You’ll have a young couple just starting out or two singles people that are sharing place for whatever reason they don’t tend to settle down and live there for years and years and years but.

The the numbers in the returns on those multifamilies are better and strong enough and the rehab of each unit is cheap enough when they move out.

[24:00] You have an easier time making those things work and and those properties actually do tend to work better in terms of,

Making an actual profit in single family homes the other way that you can certainly cash flow a single family home is to own it free and clear.

[24:17] If you do that then.

[24:25] Hi so then we get into the whole conversation about the use of leverage and if you don’t have any debt on the property yeah you’re gonna cash flow but you also lose some of the advantages of investing in real estate in the first place.

So this is where the conversation would devolve into.

I talk about return on equity and what makes sense but.

I save that for the course. We’re not gonna we’re not gonna do that here. Because we’re just talking about avoiding risk.

You have less risk if you have no cost of capital.

[25:06] Alright.

[25:10] So I’ve given you the three formulas.

And.

[25:27] Years ago,

Oh it’s been 10 years ago now,

And I had a few people come to the saying one young man came to me and said man I I got a lot out of this. It’s great. Good content. Thank you so much. And this is I probably got more out of this than all the other courses I’ve taken.

I said really you’ve taken other courses you said yeah a lot I said.

I don’t really remember.

I said man how many deals have you bought.

[26:20] Oh man.

[26:26] I I,

Now yeah I’m a little bit more risk taker more than I should have been I wish I’d known some of the things I just shared with you when I got started I could save myself some heartache and some frustration and you know.

Some draining out of my wallet but still.

I arrange to see five hood houses now this was 10 years ago and there were plenty of properties available none of people to buy them okay.

[27:07] So we were going out to look at five hood houses and we looked at five of them and three of them were good deals two of them were really good deals and I said man you need to buy this one right here right now,

I wouldn’t even charging him. I was spending my time with him for free.

Show him what to do. Tell him what I would do. And i said you need to get this one. He said I don’t know.

That’s the first time I ever personally encountered the paralysis of analysis. I said, alright, look, if you’re not gonna do it,

Do you mind if I pull the trigger,

I saw him about 3 years later he finally got his first deal and he had he was coming around to where some of us were hanging out at the courthouse auction 1 day and he was trying to wholesale his deal it wasn’t even a deal I know so I don’t know I don’t know.

Anyway.

[28:07] Nah, I didn’t really experience fear in investing till after I lost money on one or two. Then, I understood what it’s like to have a little bit of trepidation.

So, here’s what I did to overcome the fear at that point. First of all, i bring along someone who has experienced with what i’m about to do.

And make them some sort of a partner in the deal.

Just be there. I just need a voice. I need somebody to listen. I need somebody to talk to. I didn’t really need a whole lot of coaching. I just needed insurance that we were not going off the rails here with the bad deal.

[28:42] So, get someone for the experience. Secondly.

[28:52] Do everything you can to eliminate the risk but sooner or later you’re just gonna have to go.

[28:58] It’s okay to be afraid it’s okay to have some concerns about,

Get some insurance from them

And then just take the action,

Is a risky business?

Keep your eyes open.

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[29:50] Music.