The Winner’s Edge: How to Minimize Your Risk

“You can either work hard, or you can work smart.” These words have guided my actions for many years. After confronting nearly every obstacle, impasse and dead-end imaginable, they ring as true today as ever before.

Over the years I’ve learned that, while valuable, sheer determination and sweat alone are not enough to overcome problems. Nor are they enough to increase the odds of profiting from an investment.

Somewhere along the line, I decided to work smart. Once I made that decision, I dedicated myself to finding those solutions that required the least expenditure of energy and, at the same time, provided the greatest return. I set out to discover how to maximize the odds of success and have developed a set of rules.

Strive to understand these rules. Use them for every real estate deal you consider. I think you’ll be surprised at the results.

Rule 1: Play the game when the odds are in your favor to win, or don’t play.

You must sharpen your skills and learn to be as selective as possible in all your real estate deals. Selectively participate only in those investments that offer odds in your favor. The more you learn to realistically analyze a deal, the more likely you will win.

Speculation on market direction is a surefire way of losing. Any given real estate market goes through cycles. The market either goes up, goes down, or goes sideways. Never speculate on the direction of the real estate market. The odds must be in your favor to win NOW–not at some hoped-for time in the future. Either the deal works now, or it doesn’t.

Speculation on market direction is only for the foolhardy. Many new (and not-so-new) real estate investors purchase property that is not currently profitable because they believe (more likely, hope) the market is going up. They buy property with a significant negative cash flow because they hope market rents will go up soon.

Well, what happens if the market does not go up soon? What if it takes five years for market rents to go up enough to cover the negative cash flow? How long can they keep paying out their own money to cover the shortfall before they go broke?

No market can continue to go up indefinitely. If you speculate on market direction, the odds are not in your favor to win. Don’t do it. This strategy won’t guarantee a win every time, but it will increase the number of times you are profitable, and decrease the times you are not. Learning to carefully qualify each transaction, and learning to walk away when the odds are not in your favor, will produce winning results in the long run.

It doesn’t matter how many transactions you walk away from. What’s most important are the ones you participate in–those with the odds in your favor to win. If the odds are not in your favor to win, PASS.

Rule 2: Make your profit going into the deal, or don’t do the deal.

This rule is a corollary to the first rule. When you make your profit going into the deal, you are playing the game when the odds are in your favor to win. So these two rules work together. It’s possible to structure many real estate transactions so a profit is assured before you enter the transaction. Profit from any real estate investment should take one of these three forms, or a combination of them:

Cash at the completion of the deal.
Positive Cash Flow as a result of the transaction.
Equity in the piece of property.

Cash at the completion of the deal is the result of any “buy low, sell high” strategy. Any time you can buy a property for less than its current market value, and re-sell it for more than you paid for it, you will make money. Investors who want to make quick profits, use this approach.

Positive cash flow occurs whenever the mortgage payment and all expenses on a property are less than the rents. Investors who would rather invest in real estate for the long term use this approach. They may want the tax benefits of real estate ownership. They also prefer to earn a monthly income from their properties and to let the property appreciate naturally over time.

Equity can occur in either of two ways. First, at the time of purchase, whenever the purchase price is lower than the true market value of the house, there is existing equity in the property. Second, when the value of a property can be greatly increased by relatively minor or inexpensive fix-up or repair, you are creating equity. Anyone who wants to hold a property for a lengthy time (such as home buyers) should buy property with built-in equity.

Rule 3: Always minimize your financial and legal exposure.

Every real estate deal should stand on its own. In the event one deal fails, your other profitable transactions should not be connected to it in any way. Never allow one bad deal to have a domino effect and pull down all your good deals with it.

Use vehicles such as trusts and corporations to reduce both financial and legal risk. Hire an attorney who specializes in real estate or investments to help you chose the best method and to structure appropriate protection.

Another way to reduce financial exposure is by using leverage for your real estate deals. Leverage is a tool that increases the rate of return on your investment. To illustrate, let’s say you’ve found a bargain property. You can buy it for $100,000. In example #1, you pay the $100,000 in cash. In example #2, you make a 10% down payment of $10,000 and finance the other $90,000 with a mortgage. In a year, you sell the property for a $30,000 profit.

In example #1, you earn a 30% return on your $100,000 investment. $30,000 Profit divided by $100,000 Cash = .30. However, in example #2, you earn a 300% return on your invested dollar. $30,000 Profit divided by $10,000 Cash = 3.0. That’s leverage–using a small amount of money to produce BIG results.

Leverage in real estate not only greatly accelerates the rate of return on your investment dollars, it reduces your financial exposure as well. By using leverage in the above example, you have risked only 10% of your investment capital, rather than 100% of it. In the event the deal goes bad, you still have the rest of your money.

I hope you find, as I have, these rules will help you win more often than not.

I’m always looking for notes to buy, especially from banks, and I’m happy to pay a percentage of the deal to anyone who brings me real estate notes. Email me at [email protected]


By CREOnline Contributor

A content contributor to the original