Calculating the risk of a particular scenario is usually done by compar- ing the likelihood and consequences. This can be done qualitatively (high, medium, low), semi-quantitatively (usually in orders of magnitude), or quantitatively by multiplying the esti- mated likelihood with the estimated consequences. In the latter case, the risks from multiple scenarios can be added together to estimate the expected loss due to risk for the investment. Alternatively, the scenarios may be addressed individ- ually. For example, if we find that the likelihood of a title claim is about 1 in 2,000 (0.05%) and the cost of the claim to the investor is the equity in the property (say 25 percent of the purchase price), then the expected cost to the investment would be 0.0125% of the purchase price. Since be anything from a scorched area to complete destruction of the property. If the property is a tear down, a fire might result in positive consequences (not that we are advocating that). One could argue, however, that having fire insurance on a tear down is a waste of money from a risk management perspective. THREAT is what could happen. For example, the property could catch fire, or someone could make a claim against title. VULNERABILITY is how susceptible the investment is to the threat. For example, a concrete block and metal building with no contents would be far less susceptible to fire than an older wooden house inhabited by a hoarder. CONSEQUENCES can be estimated as the negative impacts that would occur if the investment succumbed to the threat. In the case of a fire, the impacts might
risk is transferred to the insurance company). Or we could mitigate the risk by installing a sprinkler system, providing fire extinguishers, or train - ing a tenant in fire response. Why don’t real estate investors usually think this way? Why do they default to all or nothing views of threats? I think it is a combination of laziness in doing the analysis and ignorance of how to assess risks. But you no longer have that excuse. What do I recommend as a risk analyst? Go beyond the usual real estate doctrine of “always” or “nev- er” when addressing risks. Do a risk assessment on those risk scenarios when you evaluate an investment. You may find cost savings that allow you to more intelligently bid than your competitors. You may find deals that others shun that can be your most profitable properties. And as you become adept at risk assess- ment and evaluation, you may find ways to creatively structure projects that reduce your risk in ways other than just insurance or avoidance (or ways that reduce your insurance costs since your risks are less than those of the usual investor). Flexibility and creativity will set you above the investors who won’t do the real analysis and assessment work and give that edge that may be more valuable in a challenging economy. •
title insurance costs about .5% of the purchase price, title insurance costs about 40 times the cost of the risk it addresses. There are other consid- erations here, too, but strictly from a risk and cost perspective, title insur- ance may less cost effective than just accepting the risk. This brings us to the real point of any risk assessment: risk man- agement. Once we have identified, estimated, and assessed the risks, what do we do about them?
In general, there are four approaches to managing risk:
1 2 3 4
accept the risk avoid/prevent the risk transfer the risk; or mitigate the risk.
All of these approaches are often used when addressing the risk of fire. In the case of the tear down we might just do nothing and accept that the property could burn down while we are figuring out how to tear it down. We can avoid the risk by not doing the investment because of the fire hazard or prevent the risk by re - moving all sources of fire and com - bustible materials. We can transfer the risk by buying fire insurance (the
Steve Streetman, president of StreetSmart Investments, LLC, a com- mercial real estate investing company, is an avid cryptocurrency investor and has worked in cryptography and high-end
computer modeling for over 30 years. He teaches commercial real estate investment courses and is a real estate agent with RealInvestors Real Estate Services. His book “Cryptocurrency and Real Estate: How Bitcoin and BlockchainWill Transform Real Estate Investing” is anticipated to release in 2020.
thinkrealty . com | 73
Made with FlippingBook Online newsletter