In the 80’s movie Wall Street, Michael Douglas’ character Gordon Gecko, utters the famous words “Greed is Good.”
In the world of commercial real estate, I would like to declare that, “Risk is good.” Why? Because risk creates opportunities.
Bruce Arians, head coach of the Tampa Buccaneers, when describing his approach to offense is often quoted as saying, “no risk it, no biscuit.” The idea is if you want to score touchdowns, you have to take shots downfield and go for those bombs. Of course, they’re lower percentage throws, but the payoff is also greater.
In the world of commercial real estate (CRE) investing, I embrace “no risk it, no biscuit.” However, where the investing public shies away from certain properties because of the perceived risk, I see the value.
How? Because with CRE, the perceived risk of a project or property can be proactively mitigated through skilled management to achieve above-market returns but at reduced risk.
Listen, everyone knows I’m a diehard Kansas City Chiefs fan, but this year’s Tampa Bay Buccaneers vs. last year’s team is a perfect case study of perceived risk vs. actual risk and how skilled leadership is the key to succeeding in the face of risk.
In 2019, running the “no risk it no biscuit” offense, QB Jameis Winston had a 33/30 TD/INT ratio. The Buccaneers missed the playoffs with a 7-9 record. In 2020, with Tom Brady at the helm and running the same “no risk it, no biscuit” offense, Brady amassed a team record of 40 TD’s to only 12 INTs. The Buccaneers ended the season with an 11-5 record and are going to the playoffs for the first time in 13 years.
The Buccaneers were able to reduce the perceived high risk of a downfield game with skilled management. They got the GOAT quarterback to run the show and gave him additional weapons in the form of Gronk and Antonio Brown. The ultimate actual risk of this vertical offensive approach was significantly reduced from the perceived risk because of skilled management decisions – resulting in tremendous value in the form of a trip to the playoffs.
Investing in CRE isn’t far off from this Tampa Bay scenario. Where the public sees risk, we see the reward. To the public, the perceived risk of CRE investing seems high – high enough to deter many investors from this asset class.
Much of this perceived risk comes from bias in the press and social media. When people think of owning rental real estate, they’ve been fed this perception of constantly dealing with headaches like burst water heaters in the middle of the night and deadbeat tenants who don’t pay rent.
The perceived risk is what keeps many investors away and opens up opportunities for investors like me because I know how to take that perceived risk and reduce it to the point where the actual risk is lower than the perceived risk and I can above-market returns at reduced risk.
I know that investors have ingrained in their heads that the risk-reward tradeoff says that reduced risk means reduced reward. The traditional risk-reward paradigm says we can only achieve high returns by undertaking high risk. This is where CRE departs from Wall Street. With CRE, skilled managers can reduce risk while maintaining or improving returns through proactive risk management.
Do you dread repairing toilets in the middle of the night? Fearful of suffering high vacancies from deadbeat tenants?
The reality is skilled managers, eliminate these concerns through risk-mitigating actions. The novice investor may suffer all these headaches by trying to do everything themselves, but skilled management has the infrastructure, systems, and personnel to reduce and even eliminate the most common risk factors.
Investors with the proper experience, infrastructure, systems, and personnel will have skilled property management to deal with repair headaches and processes to screen more qualified tenants.
Mitigating Risks = Value-Add
Here’s a summary of my favorite risk-mitigating/value-adding strategies:
- Improving overall management and property management efficiencies.
- Internal and external improvements to improve curb appeal and to attract and retain tenants.
- More stringent tenant screening.
- Improved security.
- Green energy initiatives.
- Bringing rents to market rates.
Risk is good. Perceived risk scares away potential competitors, opening up opportunities to skilled managers to add significant value.
Through proactive risk reduction and management, the resulting actual risk of a project is such that skilled investors can extract significant value out of projects that many didn’t think possible.
Some risk-mitigating actions can be as simple as running background checks on tenants. Others may be more involved like significant rehab work.
The bottom line is, opportunities exist to take a risk and use it to your advantage to add significant value and improve ROI. This is why risk is good.