You Can Dial Back Real Estate Risk

[Editor’s Note: Make sure to sign up for Tuesday’s free real estate investing webinar with Dr. Jim Dahle. He’ll answer all of your questions and talk through the pros and cons of investing in this asset class. Now could be a great time to get started with real estate investing, so make sure to register for the webinar today!]

By Dr. Jim Dahle, WCI Founder

I have run into people frustrated with their real estate investment—whether they invested directly, privately, or via public investments. Upon further questioning, I often discover they are relatively new to real estate investing. They might have chosen a rather aggressive style of investing, and then the inevitable risk showed up, as it often does. Their investment underperformed their expectations, often terribly. For some reason, they seemed to think real estate was exempt from the rules that govern all investing.

Although they know it’s important to diversify when investing in stocks, they thought that this key principle didn’t apply in real estate investing. Putting all of your eggs into one basket has the same negative consequences, whether that basket is a single stock or a single property.

Another important lesson to learn is about the risk continuum. Investors learn early that higher-risk investments often come with higher rewards. But they don’t seem to learn that the more risk you take on, the wider the range of possible outcomes you can expect. It’s almost comical sometimes to see how little risk an investor might take with a stock and bond portfolio and then see them go hog wild on risk in the real estate portion of the portfolio. They’re comfortable with a relatively conservative 60/40 portfolio of stock and bond index funds. Then, they dump a huge chunk of money for them into a single highly leveraged real estate syndication with a questionable value-add strategy managed by a relatively new operator.

Dial Back the Risk

The longer I invest in real estate, the more I like less risky real estate investments. The main reason I invest in real estate is for high returns and low correlation with the stocks and bonds in my portfolio. But when I say “high returns,” I think about what I expect out of stocks. It’s something like 8%-10% a year long term—maybe a little more if significant leverage is involved. While some of the equity real estate investments I invest in project returns above 15%, I’m very happy when I end up with low double-digit returns (10%-15%) from my real estate investments. Yes, I know lots of funds, syndications, or properties end up with multi-year returns in the high teens or even 20s. However, I don’t need those sorts of returns to reach my financial goals, and I hope you don’t either.

Newsflash! Most fund managers, syndication operators, and realtors (all being human) overestimate their projected future returns. Most pro-formas are a little too optimistic. Most of the time you won’t get what’s projected. Sometimes you will. Sometimes you’ll…