How a Former ER Doctor Reduces Real Estate Investing Risk
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I know a lot of people that are a nervous with what impact the COVID-19 pandemic may have on their real estate portfolio.
I am certainly not immune from these feelings, and even broached some potential issues in my post, “Go (Mid)West Young Man: COVID-19 Migration Patterns?”
I reached out to Dennis Bethel, M.D., a doctor who broke free from medicine courtesy of real estate and who has been previously featured on this website to help allay some of these fears.
[Disclaimer: Dennis is a principal in the real estate syndication, 37th Parallel (the very first sponsor of this site and where a significant portion of my real estate portfolio is invested in).]
With the changes wrought by the pandemic, some people are concerned about their real estate investing risk.
As a former ER doctor and multifamily investor of almost two decades, here’s how I think about CRE (Commercial Real Estate) risks and why I’m adding more properties to my portfolio in the middle of a pandemic.
I’m a real estate guy. It’s what I do.
I’m a Principal in a private real estate acquisitions and asset management firm.
My role centers on education and I even maintain a separate educational website called NestEggRx.
So it’s easy to understand that I’m always keen to read articles about real estate and real estate investing.
Not too long ago, I came upon the article, “Go (Mid) West Young Man: Covid-19 Migration.”
In it, the article describes two Radiologists who are both real estate investors.
Each invests in resident occupied rental real estate, but one is an active investor while the other is passive.
The active investor invests in small residential properties while the passive investor prefers large multifamily ones that he doesn’t have to manage himself.
Their conversation centers on the effects of COVID-19 and resident occupied real estate.
Has COVID-19 permanently shifted us toward a greater number of people that will work from home?
Will COVID-19 shift people away from city centers and more toward suburban living?
Those are interesting risk assessment questions and not entirely unexpected from two Radiologists.
After all, who understands the trend of work from home better than a Radiologist?
They saw a revolution happen in their own industry.
The death of Radiographic film and the advent of digital technology coupled with the emergence of fiber-optic transmission have revolutionized their practice.
Today, Radiologists still dress up, drive to work, and sit alone in a dark room all day reading radiographic images.
But more and more of them are sitting around in their pajamas reading from home.
And I think it’s safe to say that more industries will find that work from home is an economically sound option that doesn’t harm productivity.
If that’s correct, then more people will be working from home.
I guess in some ways, not being tied to an office five days a week does provide a person with the option for greater mobility.
As an apartment investor, does that concern me?
The answer is no.
To better understand that, you have to fundamentally understand real estate investing risks.
And all investors should think about risk no matter what they invest in.
This is especially important since all investments have risk.
But one key thing to realize is that they don’t all have the same risk.
Some investments are less risky than others.
So my goal as an investor is to get a solid rate of return while minimizing as much risk as possible.
So how do I do that?
Let’s explore this further.
1. I invest in apartments
Do you see a day in which men and women won’t need a roof over their heads?
Of course not.
Shelter simply can’t be replaced.
Apartments can’t go the way of the horse-and-buggy, Kodak Film, or Blockbuster Video.
And e-commerce like Amazon can’t disrupt the need for shelter like it’s disrupted retail real estate.
People have always and will always need a roof over their heads.
So focusing on that basic need is serious risk reduction.
2. I invest in multifamily instead of residential real estate
When you look at the resident occupied space, it can be as small as one unit or as big as thousands of units.
In general, anything four-units or smaller is called residential real estate.
Five-units and more are considered multifamily real estate.
Whether you invest in residential or multifamily the potential to make money is there.
The reason I choose larger properties (100-units and up) has a lot to do with risk-reduction.
First, larger properties have economies of scale that just aren’t there with smaller properties.
To best illustrate this, consider a single vacancy in a duplex.
That one vacancy leaves you only 50% occupied. But one vacancy in a 100-unit property means you’re 99% occupied.
That’s the difference between making money and losing it.
Another benefit inherent in the bigger properties is access to professional property management.
These are companies headed by people who went to college to learn how to manage these properties.
They utilize bulk-buying programs, shared expense opportunities, and discounted service contracts that can really enhance the owner’s bottom line.
Lastly, large multifamily apartment buildings qualify for non-recourse lending.
That means that the purchaser is largely immune from recourse from the bank should they default.
The property itself secures the loan so investors don’t have to personally guarantee it.
This is different than in residential real estate.
Banks typically require investors to guarantee the loan in residential real estate.
So not only does that debt show up on their credit report and encumber their credit, it also makes them subject to recourse should they default.
In other words, the bank can come after them and their assets to make themselves whole.
Additionally, these properties are held within a legal structure that limits liability and hold insurance products that substantially reduce investment risk.
3. I select markets long before I select properties
Active investors often pick properties in close proximity to where they live.
This proximity makes it convenient for them to maintain and manage the property.
That strategy can add risk to an investor if they’re investing in markets with poor fundamentals or unfriendly landlord-tenant laws.
Proximity is not necessary for passive investors.
This is important because market fundamentals can vary widely from city to city and state to state.
That freedom allows passive investors to focus on markets with favorable conditions for investing.
For example, some cities and states have highly unfavorable landlord-tenant laws.
They endorse things like rent control, first in time ordinances, and even prevent landlords from doing criminal background checks on prospective renters.
Investing in markets that disfavor landlords adds risk to your investments.
That’s why I avoid investing in markets like that.
However, investing in markets that aren’t hostile to landlords is just one way to reduce risk.
I play close attention to Metropolitan Statistical Areas (MSA’s) that have both current and long-term job growth and population growth.
I also like markets with diversity of jobs.
It’s risky to invest in a market in which one industry supplies all of the jobs.
Now notice that I used the term MSA above.
This refers to a geographical region that has a relatively high population density and close economic ties throughout the area.
So instead of investing in Dallas, TX, for example, I invest in the Dallas-Fort Worth-Arlington MSA.
The MSA includes all the suburbs as well.
That’s important because once I’ve found an MSA worthy of investing; I look for submarkets within that MSA that have low crime and good schools.
I especially like them if they are close to jobs centers and entertainment options.
Sometimes these areas include city centers, but more often than not, they’re suburbs within a given metro.
The point is selecting high-quality markets.
If you do that right, you remove a ton of risk from your real estate investment.
4. I invest in garden-style apartments over low- or high-rise properties
Garden-style apartments are outdoor-style complexes.
They typically don’t have elevators or shared hallways like low- and high-rise properties.
Instead, they have individual front doors that connect each unit to the outside.
They also have their own individual HVAC system instead of shared ventilation.
The reason I invest in garden-style apartments is simple.
Over the long haul, they’ve outperformed the other two.
But in the age of COVID-19, there is no doubt that garden-style apartments have a secondary advantage.
Their makeup provides for the ability to social distance, which puts them at higher demand.
5. I invest in workforce housing instead of luxury A-grade properties
A-grade properties are the newest, nicest, properties in a market.
Typically, they are packed with luxury amenities to attract their residents.
These are people who primarily rent out of economic preference.
They can afford a house, but they prefer the convenience of renting.
While A-grade properties can be good investments, they tend to have higher vacancy rates.
Also, they aren’t as recession resistant as lower grade properties.
I prefer to invest in workforce housing (B+ – C+-grade properties).
These properties tend to be rented by blue-collar renters who rent primarily out of economic need.
They frequently can’t afford to buy a house.
So if I provide them with a clean, safe place to live in neighborhoods with good schools and low crime, they are more likely to stay longer term.
Reducing turnover and catering to people who are most likely to stay long-term reduces risk even further.
That’s especially true when you realize that there is a real shortage in the workforce multifamily housing sector.
Minimizing Real Estate Investing Risk
Commercial multifamily real estate has long been a high quality asset class for investing.
People understand the core benefits of apartments.
They realize that it’s an investment in the basic need of shelter.
Apartments have a long-history of solid returns with a lower risk profile.
But that doesn’t mean that risk can’t be reduced further.
Following a well-disciplined plan that focuses on quality markets and submarkets before investing in deals is of utmost importance.
Combining that with properties that cater to high rental demand populations while suffering from constrained supply puts the investor in the driver’s seat…even in a pandemic induced recession.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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