Risk vs Reward, what is a 'deal?'



Investor clients often ask me to find them a deal. The source of the question is simply to find them something that is under valued so the buyer can capture that value on the purchase. However, when you make those investments they often come with not so obvious risks and time commitments. So depending on your risk tolerance and how much time you want to spend maintaining your investments, choose your class carefully. Here are my opinions on a few asset classes.

Single Family

Risk: low

Reward: low

This is often the first investment a new real estate investor makes. It seems the easiest and most straight forward. These investments usually make under a 10% return annually and require maintenance as well as managing tenants. Most of the returns on these investments come from appreciation and holding them for a long time. The risk is low assuming you put in enough equity and there is a strong rental market that creates some cash flow. If you really need to liquidate the asset, you are likely to be able to and recover your capital and a gain.

Fix and Flip

Risk: medium

Reward: medium

People love these in concept. Shows like HGTV have encouraged a lot of people to try them. I love that because it promotes entrepreneurship and we need people to rehab houses. It's a great mom and pop hustle, side business, or full time business. The rewards on a fix and flip are better than those of a single family but require a lot more capital and a lot more time. So this isn't really investing in my opinion because it is too active. It is a second job.

New Construction

Risk: high

Reward: high

Building a new home with the intent to sell it almost a year later is considered speculation. You are betting that the market doesn't move enough to throw off your financial model so you can sell the completed home to a yet to be known buyer in the future. These can be very profitable, especially in an appreciating market. However they also come with debt risk assuming you use a construction loan and sales risk. You better build what the market wants. In my opinion a safe spec build should have at least 20% gross margin in it to start the project. Debt can leverage that return even higher. I've done almost 60 of these as the owner manager. I've always hired builders as they have that domain expertise. They charge a good fee and it is worth it. Being the general contractor is a hard job and requires good relationships with lots of trades that will show up and do your job. So I highly recommend hiring a professional who has been the GC for at least 50 homes if you are new to this type of deal. They are complex, full of delays, and surprises. They are not for the feint of heart, but the exits can be very gratifying.

Multi Family