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Investment Risk: When You Think You Know, You Don’t

KNOW THE RISKS

Most of us are well aware that investing, of any kind, carries some degree of risk.  When we invest our hard-earned dollars, we do so on the basis that the risks associated with the investment, are identifiable, measurable and manageable.  It goes without saying, the risks should be within some degree of certainty before any investment in made (i.e. using historical data as an indicator, not a predictor, of future value). Investment risk comes from all angles, many of which we experience on a daily basis.  Some of the most common are:

REALITY CHECK

Investment risk cannot be eliminated, it can be managed (hedged), but never completely eliminated.  Even the most formidable risk management strategies will not shield an investment from ever losing value.  Most recently, many of us in the real estate crowdfunding sector received a sobering reminder of this fact from Hurricanes Harvey and Irma – geological risk.

Before committing any capital, we spent countless hours researching the viability of host platforms such as RealtyShares and PeerStreet, assessed each investment’s loan-to-value (LTV) ratio, purpose of the loan and the borrower’s creditworthiness. Understanding local markets is one of the more difficult risks to pin down, simply because the investments are in a different state than you.  As it turns out, being spread across multiple regions is great from a diversification perspective; however, quite difficult when trying to determine the quality of specific neighborhoods, gentrification efforts, municipal legislation changes etc.

And after all that research, number crunching, and stress about getting your money back, a darn Hurricane surges in sweeping your investment three towns over.  Other than requiring an insurance policy, how do you account for a natural disaster?

SILVER-LININGS

When it comes to my own crowdfunding portfolio, 16% of the real estate investments were located in Florida.  Of that, 3% was directly exposed to Hurricane Irma’s destructive path.  While the necessary work is underway to assess the true damage and implications, I continue to stay the course and recycle principle and yield back into new investments.

Why?

Well, for starters, I am more concern about donating to relief funds that will assist my family, friends and others affected.  Secondly, there is a 1% cut of the yield the host platform retains on most investments to fund overhead.  This covers very smart people on the payroll who are way more experienced to handle this, than I.  

In the end, diversity saved my portfolio.  The returns, after 1-year, are enough to absorb a complete loss on the 3% exposure, should it come to that.  My portfolio spans across 10 States and right behind any great investment loss, is nice looking tax break.  Keep on truckin’.

@ Real estate crowdfunders – Anyone’s investment(s) take a hit from Harvey or Irma?  If so, how is the process coming along?

@ All investors – how do you manage or think about risk in each of your investments?

4 comments

  1. I live in Miami. After Hurricane Andrew in the early 90s, virtually all of the big property insurers (State Farm, Allstate, etc) left South Florida. Nowadays, we Miami homeowners are insured by either the state-owned carrier (Citizens) or multiple small carriers. The truth is that while Citizens seems to be financially solid, no one really knows how the others will fare in the event of a major catastrophe.

    Also, not everyone here has flood insurance (as happened in Houston when Harvey hit).

    Just a consideration for those investing in real estate in South Florida.

    • Miguel –
      Thank you for this insight, it really brings things into perspective. PeerStreet, the real estate crowdfunding platform I invest with, requires flood insurance for all properties located in a FEMA designated flood zone. But to your point, that doesn’t mean the property on the cusp of the flood zone is required to have insurance. We shall see what happens, but I am falling back on the fact that PeerStreet continues to boast ZERO INVESTOR principle losses. I guess this is really going to put that to the test over the foreclosed properties that are seized and sold off into the market.

      Thank you for stopping by, it was very helpful for future investments!

      • Absolutely, though an issue, as I’ve heard it, is that the FEMA flood maps are not necessarily foolproof. And since banks will not require homeowners to have flood insurance outside the FEMA flood zones, lots of people are in big trouble. See this New York Times article: http://nyti.ms/2gzFEPY (“half of the land that flooded in the county, whose seat is Houston, was outside of official flood zones”).

        • “So you are saying there’s a chance!”
          – Dumb & Dumber (1994), Loyd Christmas (Jim Carey)

          This is certainly going to change my investment decisions going forward. Thank you for all of this information. I admit, I should have done more research.

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