Last week we were in Houston, TX, to tour 6 different apartment deals being offered for sale and let me tell you, we saw the good, the bad, and the ugly. This got us thinking about what the risk profile was in each opportunity and how the investor returns should match the level of risk. This of course applies to all investment vehicles, not just real estate. Government bonds are less risky so should have lower returns. Stock shares of GameStop on the other hand are highly volatile and carry much more risk and therefore have higher ROI potential. FYI, we don’t invest in bonds or GameStop. We prefer the stability and exceptional risk-adjusted returns of real estate (not to mention the tax benefits)! We believe real estate is one of the best investment vehicles for investors seeking capital preservation, passive income, and wealth creation. In this month’s Harbor Drive Investor, we’re going to show you two of the 6 properties we toured in Houston last week and let you decide for yourself what your return target would be based on the risk profile of two different deals.
DEAL #1
This is a late 70’s constructed, 176-unit C class apartment building in a C class location on a scale of A-D (A is the best neighborhood and D is an area I would never send my mom to collect rent). The deal is solid and the neighborhood is working class (which is not a bad thing). The numbers on this deal work well and we can produce great returns for our investors with a little bit of value-add and tighten up some of the expenses with strong management. BUT THERE’S A CATCH! In case you didn’t notice from the pictures here above, one of the buildings has been destroyed from a fire. The fire building represents 16 of the 176 units and these units are uninhabitable (as you can see in the picture). After discussing this opportunity with the broker and several of our contractors in the Houston market, we feel that the cost to bring these units back would be $2 Million.
RISKY BUSINESS
As an investor in this opportunity, what type of returns on your investment would you be interested in? This is not your standard stabilized apartment investment, and we feel that there’s a fair amount of risk involved with an opportunity like this because of the fire restoration. So, getting back to the risk-adjusted returns question, we would not feel comfortable presenting this kind of deal to our investor community without compensating investors in the +/-18% to low 20’s IRR because a lot can go wrong here. We’re not saying that risk is bad, however your return profile on this (or any) investment needs to match the risk involved.
DEAL #2
This is an 80’s constructed, 144-unit B+ class apartment building in an A class location. This deal has everything you would look for in an apartment investment complete with strong historical occupancy and financials, very little deferred maintenance, robust amenities package and a little bit of value-add potential. The area median household income levels on this property are twice that of the workforce housing deal in our previous example (the fire building). With such stable occupancy and clean financials in a great location, what kind of risk profile would you think this deal has (i.e. very risky, medium risk, low risk)? As such, what kind of returns would you (as an investor) expect to see on a deal with a lower risk profile? Would you be fine with lower cash-on-cash and projected IRR in a deal that is more secure with a lower risk profile? Or are you the kind of investor that likes more risk and the potential for greater returns on investment?
WATCH: In the video below, HDH co-founder Rob Overstreet talks a bit more about Investment risk tolerance.
No matter what kind of investor you are and what your goals are, you should always understand what the risk adjusted return profile is on your investments. As mentioned, this is not exclusive to real estate investing, rather all of your investments because there’s risk in everything. Understanding how risky an investment is or isn’t will allow you to invest in deals you’re comfortable with and that match your investing goals. Remember: More risk = potential for greater returns. Less risk = lower return profile. Personally, we feel that real estate provides investors with some of the best Risk-Adjusted returns of any asset class available. Have you added real estate to your portfolio yet?
Until next time,
Happy Investing!
