Legacy Wealth Holdings

9 Strategies to Reduce Risk When Buying Commercial Real Estate

There are a lot of moving pieces in the real estate market right now, and it reminds me of when I first started in real estate investing back in 2006-2008. I remember seeing people who had a net worth of millions of dollars, and some of them went bankrupt while some of them are now worth tens of millions or even hundreds of millions of dollars! I remember thinking, how do people working in the same market with the same product or asset class have two completely different results?

 

The answer to that is that they have two different business models, two different ways of mitigating risk. So I want to give you a few hacks on how I realized some of these people went broke while others got rich, and how I’ve developed my business over the past 15 years to duplicate the ones that got rich to mitigate risk and still maximize upside. 

 

#1: Always Buy at a Discount

If you can buy at a discount, you absolutely should. Now, little asterisk, if you buy at a retail price, but get a substantial discount on the interest rate, that is still a discount. That’s a way that you can utilize what’s happening in the existing marketplace to your advantage. Interest rates might be seven or 8% right now, but if you can get seller financing at 2%, 3%, or 4%, that’s just as good as buying at a deep discount on the property.

 

#2: Create Value Through Sweat Equity

Create appreciation. Never, ever speculate on appreciation. Create it by putting sweat equity into the property, by looking at ways to increase the income and decrease the expenses. Do that, and you’ll increase the overall net operating income (NOI).

 

#3: Always Buy for Cash Flow

Cash flow is one of those standard baseline considerations. If it cash flows positive, you will be able to ride out any sort of economic storm. Assuming you have fixed debt, right. Not variable rate debt that’s going to go all over the board, but you have fixed rate debt and it cash flows positive from day one. Eventually, you will increase cash flow by bumping up rental rates and pay down some principal on that note and create even more spread on the property. Cash flow allows you to ride out any sort of economic storm.

 

#4 Stick to Good Areas

I don’t really get into the super luxury stuff and I stay the hell out of war zones. But I think that A-minus, maybe B-plus, all the way to C-plus areas are good to invest in. This is workforce housing that stays insulated and occupied, whether the market’s up or the market’s down. These areas always stay occupied and you can fill up your properties with good quality renters regardless of what’s happening in the marketplace.

 

#5 Due Diligence

Here’s a big one that falls on you. It’s not an external factor. It’s all about you. It’s doing your due diligence, making sure you check every single box on your due diligence checklist. You’re walking every single unit, you’re reviewing every single document, cross-referencing the rent roll with the profit and loss statement, with bank statements, with property leases and tenant ledgers, and everything else. You’re making sure everything is taken care of and making sure that the seller cannot do anything to pull the wool over your eyes or try to pull a fast one on you by ensuring that all due diligence — both financial and physical due diligence — is handled.

 

#6 Stress Test Your Underwriting

Make sure that you’re not utilizing a best case scenario, but kind of a middle-of-the-road type of scenario. When I’m looking at rents and I know that I can get $1,000 a month in rent, I might run it at $950 or $975 to stress test the numbers and try to kill the deal. If you cannot kill the deal by stress testing all these different variables, that’s when you know it’s a really good deal.

 

#7 Obtain Favorable Financing Terms

Make sure that they can’t call your loan due for no reason. Make sure that you have fixed rate debt, make sure you have a longer amortization schedule to reduce the monthly payments. You can still pay it off sooner, just make additional principal payments on it to knock that out. But you don’t want to be stressed with that, right? I want a long amortization schedule, a long term on that loan as well. I wouldn’t do anything with less than really a five year term right now. So that way it allows the market to cool off interest rates, to relax, allows the market to just kind of find out where it belongs before you have to refinance. And it gives you enough timeline to pay down principal and allow property appreciation by bumping up rents and letting the income grow.

 

#8 Properly Manage and Maintain Your Property

The largest expense in owning rental real estate is going to be tenant turnover, and that can be eliminated by doing two things: One is screening your tenants, and two is taking care of the property. If you do those two things, 99% of landlord issues are eliminated and you will reduce your turnover, which reduces your overall operating expenses, which increases your net operating income, which increases the property’s value. And if you can do that, everything else kind of falls into place.

 

#9 Have Multiple Exit Strategies

Understanding creative finance, understanding the different ways that you can sell a property, is really important. Whether it’s a traditional sale, a seller financing situation, a loan assumption, a master lease with an option, or maybe it’s an installment contract for deed, there’s a lot of different ways that you can get creative on both acquisitions and dispositions of properties if you understand exit strategies. So invest in that knowledge.

 

And make sure that you’re following what we’re doing here at Legacy Wealth so you can see all the different ways and creative deal structures that we’ve done for both acquisitions and dispositions of our own properties.

 

Implement those risk mitigation strategies, write them down, print them out, post them on your office wall, and make sure you don’t do deals unless you can check every single one of those boxes. These are not principles that you half ass. These are not things that you do at a lukewarm status. It’s black and white: you’re either doing it or you’re not. So if you’re not going to do it, make sure that you find an operator that is going to do it and invest your money with that person.

 

Whether it’s you investing in and operating your own properties, or you’re passively investing with other operators, make sure they’re doing these things. These are principles that we follow and have followed for the past 15 years, and following them has kept us inside the lines. We don’t grow as crazy fast as some of the other people did when the market was going gangbusters over the past few years. But guess what? We’re not feeling the pain that a lot of other people are feeling right now because of that. We’re here to build long term wealth. So if you’re operating on your own, go ahead and do that. If you’re interested in passively investing with great operators, we’d love for you to reach out. Let’s hop on a phone call and talk through ways that we can build wealth together. 

 

We made a video on this! Watch it on the Legacy Wealth YouTube channel here:

https://www.youtube.com/watch?v=H0RvA_o0Q5o