1:30 – Annualized Return For Properties Example
3:36 – Volatility and Rate of Return
7:12 – Factors in Reducing Risks & Values
12:49 – Conclusion
What actually is risk as it relates to investments and why is it important? How can you think about risk in real estate? Hear Greg Harrelson with Century 21 the Harrelson Group and Jeremy Finger with Riverbend Wealth Management, have an open discussion on this topic. For all of your real estate questions, you can contact Greg Harrelson at 843-457-7816 Gregharrelson@gmail.com www.c21theharrelsongroup.com.
Greg: Hello! It’s Greg Harrelson here with Century 21 The Harrelson Group and I wanted to invite a guest, you know, onto a Zoom call today to talk about risk and how do you factor in risk whether you’re thinking you know, if you own a piece of property maybe on the oceanfront and you’re wondering if you should sell it, maybe you’re getting a decent return, you don’t really know how to factor in risk and volatility into the equation, and so I thought the best way to have these conversations is to invite a financial advisor you know, onto a Zoom call and just kind of freely talk about this subject and see what we can learn and how investors in the security world evaluate risk, returns and make financial decisions on whether or not they should buy, sell or maybe reposition buy and sell. So let me welcome Jeremy Finger with Riverbend Wealth Management, a local financial advisement firm here in Myrtle Beach, South Carolina. Thank you, Jeremy for joining us.
Jeremy: Thank you Greg I appreciate you having me, thank you.
Greg: Yeah. I kinda prompt you a little bit ahead of time just to kinda share with you what I had in mind so let me kinda set up the scenario, obviously there are investors that own property or maybe just owners that have second homes along the coast, maybe in Myrtle Beach and other coastal areas in South Carolina, where they’re thinking they wanna sell their property, but when they look at it and they look at all the expenses, the holding cost, the rental management fee and maybe they own a property that’s worth $200,000, they own it in cash but they’re only making, say, $4,000 a year on that particular property in positive cashflow that’s a very common scenario by the way. It’s $4,000 off of $200,000, so could you just walk us through, first of all, what’s the annualized return on that, if you got a $200,000 asset, and you’re making $4,000 a year after all expenses. What’s the annualized return or are there other factors that we need to factor in to consider annualized return?
Jeremy: Okay, so that’s a great question Greg, and thank you for bringing this to my attention, I have to go over this with my clients often, not only with the stuff they have with me, but with other investments like real estate. But a $4,000 positive cash flow on a $200,000 investment is a 2% return, and so what you do is, you take 4,000 divided by 200,000 to get two percent, and as far as that is concerned some of the things that I would ask you, as far as risk is concerned, occupancy rate, HOA possibly going up, multiple different taxes being assessed, initiative property, there’s all kinds of variances there that a homeowner would know. In my world, a risk free return would be the US treasury, I mean almost really for the world a risk free return, so anything going above that you need to get compensated for, if you’re going to take on more risk you need to get paid more return.
Jeremy: So that’s how it is in my world.
Greg: Yeah so, I’m glad you’re kinda moving in the direction of what I want to talk about here so let’s go back to the $4,000 return off a $200,000 which equates to 2% annualized return. So a lot of times, and of course, I don’t really have an opinion and I’m not going to share an opinion on if that’s a good return or a not good return because I think every individual that’s probably slightly different. I know when you and I might be talking about investing money, I talk to you about “I’m fifty years old and I want to accomplish this” so you may say to me “Based on your situation you’re risk should be about this level” versus somebody else could be younger, they may take more risks, or somebody might be older and they may take less risks. So risk is definitely a personal conversation I know you’ve taught me that, you know, over the years but what I want to share with this is there’s condo owners that sometimes maybe a little bit older, that are making a 2% return on their money and I look at it and say “Gosh you know what I wonder if they should be in an investment that has so much volatility” meaning they like the 2%, they’re okay with the return but then all of a sudden something happens, maybe rental occupancy goes down, and now all of a sudden that 2% return is no return, or these special assessments come on and then that one year they are assessed $200,000 or $300,000 that wipes out the majority of their return so when you’re in that situation where maybe you’re a little bit older and at a time that you might be thinking of taking less risk, how do you factor in volatility from a condo ownership standpoint into your rate of return to determine whether or not you should reposition your money, because we can talk about other places to make money in real estate, but how do you factor in risk?
Jeremy: Okay, so there’s… okay, factoring risk, so factoring in risk in my world and I’m going to translate it to real estate, but in my world is a sharp ratio, I’m not getting too technical with it, if I’m getting 2% it better be pretty safe, fairly if I’m getting 1% on the US treasury, for example getting 2% is really not that much more, so it better be relatively safe, okay? In real estate, I would imagine with all the different factors you just described, that’s a lot of moving parts that has to happen right for that person to get 2%, is that correct?
Greg: Yeah, basically it’s very sensitive, you know, that 2%, there’s a lot of factors that the owner does not control, it could just randomly happen then all of a sudden it could go a little bit higher or it could vanish.
Jeremy: Okay, that being said, the more factors that change the outcome, the higher the risk, okay? And so, I would imagine that oceanfront real estate it being, the economy and things like that amongst many, many, many other factors, is pretty volatile and to take on that type of risk for 2% return is something that I personally wouldn’t do and I would not advise my clients to do.
Greg: Understood, yeah so you said something interesting there’s so many factors, so like on an oceanfront complex, a lot of times they have the ability to say “hey, it’s been three years since you’ve changed your furniture, you need to redo all the furniture now” and that furniture package is $10,000, $8,000 whatever it is could knock out a couple years of return, that’s something you can’t control versus maybe if they were to sell and reposition their money into maybe a single family home then they could immediately get a better return on their money and there’s less factors, they make all the decisions so nobody can assess them, nobody can say “You’ve gotta change out your furniture” you may not be shut down and lose rental income because of a hurricane, things like that is that what you’re talking about?
Jeremy: Absolutely! That’s absolutely what I’m talking about. If you reduce the number of factors that can change your return, you’ve reduced the risk.
Greg: Okay, got it.
Jeremy: There’s one other thing to keep in mind as well, Greg, I do want to throw this out here, is that in a $200,000 example, let’s just suppose it’s free and clear, that person has a $200,000 asset, okay? And $200,000 in some people may represent 50% of their investible money which is a huge amount of risk, that may be taking for 50% of their money. That 200,000 maybe 1% of someone’s money but they have that $20,000,000, so that’s also a factor is what dollar amount does this represent in someone’s life as well.
Greg: Man, that’s, you know, that’s a new one for me, you know, we’ve had a lot of conversations on how to evaluate returns, rate of returns in real estate investments, and I try to emulate the financial world as much as I can when it comes to my interpretation or analysis of it, but that is a new one right there. I also want to say something else here, you know, we’re talking all financial, we’re talking as if this condo is nothing more than a piece of paper, right?
Jeremy: It’s not, it’s way more than that!
Greg: Yeah, it is, and there’s a lot of people that are buying these properties and they get to use it for a few weeks so in their mind they have a place to come down and live for two weeks or stay down, they have family that they can share their condo with, they got workers they can send down here, friends that they can let use the property for free or at a discounted rate, and they get a lot of value out of that, and I don’t want to discount that because there’s emotional returns and there’s financial returns, we are only talking about financial returns here so that doesn’t mean everybody needs to go out and sell their property, it doesn’t mean everyone needs to go out and start buying more property, what it does mean is that when you are buying or when you’re owning, you also want to look at the emotional return you’re getting because in Myrtle Beach, what happens is a lot of people will buy a condo and then four or five years later they’re not really using it anymore, it’s kind of ran its course, and then they keep it hoping that financially it’ll make sense, so they bought it for the emotional returns, but then the emotional returns run out and it turns into an investment, and now they are evaluated from an investment return, what I try to tell people is that when the emotional returns are no longer there, then you have to start looking at it as it’s an investment and this conversation comes into play, so I just wanted for those viewers out there I wanted to acknowledge that this is a financial conversation, lots of logic, there wasn’t much emotion in it, but I also don’t want to ignore that when you own a property if you’re getting use of it there’s a value in the experience, in the pictures you get to take at Thanksgiving with your family the birthday parties that you have in your condo. Let’s not ignore that that is additional value. Does that make sense Jeremy?
Jeremy: Very good point, absolutely good point. The negatives would be as HOAs come up and property gets damaged, that’s a negative respect to owner property then of course the positive to owner property is all the things you just described.
Jeremy: And the positive things you described is something that is hard to quantify.
Greg: Absolutely, I mean I’ve got things that I own that make no sense financially, but make every bit of sense emotionally and the experience for my family, and I won’t sell them for anything, so you know, we just want to understand both sides of the spectrum, so before we get off one of the real things that I kinda took away from the conversation with you is this: Is that the more variables there are that can influence the annualized return, especially variables that you don’t control, the more variables there are the more risk that you’re exposed to.
Jeremy:Absolutely and the dept of those variables as well.
Greg: The depth, give me an example.
Jeremy: Meaning that, like you just said, about $10,000 package for furniture, that’s an enormous dollar amount versus the amount of income they get that’s a huge depth of a variable.
Jeremy: But let’s just say you can buy furniture for 500 bucks that would be a small variable to give you an example.
Greg: Okay, well good, again thank you so much Jeremy. It’s Jeremy Finger with Riverbend Wealth Management here to just help us make some sense out of the financial side of real estate investing, so Jeremy, thanks a lot. I know we’re going to do quite a bit more of these.
Jeremy: All right thank you very much buddy.
Greg: You’re welcome.
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