“Real estate is like musical chairs: You just have to make sure you have somewhere to sit when the music stops playing,” said a client of mine at the beginning of his real estate investing career. Of course, he was feeling the risk associated with investing, in a single decision, what might be a decade of income for most people. The music stopped a couple of times over the next 20 years, but he always found a place to sit. Now, his portfolio has a few hundred Hub rental apartments in it.

Harold Brown once acknowledged the risk associated with real estate investing a different way. Counseling a 30-year-old on how to get rich in real estate, his simple advice was simple: “Survive.” The octogenarian survived five downturns and some of the apartments he bought for a few thousand dollars a unit are now worth a few hundred thousand dollars a unit.

Mitigating Risk

Although it’s rarely openly discussed, market risk is an inherent part of the investment conversation.

Ed Marsteiner, the director of acquisitions for National Development, said that real estate investors and developers are really in the risk mitigation business, and that “the great investors and great developers are great risk mitigators.”

“That’s our ultimate focus, on ways that we reduce risk in a deal,” he said. Clearly, their track record shows that National Development are great investors, great developers and of course, great risk mitigators.

Michael Roberts, senior vice president of development at AvalonBay Communities, said one way to reduce risk is “to stay with what you know, what has been successful for you in the past.” He pointed out that “there’s always a tendency in a heated market to look for pioneering locations and going outside of what you normally do, but that it’s less risky to invest in markets, specifically submarkets, where there is investment, infrastructure, jobs, people living in the area that have attractive incomers and other investors.” Thoughts like that make it easy to understand why in the last 15 years AvalonBay has become such a leader in our market.

While there are a lot of ways to mitigate risk in an investment, Jonathan Davis, the founder and CEO of The Davis Cos., shared his mantra for the disciplined investor: “You make it on the buy.” Davis said, “If you buy right, then it cures a multitude of sins.”

And while risk is an intricate part of the investment equation, it can be challenging to see when the market has become more risky. It’s not as if markets have bond ratings that publicly change.

Marsteiner said that where we are in the real estate cycle is a frequent conversation among his peers. And while there is risk in all the real estate cycles, things that indicate to him that the investing environment is more risky is when there is too much emphasis that the purchase price is cheaper than replacement cost or when he hears that vacancy is opportunity. Instead of buying assets that need historic highs to justify the acquisition, he likes to buy when the assumptions are places that the world has already been. Jon Davis phrased it similarly, saying that investments get more risky when cap rates go down … Ah, the good old, bad old days of real estate, when real estate had a lot less value.

Feeling Strong

Our market is certainly seeing reduced cap rates, pioneering locations, historic highs and maybe even a new paradigm concerning luxury apartment construction, yet it feels like the strongest market in my 18 years in Boston real estate. Is it? Or do I just get that feeling because my favorite saying about real estate risk is that the cheaper it is, the riskier it is?

David Begelfer puts part of the risk conversation in context, noting that “the reality in the marketplace is that it’s always a herd mentality – you know people love to buy at the top of the market, and no one ever wants to buy at the bottom of the market.”

Could the herd mentality be the most risky aspect of real estate investing? It certainly can lead to missed opportunity. Some may recall that in 1994, the 35 cents a square foot paid for the former headquarters of Wang Computer seemed very risky. Yet just eight years later those buildings sold for $130 a square foot. And when more recently, the market seemed too risky to finance or construct condominiums, Millennium Partners did. The result, of course, was the fastest sell-out in the company’s history.

But of course, herd mentality can also lead to irrational exuberance. So in terms of risk, sometimes when everybody zigs, the best strategy is to zag.
David Bates is a broker with William Raveis Real Estate and author of The Bates Real Estate Blog, www.BatesRealEstateReport.com, and a recently published e-book, “Context: Nine Key Condo Markets, 2.0.”