How are you weighing up risk vs. reward on potential projects? What is your Risk Assessment Strategy?
I think we could all do with a good discussion around this in the property industry. There are a lot of potential risks and I wish it was spoken about more openly – but in a balanced, and productive way…
So let’s go.
This might sound strange to hear, doing what we do… but we at Tomes Homes actually have a very LOW risk profile… and yet we have still managed to do a lot of projects and move things forwards very quickly…
I had a question from a client this week on this very topic, and it forced me to get into more DETAIL about our decision making process when it comes to weighing up risk vs. reward. So I wanted to share this as I hope it can help you too.
Overall, the question is…
What kind of returns do you need to see to feel COMFORTABLE with the RISKS you are taking on?
And the sub questions are…
1- What is your risk assessment model for this?
2- How are you deciding the level at which a projects risk outweighs its potential reward?
3- Which factors weigh most strongly for / against a project?
Some of the areas we would consider as part of this overall assessment are…
- Are you on high interest finance? How confident are you on your timelines? Is there any chance (no matter how small) of timeframes extending beyond the end of your finance terms?
- How confident are you on the viability of your refinance and expected interest rates? Do you have a tried and tested Lender lined up?
- Deal structure: are you fully financing the project with debt, or are you sharing the reward / risk with equity partners?
- Level of refurb / conversion / scope of the project – how many unknowns are there?
- What planning / building control / utility / warranty or similar other factors are there that may be outside your control – how many parties are you reliant on to create a successful project and ‘get out’?
- Current market conditions, is there a chance these could get worse before the end of the project? If so, what is the impact?
- Viability of exit strategies: thinking about how well does it cashflow and how easy would they be to sell if necessary?
- What experience do you have to date of doing this specific type of project (and so therefore what awareness do you have of the potential pitfalls)?
- What team do you have around you to support you, and are you totally confident on their ability to deliver for YOU?
We would be assessing each of these on a ‘reasonable worst case scenario’ basis, to consider just how much impact they could have on the project if things didn’t go our way, and what ideas/plans we can think of to be able to mitigate or deal with these risks where possible.
Our assessment of the factors above have lead to real refinement of our business model: the area, the purchase prices, the deal structure, the finance type, the level of works we would consider and this is all then translated into a level of profit that we would require to be happy moving ahead on each and every project. For us the assessment figure we usually use is % uplift on cost based on the End Value, which gives us the profit margin available for every project. The concept is simple, the higher the risk (as assessed using the areas above), then the higher this % profit margin needs to be.
There are no ‘right’ or ‘wrong’ answers to any of the above – it will be very personal to you and your attitude to risk. But you should know answers to questions like this, and to be able to have a rational discussion around them when deciding whether a deal is right for you or not. Once you’ve decided what you are comfortable with in terms of risk vs. reward then you can make an unemotional business decision as to whether a project fits your personal risk assessment model or not.
You will probably need to reflect on your decision as you go through the purchase process on a project. Every time information of significant importance comes to light in regards to a project, we would always try and review the deal again from a completely fresh perspective, just to ensure it still makes sense for our business to move ahead with it (as if we were being offered that deal afresh at that moment). This is a positive thing to be doing – even though it may feel you are going around in circles sometimes.
When having these ‘Risk Reviews’ on a project when something changes, there are a couple of things that I would say that you should NOT let influence your decision to proceed with a project…
1 – Time you have put in to date
2 – Money invested to date
3 – Letting down stakeholders
These can all influence your EMOTIONS. And when it comes to making a decision to proceed with a project it needs to be based on cold, hard, LOGIC. It’s a business decision.
As a quick estimate, we’ve lost between £15k-£20k (and hundreds of hours of our time) walking away from situations where we have made the decision that a project no longer fits our risk criteria meaning that we are no longer comfortable to move ahead. And with the benefit of hindsight, those have been some of the BEST DECISIONS we have made. I would definitely choose to lose that money again to NOT do those projects.
Don’t just take action and buy something because you want to ‘do something’ – make sure you are weighing up the risk and reward in a balanced way or you could get seriously burned.
There’s no point (in my opinion) just going BIG, building up something massive, that has a high % chance of just falling apart when a few factors don’t go the right way.
DON’T just take MASSIVE ACTION just for the sake of it, because I promise you… there will always be another deal!
Questions, comments, thoughts and builds on the above would all be very much welcome so we can all help each other to do better deals that help us to grow sustainably.