Risk And Danger In Real Estate Flipping
Written by admin on March 20th, 2010
Danger is something to be avoided at all costs. A sign that says “Danger-Unexploded Ordinance” means keep away. Rational individuals do not trespass. Risk needs to be embraced by investors because without risk there is little, if any, return. All forms of investment are risky.
Risk and danger are not the same.Avoiding risk is not the issue. Getting compensated adequately for bearing risk is the issue. All commercial real estate opportunities have risk, just as all other investments have risk.
For investors the risk they are exposed to is not simply the sum of the riskiness of all their individual investments. Rather, it is the risk inherent in their entire portfolio. The risk of individual investments is not the same thing as the risk in the portfolio. This is because the risks of the different investments in your portfolio are more or less correlated with the risks of other investments in your portfolio.
The effect of diversification among different types of investments is generally to reduce the risk of the overall portfolio without necessarily reducing return. This happens because the individual risk on one element in the portfolio may be largely independent of the risk of another element in your portfolio, so the risk of the portfolio itself declines.
There are a lot of highly technical and mathematical ways to measure risk. All of them suffer from a variety of imperfections. Indeed, they are so mind numbing in their complexity, that the best approach to evaluating risk for the individual investor is common sense.
An important implication of this concept is that investors should not evaluate the risk and return on an individual investment in terms of the riskiness of that particular investment alone.
Instead, the risk should be judged by the impact of that investment on the riskiness of the overall portfolio itself. This means that it is possible to add a relatively risky investment to a portfolio and have the total riskiness of the portfolio go down. This reflects the way in which the riskiness of that investment is correlated with the riskiness of the existing investments in the portfolio.
