Top Risks of Real Estate Leverage

Used properly, real estate leverage can be an effective tool for real estate investors to increase their return on investment. The key is to avoid making decisions without proper consideration of the areas of risk in leverage. Avoid these high risk behaviors and you have a far better chance of realizing success in using real estate leverage.

1. Don't Count on High Levels of Appreciation

Many a real estate investor has gotten into financial trouble by looking at past history, even if recent, and relying on the future to produce the same results. Even if property has been appreciating at a 12% to 20% rate for a number of years, counting on that rate to continue is an extremely risky proposition. It can cause you to overpay for properties, expecting to realize the difference at sale from appreciation. If it doesn't happen, you're holding a loss or worse.

2. Don't End up With Too High a Payment

It can seem like a great investment to control a property with a very small down payment. You're looking at the numbers and seeing a really high return on investment due to your low cash outlay. The problem is the higher payments that come with higher leverage. Should the market soften or your properties experience higher-than-expected vacancy or credit losses, you could find yourself unable to maintain those higher mortgage payments that seemed fine at the beginning.

3. Don't Let Good Financing Result in a Bad Purchase

Many an investor has overpaid for a property because they found nirvana in a high leverage financing setup. Just because you can get a property with very little cash outlay doesn't mean that it's a good buy. Look at the value of the property in the context of current and expected market trends. If the property is overpriced, appreciation will be minimal or worse be non-existent. And woe be unto you if the market retraces itself for a while. Your overpriced property will be a significant drag and you'll not be able to unload it without taking a loss.

4. Don't Forget That Cash Flow is King

If just one of these "don't" behaviors sticks in your mind, this is the one that you should consider carefully. Errors in judgement in one or more of the other items here can be overlooked if you have that one great thing - excellent cash flow. If your rental income minus your mortgage costs and expenses is putting a nice cash return in your pocket every month, then the fact that the property didn't gain in value this year won't be as worrisome of an event.

*by James Kimmons . . .

Where next for risk management?

Risk management might be enjoying an unprecedented level of visibility in the wake of the financial crisis, but companies that take a genuinely strategic approach to their risk management remain few and far between.

They might acknowledge the importance of good strategic risk management, but a new report from the Economist Intelligence Unit reveals that most companies remain reluctant to make significant financial investment in their risk functions or to integrate risk management into the heart of their day-to-day activities and culture.

The report, Fall guys: Risk management in the front line, suggests that many companies have still not grasped strategic risk management. Senior executives regard the identification of new and emerging risks – such as weak demand and market volatility – as the key goal of risk management. But only around a third felt that their company is effective at anticipating and measuring emerging risks.
This problem is compounded by the fact that most companies fail to involve risk functions in key business decisions. Few companies even expect risk functions to play a support role in decision-making, with just four out of 10 saying they expect risk managers to provide analysis to help management set corporate strategy.
And instead of helping business managers to achieve their objectives, the bulk of the risk manager's job appears to be taken up with compliance, controls and monitoring.
"In the wake of the financial crisis, there were plenty of stories about risk managers whose legitimate concerns about the business were ignored and regarded as a brake on growth," said Iain Scott, senior editor at the Economist Intelligence Unit.
"Three years on, the incentive to ensure that there is a clear and consistent approach to managing risk across the enterprise has never been greater. But while strategic risks dominate companies' concerns about the year ahead, many clearly find it difficult to link risk management with overall company strategy. Often, the barriers to effective strategic risk management appear to be corporate culture and poor communication."
The report points to a lack of investment as another reason for this failure to integrate risk management into the strategic decision-making process. Despite its greater prominence, risk management has not generally attracted significant financial investment over the past year. In fact fewer than half of companies have invested in risk processes and fewer than a quarter have allocated funds to boost headcount or training of risk managers.
As result, there is a danger that the authority and importance of risk management will decline when the good times return – a danger that is exacerbated, the report argues, by a lack of risk expertise among non-executive directors who ought to be playing a crucial role in setting the tone from the top and instilling a broader culture of risk awareness in the business.
According to Andrew Kendrick, Chairman of ACE European Group, who sponsored the report, said that the risk management profession had arrived at a crossroads
"If it allows itself to be side-lined into the purely technical aspects of risk management and fails to take the steps necessary to engage colleagues and build a risk culture within their business, it will lose its relevance as better economic times return.
"If, on the other hand, risk managers concentrate on proving their worth as positive and proactive contributors and demonstrate that they can help their businesses take advantage of risk, they will strengthen their position. Ultimately this will not only secure their future as an invaluable corporate resource but will also help ensure the long-term success of their organisation."

*by Brian Amble . . .

Top 6 Problems with Risk Management

When you try to implement a methodology or invite a habit in your organization it won’t ever go without any problems. People don’t like to change, albeit their adaptation skills are high. Someone has to overcome the resistance and make whole thing working. He needs to find out what exactly doesn’t work and why. MSF is no different here.
One of hardest parts of MSF to implement was risk management. It’s funny because when you read about that it looks so reasonable and it all makes sense. We unconsciously manage risks in our lives whole time. Unfortunately, people’s attitude changes when it comes to a bit more formal process, which involves regular participation. Here are some typical issues with risk management. It’s based on MSF implementation example, but case is general.
1. That’s too general – I don’t see how it can work. That’s one problem with defining a risk: if it’s too general, e.g. “new version will be released late” it says nothing about real problem – potential reason why there can be a slip. Lead developer will be sick. Our last tester will change a job. Program manager is taking holidays during last two weeks of timeline. A reason should be named, not a result. And remember many reasons leads to the same result, so in this case naming a reason will bring more detailed risk.
2. That’s too detailed – I don’t understand a problem. That’s another problem with defining a risk: if it’s too detailed, e.g. “problems with multithreading in new API function will result in overrunning code complete milestone”, no one understands it. This risk is probably understandable by two or three developers actually using the function. For the rest of the team there will be a bigger impact on project when coffee is over. They don’t understand the risk and that’s why they won’t rate it high, so you can spare some time with not adding it to the list. Either make it understandable or throw it away.
3. Where’s the avoidance plan? That’s the hardest way of inventing a risk. Usually it’s easy to name the threat and rather not difficult to find emergency plan. But when you don’t equip your risk with good avoidance plan it’s almost worthless. OK, we can be late with the project, but what to do to ship on time? The answer can’t be just: “work harder,” it should be something different from things you’d do if there were no risk. Recruit someone, plan some bonuses for working overtime, switch some tasks between people, negotiate deadlines with customer, do something new. Of course sometimes no matter how hard you try you won’t come with anything reasonable here. Then you just accept the risk is going to materialize – you aren’t shipping on the end of the month. There’s nothing more to do. Shit happens.
4. I don’t see any change. OK we have our nicely crafted risks, we vote for them and discuss them on weekly basis, but where’s the difference? In the top 5 list there’s always the same set of risks, the same set of people responsible for them and the same things told. “This week nothing changed.” If really nothing changed person responsible for the risk should be ashamed, but usually something changed but it’s not reported because it doesn’t seem important. “Most of planned tests in accounting module were done, number of bugs increased, but we finally closed the tricky issue with deadlocks. In my opinion risk still stands high, even a bit higher as we’re a week closer to the deadline, but we’re moving forward.” Do you see a change now? There can be another reason – when often nothing changes and it doesn’t need to be the problem with people, it’s possible that you evaluate risks too often. I don’t say that weekly basis will work for every project.
5. Hey, that’s another thing I have to do. That’s obvious. Evaluating risks takes several minutes per week, but still it’s another thing to do. No one wants more bureaucratic work. Unless people believe that it really works it’ll always be something they do because they have to.
6. I don’t believe in that. That’s the most important and hardest to resolve issue. When you invite risk management process it doesn’t work perfectly from the very beginning. I’d even risk a statement that risk management on the very beginning doesn’t work at all. What more, even when it starts working, results are usually seen from management level – most of the team doesn’t see a difference even if you’ve ruled out an overrunning the deadline risk. After some time it becomes another duty which has to be done but gives nothing in exchange. You can’t tell the team to believe in the process. They have to see it works. Personally I started to believe in risk management after more than a year of participating. We ruled out two top risks only because we were working on them during whole development cycle and that was because they were topping during risk management sessions. When something like that happens show it to the team: “Look, after first sessions we feared this and that and when we were finishing a version do anyone even remember that?”
The key thing is confidence that risk management works. If you can convince the team that it’s helpful you’re more than halfway home. The rest can be and will be altered during risk management sessions. The hardest thing is improvement in people’s confidence.

*by Pawel Brodzinski . . .

Invest in Gold

Financial asset classes and instruments usually carry three main types of risk.
• Credit risk: the risk that a debtor will not pay
• Liquidity risk: the risk that the asset cannot be sold as a buyer cannot be found
• Market risk: the risk that the price will fall due to a change in market conditions
Gold is unique in that it does not carry a credit risk. Gold is no one's liability. When you invest in gold, there’s no risk that a coupon or a redemption payment will not be made, as for a bond. There’s no chance that a company will go out of business, as with an equity.
Unlike a currency, the economic policies of the issuing country cannot affect the value of gold, nor can inflation in that country undermine it.
Gold benefits from demand among a wide range of buyers - from the jewellery sector to financial institutions, to the technology sector and manufacturers of industrial products and medicines. A wide range of investment channels is available, including coins and bars, jewellery, futures and options, exchange-traded funds, certificates and structured products.
Liquidity risk: Worldwide markets trade gold 24 hours a day. The gold market is deep and liquid, as demonstrated by the fact that gold can trade at narrower spreads and more rapidly than most diversifiers or even mainstream investments.
Gold, like all financial assets, is subject to market risk. However, it tends to have low correlations to most assets usually held by institutional and individual investors, which significantly enhances gold's attractiveness as a portfolio diversifier. Research published in October 2010, demonstrated that gold can help to reduce the potential loss suffered when infrequent or unlikely but consequential negative events, often referred to as “tail risks”, occur. Specifically, even a small allocation to gold, ranging between 2.5% and 9.0%, can decrease the Value at Risk (VaR).
Volatility is a good indicator of market risk, measuring the dispersion of returns for a given security or market index. The more volatile an asset, usually the riskier it is. The gold price is typically less volatile than other commodity prices. This is because of the depth and liquidity of the gold market, which is supported by the availability of large above-ground stocks of gold.
Gold is virtually indestructible, which means nearly all the gold ever mined still exists today. Much of it is in near market form, meaning sudden excess demand for gold can usually be satisfied with relative ease.
Adding to price stability, gold is mined all over the world. Unlike many other commodities, this geographical diversity reduces the chance of supply shocks from any specific country or region impacting heavily on gold’s price. Consequently, gold is generally less volatile than heavily traded blue-chip stock market indices such as the FTSE 100 or the S&P 500.

 

Source : http://www.gold.org/investment/why_how_and_where/why_invest/gold_and_risk/