Soundbite: Risk, uncertainty & fear…how to handle it

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An advantage of having some out-of-season soundbite episodes is the flexibility to dive into topical issues. This week, the subject of risk has been knocking at my door in various quarters, not for me personally, but for people that I encounter. So, today we shall have a little chat about risk and it’s buddies uncertainty and fear as we understand a little of what it’s about and then what we can do about them.

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Today’s must do’s

Consider how you react to risk. Are you conscious of your risk profile, do you identify both the likelihood and impact of risks in property, or are you frozen by uncertainty and fear? I would suggest that you adopt the 4-step process outlined in today’s episode:

  1. Identify and understand what risks there are
  2. Try to establish how likely they are to happen
  3. Assess the impact of them on us if they do happen
  4. Take steps to control, manage or just accept them

It will help you to make better investment decisions and should also help to manage your personal stress, reduce uncertainty and overcome fear as well 😊

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Transcription of the show

Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and it’s a pleasure to have you join me on the show again today.

An advantage of having some out-of-series soundbite episodes is the flexibility to dive into topical issues. This week, the subject of risk has been knocking at my door from various quarters, not for me personally, but for people that I encounter. So, today we shall have a little chat about risk and its buddies uncertainty and fear, as we understand a little of what it’s about and then what we can do about them.

Property Chatter

Risk, uncertainty & fear

First, let’s take a look at a couple of classic definition of risk.

From the Oxford Dictionary: “A situation involving exposure to danger.”

From the Cambridge Dictionary: “The possibility of something bad happening.”

Cheerful eh?

As humans, originally coming from cavemen roaming through treacherous landscapes full of wild animals and other dangers, we are hard-wired to respond to danger with a ‘fight or flight’ response. In these days, if we encounter danger, we either start a fight (usually if cornered), or more likely, will run away instead.

This reaction is still with us today, even though we are more civilised, experienced and generally speaking don’t have to fear being eaten by a sabre-toothed tiger!

Just consider a situation when someone cuts you up on the road, or you feel like you are being followed, or if someone starts yelling in your face. We all recognise that feeling where our heart rate rises, our hands get sweaty and we start to get ready to fight or flight.

I looked up Adrenaline and how it affects our bodies, here is what the Hormone Network has to say about it:

Adrenaline triggers the body’s fight-or-flight response. This reaction causes air passages to dilate to provide the muscles with the oxygen they need to either fight danger or run away. Adrenaline also triggers the blood vessels to contract to re-direct blood toward major muscle groups, including the heart and lungs. The body’s ability to feel pain also decreases as a result, which is why we can continue running from or fighting danger even when injured. Adrenaline causes a noticeable increase in strength and performance, as well as heightened awareness, in stressful times. After the stress has subsided, adrenaline’s effect can last for up to an hour.

It goes on to talk about the problems of too much adrenaline:

Adrenaline is an important part of your body’s ability to survive, but sometimes the body will release the hormone when it is under stress, but not facing real danger. This can create feelings of dizziness, light-headedness and vision changes. Also, adrenaline causes a release of glucose, which a fight-or-flight response would use. When no danger is present, that extra energy has no use, and this can leave the person feeling restless and irritable. Excessively high levels of the hormone due to stress without real danger can cause heart damage, insomnia and a jittery, nervous feeling.

OK, so let’s pause for a moment here then and summarise…

  • We are pre-programmed to look out for danger.
  • If we identify danger our bodies react to this stress physically by releasing adrenaline
  • Adrenaline helps us to get ready to fight or flight…or to run away
  • Stress-induced adrenaline can lead to some unpleasant or unwanted physical and medical side effects.

Two things should now be apparent…1) we have different levels of awareness and tolerance to danger or stress, and 2) we almost can’t help ourselves but to follow this process when we sense danger.

The first point is often related to uncertainty and fear in situations other than a real danger of personal harm and injury. In situations of real danger, if say we are being attacked, then our fight or flight response is actually very helpful. However, if we are not in any real physical harm, then our response can be unhelpful. Of course, what some may feel dangerous, others may not and so this gives rise to our different attitudes to risk. That’s why some people are thrill-seekers throwing themselves out of aeroplanes and others check the crime stats before visiting a new country!

So, we have different levels of comfort with risk, a risk-tolerance.

The second point is all about control. If our bodies automatically jump into fight or flight mode, adrenaline is released and quite often we can’t help but experience certain physical responses. However, we can learn to mentally and emotionally control our physical reactions to help bring us out of a stressful state and back to a normal state, where we can think more clearly and maybe not punch someone in the face instead!

So, we have different abilities in how we control how we react to risk too, a kind risk management.

In other words, if we understand our risk tolerance and practice our risk management, then we should be able to better manage our personal risk profile.

Most people do all of this unconsciously and so I like to help make this process a little more conscious or front of mind.

This means, deliberately thinking about what our attitude to risk is – low, medium or high at the basic level and also how we tend to manage or control risk in our lives.

In terms of investing, as with the rest of our lives, risk exists. Let’s not hide from the fact. Here is a definition of risk from an investment point of view, taken from The Investopedia:

Risk involves the chance an investment’s actual return will differ from the expected return. Risk includes the possibility of losing some or all of the original investment.

There is also the risk-reward trade-off to consider. This usually suggests that in order to compensate investors for taking a higher risk, a higher reward needs to be offered. Whilst it is not ALWAYS true that we can judge an investment’s level of risk by the potential reward available, it is a useful indicator.

So, with these consideration in mind – our appetite for risk along with our wish or need for reward, we need to then be able to measure the level of risk involved and then put steps in place to control or manage the risk.

Spoiler alert – there is no such thing as a risk-free investment, so let’s get used to the idea that we will need to practice risk measurement and risk management too!

Before I move on, I do wish to say that there are also some risks that are either not real or are so low that they can stifle us into fear and inaction. This means we need an ability of understanding it and then testing to see how real it is. This leads me on nicely to a 4-step process that we could adopt to better understand and manage our investment risk.

In assessing risk, we need to do four things:

  1. Identify and understand what risks there are
  2. Try to establish how likely they are to happen
  3. Assess the impact of them on us if they do happen
  4. Take steps to control, manage or just accept them

This should be a conscious or thoughtful exercise.

That said, I could argue that there are dozens, if not hundreds of potential risks that we could consider with any investment and property is no exception. Whilst, the likelihood of the sky falling in is a risk…it is not a very high risk based on several thousand years where this planet has not seen the sky falling in so far. So, we have to accept that some risks are just so low or remote that we either need to ignore them, or potentially just insure for them instead. Insurance, incidentally is a form of risk management.

I cannot go into too much detail about all of the potential risks that we might encounter in property investing. However, here are some examples we might need to be aware of, along with my sense of their likelihood, impact and some potential risk management controls we could apply to them.

  1. Interest rates go up

What is could it could mean.

This is mainly relevant when we use a mortgage to fund our property purchase, so if we are paying cash…perhaps we can ignore it? If interest rates rise, so too will our mortgage repayments and so potentially will our BTL rental profits reduce.

Impact

If interest rates rise by a certain level, we could end up in a loss situation and if we cannot fund these losses we face the threat of having the property repossessed.

Likelihood

If we take a look at interest rates over the last 20 years, you will see that they do fluctuate yes, but they are not usually highly volatile and make huge jumps. Rarely have we seen major jumps over a short period of time, but we have seen them trend up and trend down or remain stable for reasonable periods of time.

So, let’s get the facts before we live in fear of them jumping up and catching us out. The Bank of England now requires that mortgage lenders ‘stress test’ our ability to service a mortgage based on 145% rental coverage at a rate of 3% above our fixed rate or the standard variable rate in general terms. This is in fact a form of risk management that has been imposed upon us.

Is it likely that we will see interest rates rise by say 3% in a year? Well, the history of the past 20 years would suggest not. However, if you have a memory or insight into the 1970s you might recall that on a couple of occasions it has happened, so once or twice in around 50 years. I should also point out that inflation and wages have also tended to rise following periods of higher interest rates too, although usually with a slight lag. This means our tenants should then be able to afford rental increases to help offset the rising cost of our mortgage.

Risk management suggestions

Fix our mortgage rate for as long as we can comfortably afford. I usually favour a 5-year fixed rate unless I plan to sell a property before then.

We could also, set aside a contingency fund in case rates go up to fund a short-term gap.

We could probably expect to see some level of rental increase to offset this potential risk, especially over longer periods of time.

  1. We might get ripped off by [insert blank] in a property deal

Firstly, in property we either need or want to deal with several different types of people, from agents to professional advisers to contractors and so on. Someone might deliberately or negligently let us down, resulting in us losing some money or face another type of risk. An example might be a deal sourcer misrepresenting a great property project, or a surveyor getting a property valuation wrong for example.

What it could mean

With the example of a deal sourcer misrepresenting a property deal, we could either discover it and withdraw but be left with certain abortive costs or not discover it and be landed with a lemon of a property instead. With a poor valuation, we may find that we cannot resell the property for what we paid for it.

Impact

Abortive costs and potential loss of any sourcing fee.

Holding a property that does not perform as we were told it would.

The impact could range from the loss of a few thousand pounds in fees to being stuck with a property that we cannot get finance on or sell for what we paid for it for example. We would need to look at the impact in each case to fully understand it and then quantify it.

Likelihood

It largely depends on two things: 1) the character and values of the people involved and 2) the level of regulation and redress that they are controlled by.

In cases where we deal with professionals, such as the surveyor, they should be qualified, registered and insured to undertake their work and so this acts as an external risk management control mechanism that we can take some comfort in. However, that said, leading up to the last housing crash, there were some cases of valuers getting their valuations wrong and even the odd few acting fraudulently or corruptly. These were small numbers even so.

In the case of non-professionals, there is less external control over what they do and so a greater likelihood of them turning out to be rogues and ripping us off.

Risk management suggestions

  • Use people that are members of a professional or industry body with some sort of redress scheme as far as possible. These external bodies do help to reduce our risk but do not absolve us from our personal responsibility to make further checks ourselves.
  • Do background checks on the people that you work with – Google them and seek references or social proof of their capabilities.
  • Work with people with experience and a proven track record as far as possible.
  • Document your expectations, agreement and include provisions or conditions for a refund / return of fees if paying in advance for services offered.

  1. Over-paying for a property

If we buy a property, we want to know that it is worth what we are paying for or even less.

What it could mean

If we overpay for a property, we might lose money if we try and resell it or we may reduce our returns if we got the sums wrong. We could also be stuck with a property or even have a reduced valuation for a mortgage.

Impact

  • Loss of some capital or investment performance
  • Reduced lending capability
  • Unable to resell

Likelihood

If we are buying on the open market and have a survey or valuation done, then the chances are low that we will be committed to taking on an over-valued property. Once we remove these external controls, then unless we undertake certain checks, we are more likely to see it happening.

Risk management suggestions

  • Benchmark prices against recent sold comparables for like-for-like properties in the local area.
  • Get a survey or valuation done
  • Enlist a trusted adviser or professional to assess a property’s condition
  • Undertake thorough legal checks using a recognised and suitably qualified solicitor

So, that’s just 3 potential risks that we have covered today. Some of you might be thinking, I wouldn’t do all of what you suggest Richard, whereas others might be saying, blimey Richard I would go way deeper than that! That’s our risk tolerance or risk appetite speaking and as I said, it’s good to be aware of that as we are different.

Then, of course we do need to work out how likely a certain issue is of happening in order to quantify that risk before then trying to evaluate or measure the potential impact it could have on us. Remember, that not everything we worry about will actually happen. Finally, we should put steps in place that helps us to control or manage these risks to our desired risk profile.

However, the most important thing is to do all of this consciously and in a thoughtful manner. If we follow these four steps, we should become more aware of the risks that we are taking and our ability to tolerate them to help reduce uncertainty. We should also factually evaluate how likely they are to happen and so help to reduce our fear as a result. Finally, we then determine what steps we can and will take to control and manage these risks, perhaps trading off our returns in the process.

It may be the case that we either proceed with greater risk management controls, compromise on our returns by building in additional protection or even decide not to proceed with an investment at all. The main thing to keep in mind is to try to eliminate the physiological fight or flight stress response, the thought of not knowing what we are facing and also the emotion of fear that something might go wrong that we may experience during our investment activities.

By adopting this system or process, we can start to both understand and manage our personal risk and make it more conscious and rational, rather than unconscious and perhaps irrational or emotive.

I know this might be more difficult for some people than others, especially if you are more intuitive or emotional as a person generally. However, if you can at least try or even force yourself to adopt the type of approach that I am outlining here, it could help to reduce your personal stress. It will also shift you more toward the approach of a professional investor that can identify, measure and then control their investment decisions. It will be worth the effort both personally and also from an investment performance point of view.

Trust me on this, it is something I have learnt to deal with better over several decades in business and investing too!

I know I could have gone deeper on this topic but of course time is limited and Matthew my producer is waiting for the recording as I speak! However, if you want to discuss it further with me, remember that you can email me podcast@thepropertyvoice.net if you want to talk about anything from today’s show or more generally in property investing. The show notes will be over at the website www.thepropertyvoice.net

But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao-ciao.

The post Soundbite: Risk, uncertainty & fear…how to handle it appeared first on The Property Voice.

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