House to House: Managing Your Risk in Buying Real Estate, Part Two 

by Gary Isom, AREC Executive Director

Last week, you heard about how important it is for buyers to know their own personal risk tolerance level, or their willingness and ability to accept the risks associated with buying real estate. Let’s take that discussion one step further. Since every real estate purchase involves risk, buyers should not only know how much risk they can tolerate but how they will choose to manage that risk.

There are basically four methods of managing risk: avoiding risk, reducing risk, transferring risk and assuming risk. Once a buyer identifies his risk tolerance level, he should also determine his preference for managing those risks and then make his buying decisions accordingly. Unfortunately, many buyers fail to do this and end up making decisions that simply do not correlate to their level of risk tolerance.

When I purchased my current home, it was a foreclosed property that had been on the market for over a year. I spent several hours looking at the house and eventually decided to make an offer. I knew there were problems with the property. I also knew that after my purchase I would likely learn about other problems that I hadn’t found. I accepted the fact that once I closed on the property, all those problems would become my problems. In other words, I assumed the risk.

Consumers who are not thus inclined to assume unforeseen or contingent risk have several options, primarily by employing tools that reduce risk. Sadly, these are the tools that buyers frequently pass up in order to save money. One such tool is a property survey. A survey offers a buyer protection by addressing the risks associated with property boundaries, easements, encroachments, rights of way, utilities, etc.

Another important tool that buyers often forego is the home inspection. A buyer who expects the property they are purchasing to be problem-free should have that property inspected so that they can be as fully informed as possible prior to closing.

While not required by law, buyers can also request a seller disclosure form, or property condition disclosure, from the seller. The Arkansas REALTORS Association has a form designed specifically for this purpose which all real estate licensees can make available to their clients and customers.

If a buyer is concerned about paying too much for the property, an appraisal should be considered (if not already required by the lender). The last thing this buyer should do is base their decision upon the square feet of the property and what a typical house in that neighborhood sells for per square foot. It’s fine to use this “rule of thumb” as a guideline, but if your risk tolerance is such that you really fear paying too much for the property, get an appraisal.

Another method of managing risk is transferring the risk. A home warranty is one way many consumers choose to do this. However, buyers who purchase a home warranty should take time to read the warranty and discover what is and is not covered. This should be done prior to closing.

Homeowners insurance is another tool that transfers risk. When I bought my home, I didn’t assume 100% of the risk involved. I also chose to transfer risk by purchasing homeowners insurance to cover catastrophic loss such as fire or storm damage.

In summary, if you, as a buyer, determine that you have a low risk tolerance, you need to decide how you will utilize the four methods of managing the risks associated with purchasing real estate. First, the only way to truly avoid risk is to NOT purchase real estate. While this may be the best solution for some consumers, for most of us, it’s not really viable.

As such, you will need to consider other ways to manage your risk. The tools above – surveys, home inspections, property condition disclosures, and appraisals – can help reduce risk. Home warranties and homeowner’s insurance aid in transferring risk. Lastly, assuming some level of risk is inherent in the purchase of real estate – the question is how much risk you’re willing to assume.

So, before you make that next real estate purchase, be honest with yourself and assess your risk tolerance level. If you want the property you purchase to be as problem-free as possible with the fewest possible post-purchase repair expenses, utilize those tools that match your low risk tolerance level. However, you’ll have to accept the fact that your front-end investment will likely be greater.

If, on the other hand, you’re willing to roll the dice and take a chance to hold down those front-end expenses, then by all means proceed accordingly. But, as I said before, be honest with yourself. If you don’t want to pay top dollar for the property and the costs associated with surveys, home inspections, etc., then when those post-purchase surprises pop up, be willing to accept the fact that you agreed to assume that risk when you purchased the property. Be prepared to open up your checkbook as opposed to spending time looking around for someone else to bear the costs of your decisions. Real estate just does not come with a money-back guarantee.

 

House to House is distributed weekly by the Arkansas REALTORS® Association.  For more information on homeownership in Arkansas, readers may visit www.ArkansasRealtors.com.