FEATURE: Smart Risk-Taking

Calculated Risk

BY MARIWYN EVANS

Risk is a part of life. Speeding to make an appointment on time. Committing your entire marketing budget to build a killer Web site. Investing your savings in a new apartment building. Entering a vacant listing with a stranger.

Whenever you engage in something with an uncertain outcome, you’re taking a risk. The higher the uncertainty, the higher the risk. That risk may be financial, legal, intellectual, social, or physical, but in every case, you’re staking the potential consequences against the expected benefits. Most people think of risk in terms of loss; indeed, Merriam-Webster’s Collegiate Dictionary defines risk as “possible loss or injury.” Yet, risks can also present opportunities that will be lost if a risk is avoided, notes William Shenkir, William Stamps Farish Professor of Free Enterprise at the McIntire School of Commerce at the University of Virginia in Charlottesville.

That’s why learning to take wise risks is so critical to both personal and business success. When it comes to risk—whether you’re Richard Nixon normalizing relations with Communist China or Lance Armstrong winning seven Tour de France victories after overcoming cancer—nothing ventured, nothing gained.

The psychology of risk

Most people prefer the comfort and safety of regular routines. Yet some of us are natural-born risk takers, says Frank Farley, the Laura Carnell Professor of Educational Psychology at Temple University in Philadelphia. These “Big T” risk takers—the T stands for thrill-seekers—are the people who go from one start-up to another,hang glide off cliffs, or propose radical new ideas and theories. “Big-time risk takers are the experimenters of life; they want excitement, not safety,” he says. That excitement may be Albert Einstein developing the theory of relativity or Evel Knievel jumping over 10 cars on a motorcycle, says Farley, but it always involves the willingness to see beyond the customary way of doing things and embrace innovation.

Nurture as well as nature plays a part in our reaction to risk, says Kimberly Thompson, associate professor of risk analysis and decision science at the Harvard School of Public Health. Your risk-taking profile as an adult is influenced by whether you were encouraged to try new things as a child or constantly cautioned about danger, notes Thompson. And these messages can be inconsistent. “We encourage small children to take risks—get up and walk, ride a bike, raise their hand in class. Then when they’re older, we often discourage risk taking in social situations or career choices,” she says.

Your sense of self-worth and self-confidence can play a big part in your willingness to take risks, adds Farley. “Risk takers believe that their fate lies in their hands.” Another distinction is that risk takers don’t equate failing with being a failure.

Ralph Keyes, author of Chancing It: Why We Take Risks (Little Brown & Co., 1985), differentiates between what he calls “sprinter” and “marathon” risk takers. Entrepreneurs tend to be sprinters, who feed off the excitement of the new. Marathoners are more willing to shoulder long-term risks, such as slowly building a company.

In general, women may have more difficulty taking risks than men, notes Laurie Geary, principal of In Gear Coaching & Training (www.ingearcoaching.com), in Cambridge, Mass. Cultural expectations that emphasize caution, a shortage of risk-taking role models, and fear of failure—as well as fear of success—all contribute to women’s inhibitions, says Geary in her workbook Risk to Grow! (In Gear Coaching & Training, 2001).

A three-step process

Whatever your emotional makeup, it doesn’t have to hold you hostage. Whether your tendency is to sit on your hands or go with your gut, you can develop a reasoned approach to risk.

“Risk taking should be a rational, not an emotional, decision,” says Carl Pritchard, principal with Pritchard Management Associates Inc. (www.carlpritchard.com), a company that analyzes risks and conducts risk management training for businesses. In corporations, analysts use sophisticated statistical models to assess the probability of risk. One widely used type of calculation is the Monte Carlo simulation, which randomly generates values for uncertain variables over and over to simulate a model of uncertainty.

For most people, though, a simple, three-step process will provide a reasonable basis for rating risks. The first step is to identify all recognizable risks and the impact of each specific event, says Pritchard, who is also the author of Risk Management: Concepts and Guidance (ESI International, 2001). For example, if you invest in a single-family rental property, one risk might be that you are unable to find a tenant who will pay a high enough rent to cover the mortgage payments. Another might be that a tornado will hit the building and damage the structure so that you’ll lose several months’ rent. Pritchard suggests that you state specifically what the outcome of an occurrence would be and write each as a complete sentence.

The ideal way to do this exercise is in a group setting, suggests Shenkir, since each person will bring unique experiences to the exercise. You can brainstorm with others either face-to-face or through group discussion software. Pritchard suggests that each participant in a risk brainstorming session use paper or Post-it notes to write down five possible risks. Then the risks can be grouped into broad categories—legal, financial, and so on. At this stage, the key is to think of every conceivable risk that might affect the investment. Don’t worry about how likely a risk is; just put it on the list.

Next, take the laundry list of risks—either as a group or on your own—and attempt to assess the quantitative and qualitative impact of each event—how likely is it that each event will occur and how big an impact will each event have on you? For this analysis to have value, risks must be ranked on researched data, not just instinct, says Thompson, who is also the author of Risk in Perspective: Insight and Humor in the Age of Risk Management, a guide to risk management related to the health care arena. You have to analyze data on past events for similar situations, ask your peers for their opinions on the likelihood of events, and research trends so you can rationally assign a value to each risk. Past results are about 90 percent accurate in predicting future outcomes, according to Pritchard.

In our example, if you find that residential vacancies in your area are at a five-year high, you may calculate a high probability that you won’t be able to rent your investment unit and may face a financial loss. On the other hand, if you have enough money saved to cover your mortgage for a year, the risk of the occurrence remains high, but the magnitude of the impact falls to medium or low.

The probability of some occurrences may not be easy to quantify, but resist the temptation to guess, says Zur Shapira, William R. Berkley Professor of Entrepreneurship and Management at the Stern School of Business at New York University and author of several books on risk taking. “Research shows that intuition isn’t a good way to assess risk, primarily because people are much more sensitive to losses than gains.” For example, he notes, an investor will take more risk to avoid losing $50,000 than to gain $50,000. Similarly, he says, managers in many companies are less willing to initiate new programs because the penalty for failing is much higher than the accolades and other benefits for success. The same phenomenon makes many sellers reluctant to list a house in a falling market.

One way to track risk probabilities is using a simple spreadsheet that lists each risk, ranks the probability of the event, and puts the magnitude of the impact on either a numeric or a high-medium-low scale. An alternative is to plot the risk of each event on a risk map, suggests Shenkir. The horizontal axis of the map ranks the likelihood of an event on a numeric scale; the vertical axis shows the impact (see illustration above). By plotting each event, you can weigh its riskiness compared with that of other options. For example, an incident with a high impact but a very low likelihood of taking place may have only a moderate risk, as would an event with a considerable likelihood but a very low impact. You can also assign dollar values to the vertical axis.

Another option is to give each risk an expected value by multiplying the amount of a potential loss or gain of each possible outcome by the probability of its occurrence and then adding the sum of these calculations, suggests Shapira in his book Risk Taking: A Managerial Perspective (Russell Sage Foundation, 1995). In a simple example, Shapira calculates the expected value of a coin toss, in which a participant who chooses heads in a coin toss will win $10 if the result is heads and nothing if it’s tails. The expected value of the game is $5 (0.5 x $10 + 0.5 x $0 = $5).

One flaw in objective risk analysis is that it doesn’t take into account the emotional side of risk taking, notes Temple University’s Farley. Your emotional reaction to risk can affect how you weigh variables even when you’re trying to be objective. A fearful person will give more weight to a possible cost while an optimistic person might give too little emphasis to the downside.

Factoring in your feelings and attitudes is fine, so long as you don’t do so at the expense of the data, says Shapira. Some people ignore risks because they don’t believe that something negative will happen to them; others always think the worst.

The final step in risk analysis is to decide upon a response to each risk on the basis of your analysis. Decide which categories of risk worry you most and focus on them. Identify what level of risk you’re comfortable with, and then choose your best options. One method is to look at the worst-case scenario for a risk, then decide if you can handle that, suggest Shapira. Another eliminator is to look at outcomes with irreversible consequences, then concentrate on the outcomes you know you could recover from.

A part of the decision on accepting or avoiding any risk is what the payoff would be in relation to the possible loss. A basic principle of investing is that as the risk rises, so should the potential for return. The same rule of thumb applies to other types of risk analysis, says Pritchard. For example, suppose that you have the choice between buying an investment property in an established neighborhood and a lower priced one in a marginal neighborhood that seems to be improving. The risk is higher in the changing neighborhood, since it may not improve rapidly and prospects may not be as eager to live there. At the same time, there is probably more profit potential in the riskier neighborhood since the initial price was lower.

Payoffs for risks don’t have to be just money. “Rewards can be whatever you prize: your reputation, being thought of as the largest company in town, having the prestige of more sales,” Pritchard says.

Also consider what you can do to build a safety net and to manage and shift your risks, suggests Geary, who also writes a newsletter called “Gear Up for Success.” Buy errors & omissions insurance. Develop a code word to warn your office that you’re in danger at a listing. Build up a reserve fund to cover expenses if your investment property is vacant. Study the requirements of fair housing and other laws to lessen the likelihood of a violation. On the company level, a broker could institute a risk management plan that includes training sales associates in handling legal and financial risks. Data security should also be included in a risk management plan.

In the end, don’t be afraid to walk away from a risk if the downside seems too great, says Pritchard. “Saying ‘no thanks’ to some deals is an important tool in managing your overall risk portfolio,” agrees Thompson.

Becoming a better risk taker

If you’re a person who likes to stay in your comfort zone, it’s possible to change your risk-taking profile, at least to some degree, say experts. “You may not be able to change it big time, but you can move your willingness to take risk along a scale,” says Farley.

Begin by taking on activities with slightly more risk than you’re used to, suggests Thompson. “Start with something that’s a little riskier than you’re comfortable with.” Eat a new food; try a new technology. As you get experience with change and risk, you’ll be more comfortable with uncertainty and more confident about your abilities to manage it.

“It’s like building up a muscle with exercise; you build up your risk ‘muscle’ by risking,” says Geary. She also suggests focusing on one or two areas where you feel risk-averse and would like to change.

Business factors—such as your level of capital reserves and the current conditions in the market—can affect your risk profile, too, says Shenkir. “And if you have a rich uncle to bail you out, you can be more of a risk taker.”

A person’s risk profile can also change as life events change, says Shapira. New sales associates, for example, may be willing to risk working with difficult clients because they don’t have any other options, while an established salesperson would be more likely to refer that business elsewhere. People also may be willing to take risks in some aspects of life, like starting a business, but not in others, such as investing for a child’s education.

As people’s knowledge in an area increases, they may feel more comfortable taking risk because they feel more confident in their judgment. It helps to look back at times you took risks successfully, says Geary. Identifying role models who were successful risk takers can also help.

Yet, experienced people often mistake skill and knowledge for the ability to control outcomes, says Shapira. “That’s like buying a lottery ticket and being sure you’ll win because you’ve played your lucky number,” he says.

The only option you shouldn’t consider is not taking risks at all. “In a rapidly changing world, you’re at a disadvantage if you don’t take risks. Today, the ability to change is necessary for survival,” says Farley.

Even if you’re content with where you are, the world is changing around you, agrees Thompson. An unwillingness to take risks and explore new options could find you left behind. Why risk it?

Diffusing Real Estate Risks
Real estate is a risky business. You can get into legal trouble for failing to disclose material facts—or for saying too much. You stake your income for the month on your ability to say the right thing to an anxious seller or buyer. Read the RISK&Solution boxes on the following pages for guidance on how to manage common real estate risks. Although you can’t eliminate risks, you can lower your chances of a negative outcome.

RISK
Not living up to your fiduciary duty. Agency disclosure has become a hot-button issue, particularly with the rise in buyer agency and limited-service models changing consumers’ expectations, says Ann Throckmorton, CRB, chief compliance officer at Award-Superstars in San Diego.

Solution
Develop a form for consumers that spells out exactly what services you do and don’t provide and get consumers to sign it. Check out NAR’s Field Guide to Agency Disclosure at REALTOR.org for an update on your state’s disclosure requirements.

RISK
Undercapitalizing your business. Too many sales associates don’t have enough money in reserves to survive slumps or even to pay their quarterly taxes, says Jim Dye, CRB, regional vice president for RealtySouth in Birmingham, Ala.

Solution
Take approximately 25 percent of every commission you earn and bank it against required quarterly tax payments, suggest Dye. In addition, keep six months of living expenses in a savings account in case times get tough.

RISK
Disregarding your personal safety. Sixty-seven percent of REALTORS®, in a 2003 survey by the NATIONAL ASSOCIATION OF REALTORS®, said they’d experienced safety concerns or harassment at work. Often attacks occur when sales associates are alone in a property with the perpetrator.

Solution
Don’t let your desire to help a client or earn a commission overcome your need for personal safety, warns Susan Ewert Younger, ABR MSM, CRB, an associate broker with RE/MAX State Line in Leawood, Kan., and a member of NAR’s Risk Management Committee. Insist that clients meet you at your office or a public place. Get a copy of a prospect’s driver’s license and leave it at the office when you go out on a showing. And develop code words that your office receptionist will recognize as a call for help. For more advice on safety procedures for yourself or your office, go to the NAR Safety Week page at REALTOR.org/safety.

RISK
Trying to be the authority. Salespeople can get into trouble with clients by trying to provide all the answers and later facing charges of misrepresentation, says Jim Dye, with RealtySouth in Birmingham, Ala. “We send out signals to our buyers that we can be relied upon as the source,” he says.

Solution
Don’t try to predict the future—“This basement won’t leak”—or imply knowledge you don’t have in order to gain credibility. And never be afraid to say, “I don’t know.” For risk management resources including the new book Real Estate Brokerage Essentials, visit REALTOR.org/Store.

RISK
Fair housing violations. With prosecutions for fair housing violations on the upswing, it’s critical to understand what groups are protected by the Fair Housing Act and what is permitted when creating advertising or advising a client on housing options.

Solution
Avoid making statements about any characteristics of a person or neighborhood that relate to a protected class under the Act. The basics of fair housing are simple, says Dave Mansell, CRB, past president of Coldwell Banker Residential Brokerage in Utah, and 2006 chair of the NAR Risk Management Committee. “Just treat everyone the same way you would expect or like to be treated if you were in the customer’s shoes. High ethical standards should be the norm and following the fair housing guidelines [should be] second nature.” You can purchase NAR’s Fair Housing Handbook, Third Edition, at REALTOR.org or by calling 800/874-6500.

Risk Taker: Hemley Gonzalez CEO and broker
Affordable Real Estate LLC, Miami Beach, Fla.

Start me up

When you’re the grandson of a Cuban woman who braved the Straits of Florida in the Mariel boat lift, risk taking is clearly in your blood. Miami’s Hemley Gonzalez has lived up to that heritage, and not just during his downtime, when he may be trekking through Tibet or hanging from a high wire in the Costa Rican rainforest (right). In 2003, at age 27, Gonzalez launched his own brokerage company after nine years as a sales associate. The company specializes in affordable condominiums for first-time home buyers and investors, a niche often overlooked by other brokers.

• “Taking risks is about believing in yourself and having other people believe in you,” he says. “I felt like my grandmother and parents had taken the ultimate risk in coming to a new country. I had to prove myself worthy of that risk.”
• When Gonzalez pitched his idea for a brokerage to a long-term client, “I relied mostly on hand gestures, a few numbers, and belief in myself,” he says. His backer-turned-mentor helped him develop a business plan, but even then, “our initial research was overly optimistic.” Gonzalez frequently worked into the early morning hours before he could afford to hire more staff. He has learned to be more realistic and objective in analyzing what the market will support, he says, but “if I don’t continue to take risks, the company won’t grow.” His latest venture is a plan to roll out the Affordable Condo concept in New York City; San Francisco; and Latin America, starting with Brazil and Argentina.
  
  Risk Takers: Arlene and Tom Schneller
  Snow Country Real Estate, Bessemer, Mich.
  
  Shooting for gains
  
  “If you wait until you have the money to invest in real estate, you never will,” says Arlene Schneller. She and her husband Tom bought their first investment property—a $10,000 foreclosed home—when Arlene was just 19.
• The Schnellers, who are avid kayakers, say they got in “way over our heads” on that highly leveraged first purchase and had to sell. But they didn’t lose their belief in the importance of taking measured risks. Their ability to see potential where others see only problems has netted them a substantial portfolio of residential and commercial properties.
• “Profit is the payment for risk, but knowing what you’re doing limits that risk,” says Tom, who heads a construction company.
• From that first sale, the Schnellers took their equity and, at Arlene’s insistence, bought a waterfront lot on Lake Gogebic in 1982. With 18 percent interest rates and a flood of properties on the market, they were able to buy the property on a land contract with 11 percent interest for $75 per front foot.
• People thought they were crazy, but “we had a coach at the time who convinced us that they weren’t making any more lakefront property,” says Arlene. Today, with the second-home buyer boom, the Schnellers own 1,000 feet of lake footage, and land is selling for $1,000 per front foot.
• The Schnellers haven’t lost their ability to see beyond the present. They recently bought two parcels of land across from a proposed Wal-Mart site. “The land was owned by a local real estate practitioner who didn’t want to take the risk because the property doesn’t cash flow out,” says Tom. But when the Schnellers researched the site and found that Wal-Mart had previously optioned one parcel, they took an educated risk and bought the two parcels for $202,000. Today, together they appraise for $1.7 million. “I’ve seen so many people who come back five years later and in hindsight wish they’d taken a risk. That’s what keeps us motivated not to pass up opportunities,” says Tom.
  
  Risk Taker: Dino Bello broker-owner
  Help-U-Sell Dixie Realty, Pittsburgh, Pa.
  
  Surprising second act
  
  After 25 years of operating a traditional brokerage, most people would be content to stick with a sure thing. But, at 73, the outspoken Dino Bello isn’t most people. Four years ago, the broker-owner’s franchise was up for renewal. Contemplating the fact that buyers and sellers were looking for a way to save money, Bello began running the numbers to see if he could operate his business profitably with a lower fee structure. He was preparing to launch his own fee-for-service concept in 2001. Then he visited a Help-U-Sell booth at the Tri-state (New York, New Jersey, and Pennsylvania) REALTORS® conference and decided there was no need to reinvent the wheel.
• “It took some initial persuasion to convince my son and partner, Michael, but after both of us met with the Help-U-Sell representative, we were sold on their model,” he says. Help-U-Sell allows sellers to choose from several marketing plans; fees for services are determined once a plan is selected. In the four years since the Bellos agreed to be the western Pennsylvania franchise for Help-U-Sell, they’ve added a second office and plan to open two more in the near future.
• The initial launch wasn’t easy. Bello (pictured here at the Allegheny County Courthouse) had to go to court to get the right to advertise his lower rates in the local home guides. But neither that nor recent health concerns have stopped Bello’s drive. When he’s not running his company, Bello is a vocal advocate for REALTORS® and property owners in both the state and federal arena.
• “You have to take the risk to get the money,” says Bello, “but when you place your customer’s needs ahead of the commission, the money will always find a way back to you.”