Reducing Your Risk in Real Estate Deals

You've undoubtedly heard about reducing your "risk" in real estate, but have you ever really thought about what that means?

The risks are significant, and even though they are clearly identifiable, few home buyers do anything to understand and reduce their risk.

Here's some guidance based on the example of two different people buying a used car and how their experiences relate to real estate.

Buying a Used Car

Risky Robert, a dice rolling Las Vegan, decides it's time to buy a car. He drives to the nearest dealership, where he meets a very nice used-car salesperson. The salesperson shows Robert several cars on the lot, tells him about the great quality of each car and how the car he proposes for Robert was only driven by a grandma to church. Robert likes that tidbit about grandma and test-drives the car and likes it. The sales guy quotes the fair price, they haggle a little, Robert takes the dealership financing and he's got a new used car.

And that's risky behavior!

There Is a Better Way

Due Diligence Diane, a sensible Seattleite, starts her shopping online. She looks at Kelley Blue Book and Consumer Reports for the best value deals, car reliability information and pricing. She decides which car she wants and how much she'd like to pay before even leaving her home. She's not going to get talked into a car model she knows nothing about, and worse, from a salesperson who gets the biggest commission if he can get her to buy the dud that's been sitting on the lot for 180 days.

Diane also checks the Better Business Bureau website to find a used-car dealership with a good rating. Also, she looks at car financing options and rates from local lenders, so she can compare those to what the dealership is offering. She still hasn't left her house, but she is now armed with a bevy of valuable information that will help her make a smart and safer purchase.

Then Diane goes to one of the BBB-accredited dealerships and test-drives one of the cars that she already knows is reliable. This salesperson too says the car was only driven to church by a grandma, so Diane demands a vehicle history report that will prove or disprove that claim. Diane also takes the car to her trusted personal mechanic for a quick look, requires that the dealer make it a certified used automobile and requests to see the prior owner's maintenance records. She haggles on price a little and laughs and then rejects the dealership's financing offer; instead taking a lower interest rate loan from the local credit union. She then buys the right car for her.

Now Robert and Diane both bought cars today, but one of them significantly reduced risk, probably bought a much better car, at a better price, with better financing and from a reputable dealership.

The Real Estate Connection

Most real estate buyers, probably 95 percent, are doppelgangers who follow Risky Robert's behavior when purchasing property. Many times this occurs because people simply do not buy real estate often, so they "don't know what they don't know." They look for houses, have a home inspection done, maybe breeze through the contract, accept the only loan financing offer they've received and don't even look at the title policy, escrow or homeowners' association documents before closing on their purchase.

That's risk — being the Risky Robert in the room and not taking every single prudent precaution that you can to mitigate the chances of something going wrong.

• What Is Real Estate Due Diligence?
• How Much Paperwork to Buy a House?
• What to Review in HOA Documents When Buying

Leonard Baron, MBA, is America's Real Estate Professor His unbiased, neutral and inexpensive "Real Estate Ownership, Investment and Due Diligence 101" textbook teaches real estate owners how to make smart and safe purchase decisions. He is a past lecturer at San Diego State University and teaches continuing education to California real estate agents at The Career Compass.

first appeared on bloomberg.com