02/11/22

How JLAM Manages Risk in Turbulent Markets

Volatility, Risk, and Real Estate

Every sophisticated Investor or Investment Advisor is seeking to maximize return and minimize risk, but many investors find themselves reallocating to the same plain vanilla investment managers over and over. 

Following the usual approach of having a diversified equity portfolio so that risk is not concentrated in any one market or company, are you really that diversified? Conventional wisdom is to turn to bonds, with most traditional portfolios having a meaningful fixed-income allocation.  However, bonds can fail to provide adequate diversification and can be subject to significant volatility.

It is so easy to get stuck in this cycle; stuck doing the status quo because the strategy or manager is safe - but you are frustrated because you know that there must be better investment opportunities out there! 

Enter real estate. Moving a portion of your investment portfolio into real estate can broaden your investment base and further hedge against risks that can affect the stock and bond market as a whole. But isn’t real estate risky? By diversifying into real estate, are you actually increasing your risk exposure?

The answer can be no, if you know what you’re doing.

Real estate can be volatile at times, and recent history certainly speaks to that. We deploy capital directly into interesting, differentiated real estate projects and utilize better structures for de-risking these investments.  Great assets, outsized returns, and lower risk are attainable - read on to learn some of the ways we achieve this.

Our difference is that we manage volatility to our advantage.

How do we do that you ask?

The first step is a careful selection of projects that are composed of differentiated assets, and are not commodities. This means identifying projects that are hard to duplicate. Location matters, so we look to regions with strong growth potential and where people want to live and work. Happy tenants, whether they be apartment dwellers, commercial tenants, or homeowners, lead to the long-term stability of a property and therefore better investment performance and better economics for our investors.

Picking the right projects means following a rigorous due diligence process. We put boots on the ground. We might walk through a wooded property to get the feel of it and then explore surrounding communities, asking ourselves, can we create something special here, and is this a place we would like to live? When evaluating an occupied property, we’ll have conversations with actual tenants, understanding what attracted them to a property or what challenges they may be facing. We’ll visit competing properties and benchmark where our proposed investment would fall in a hierarchy of desirability. We’ll know what we need to do to compete before we even consider investing. 

However, identifying the right projects alone isn’t enough. In order to be successful, we need to actively manage potential income and unexpected expenses and create financing that works to our advantage. 

Right Tool. Right Time.

While it is not possible to eliminate all risks in an investment, there are ways to manage and mitigate them. Mitigating risk requires a toolbox with many tools to address each opportunity or situation because each real estate deal is different. It also requires experience to know how and when to use each tool. 

The JLAM team has many years of experience across multiple market cycles, and we have invested over a decade into building expansive networks in our target markets.  The combination of our investment and operational experience has enabled us to develop a finely-tuned underwriting process, risk control framework, and set of operating procedures.  We leverage our expertise to choose the right tool, at the right time, with the right application to mitigate the risk in each investment.

Examples of Levers for De-Risking

As noted above, asset selection is the foundation of our risk management.  From a top-down perspective, we combine quantitative analysis of each market (and submarket) with a qualitative review.  The analytical work identifies key tailwinds, trends, and market changes that will impact the investment.  The art of our work draws upon our longstanding relationships throughout the markets in which we invest to enhance our information advantages.  

At the asset level, our extensive experience developing, constructing, and managing a wide array of property types positions us to analyze the right things and ask the right questions.  Our development or business plans are refined and execution-ready.  

Drilling down to the execution level, we have countless plays to call - a sample of these includes:

  • Contract structuring
    • Purchase agreement terms that shift risk to the seller through installment sales, escrows, or contingencies
    • Service provider contracts with stipulated prices, schedules, and incentives
    • Homebuilder contracts with profit-sharing benefits and performance sureties
  • Capital structuring 
    • Conservative use of leverage to maintain operational flexibility and ensure performance is driven by the asset, not financial engineering
  • Partner selection
    • Engaging only contractors that have a high quality and performance standard to perform construction work 
    • Selecting the home builder that has the best product/market fit for the project
    • Partnering with the leasing and management teams that share the vision for the property’s market positioning

We also tend to have a longer-term view than most

When investing in larger development projects, which can take a longer time to complete, we factor in that market conditions can change over the life of the project. It’s possible that a project is undertaken with a sales expectation of $500K per home. Market appreciation can mean that when that comparable home is completed three years into a project, the average value might have moved to $600K. We may structure a larger deal with an upside participation clause with our homebuilder, meaning that we’ll share in the upside of a booming market. 

Recent supply-chain developments require more forethought and reward looking down the road a year or more, much longer than the typical 1-2 month view of many contractors. For example, two years ago windows for apartment buildings were in stock and could be on-site within a few weeks. Now lead times for the same items are 8 - 10 months or longer. Effective communication and planning with our project partners make sure that they’re looking at timelines with the same horizon that we are. 

Conclusion

There are countless tools we deploy to offset, mitigate, and control risk throughout our investment and development processes. Our team has refined these tools, and how we apply them, over several decades and hundreds of situations. 

With the foundation of acquiring differentiated real estate assets that are vibrant, full of energy, and truly special, coupled with an expert and timely application of each of the risk management arrows in our quiver, JLAM consistently shifts the risk/reward tradeoff in favor of our investors.

If our approach sounds interesting, reach out here by filling out the form to schedule a call to talk about how our approach can work for your investment portfolio.