Understanding And Embracing Risk

That's one of the key themes of his book, basically liquidity and risk avoidance. And here's a quote from the book. Sam Zell says, risk is the ultimate differentiator. I have always had a deep and complex relationship with it. I'm not a reckless person, but taking risks is really the only way to consistently achieve above average returns in life as well as in investments.

My father proved that when he left Poland. I'm probably more comfortable with risk than most people. That's because I do as much as I can to understand it. To me, risk taking rests on the ability to see all the variables and then identify the ones that will make or break you. So what Zell is saying is he's not averse to risk. He understands that risk is a tool, but he wants to be smart in the way he deploys his risk.

Now, for those of you who don't know Zell very well, Zell has been the largest owner of office buildings in the United States. He's also been the largest owner of apartments in the United States, and he is now the largest owner of mobile home and RV parks in the United States. He has about 160,000 lots, which is a huge number of lots.

And but he amassed it basically starting from very humble roots. He got into the real estate sector simply working in a management company doing small single family and apartment buildings during college. So he didn't start off with a lot of money. But he has been very successful year over year of avoiding any major calamity because America has had nothing but recessions and certain bubbles over the decades, which have sunk many other operators.

And Zell has been around a really long time. So Zell was around through the 70s, through the Jimmy Carter era, through stagflation, through Ronald Reagan's interest rates of as much as 18%. He was there for the savings alone crash. He was there for the dot-com bust. He was obviously there for the Great Recession. In fact, he's called the grave dancer because often he has this uncanny ability to dance around crises and not get stuck up in them.

And he often makes lots of his buys during the downtimes because he doesn't get sucked into that downward spiral.

So how do you then use risk in a good way? How do you use healthy risk, as Zell talked about in his quote? Well, here is Zell's theme on risk. If you look at a deal that has High risk and low reward, you should never do it. If you look at a deal that has high reward and low risk, you should always do it. And if you see a deal that has high risk and high reward, that's where the true gamesmanship begins on making smart decisions regarding risk.

Let's go over the first example. Where would you have an RV park which has high risk and low reward? Well, let's say you're looking at something that is running on all eight cylinders, is completely full, the rents are as high as the market will bear. And yet you've got on the flip side of that some other impending problem as far as the reward, because there isn't a lot there. Let's assume you buy that thing at a very, very low cap rate.

You have no upside in increasing occupancy, no upside in raising rents. So basically you go through all of that risk to get a very, very low reward, which in this case would be a cap rate, let's say, of five percent. So that would not be a deal that Zell would do because that has high risk and low reward. Now let's say you look at another deal, and this deal has

low risk and high reward. You're buying this deal with plenty of room to improve. You've got some vacancy, you're below market in your rates, all kinds of things you can do to make this a better property that makes more money. And you're buying it at a very attractive price.

So it makes total sense now to buy it with huge amounts of upside. So that would be a deal that we would say has low risk and high reward. But then what is a high risk, high reward deal? Well, those can be things, for example, as a major turnaround project.

So let's say you find an RV park, but it's not running well at all. The location seems good, but everything else is bad. The numbers are terrible, property condition is bad. It's gonna require a lot of money to bring it back to life. So how exactly is that all going to work? Well,

If you buy that property, you're gonna be taking on a huge amount of capital required to fix it. You're gonna be taking on all kinds of risks as far as a can you really achieve what your goal is to fill that thing and to raise the rates? And there's absolutely no assurance that you can do so. But yet you think, well, maybe I should because I've got this really high reward. Let's assume you can double or triple the value of the property if you can pull it off. Would you do it?

Well, the key thing to first think about in that scenario is can I mitigate that risk? What can I do to take some of the risk off the table? How can I test my theories? What can I do to help myself? And that falls back to another rule. Which is worst case, best case, realistic case. Now worst case scenario would be just that. You're unable to fix anything wrong with the R V part.

Can you survive it? Can you still pay your bills? Can you still cover the mortgage? And then your best case is obviously if everything goes your way. And then the middle, which is the realistic case, will be somewhere in between. It's not not the worst case, it's not everything bad happening. So you are able to fill.

some of the vacancy, you are able to push the rents to some degree, cut some of the costs, cleaned it up, but you can't get it all the way. Does that s number still look attractive to you? And if the answer is yes, I can survive the worst case, and I'd be thrilled at the best case and happy with your realistic case, now you're really ready to move on to the next step.

Because now, although this deal has high risk, it's got high reward. And you say, ah, well, you know what? Given that, walking that fine line, I'm still going to buy the Darv part because I believe at the end of the movie I will be successful with it. However, you may look at another scenario. And you may say, you know what? Here's the deal on this one. If I take on all this risk, I will not be able to survive my worst case scenario.

I will not be able to cover the mortgage and therefore it will sink me. And that's what Zell would tell you never to get involved in. Because you see Zell has been very, very clever and good, focusing always on liquidity. And liquidity means he only likes to buy deals that he can resell or refinance in times of trouble.

And that's why he didn't get sunk by all those many recessions. Had he not been a more risky player, had he not really been obsessed with risk, then who knows? He might have gone out of business during the Jimmy Carter era, and we never even know the name. But he didn't. And he didn't because he was very, very smart about analyzing his risk in every deal and making sure that he perpetually had enough cash or cash available through liquidity with to withstand most crises.

So when you're looking at RV parks, you really need to ponder, you need to embrace the entire concept of risk. You need to decide whether the deal has a healthy supply of reward to meet that risk, or if the risk outweighs the reward. You need to always focus your efforts, try to find deals that have high reward and low risk, avoid deals that have high risk and low reward, and then really ponder closely those that have high risk.

and high reward. Because within that set of concepts lies a lot of opportunity with very, very little downside. And always remember, as Zell said in his quote, you cannot succeed in the absence of risk. Jell would uh would not be able to be here today had his parents not immigrated from Poland during World War II. They had to take a risk. We all have to take a risk.

There's an old saying about turtles. The turtle only makes progress when it sticks its neck out. You can't just hide. You can't just build a concrete bunker and live in that bunker and expect to go anywhere. You've got to get out there and you've got to take some risk. So we all know that risk is a healthy byproduct of life. But the key is you've got to do it intelligently.

You have to be smart about risk. You have to constantly think about risk. Not be afraid to ponder risk. Not be afraid to be obsessed with risk. Because when you use risk as a tool, That's when you can make really good RV park deals. This is Frank Rolf, the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.