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Conservative Optimism

by Andrew C. MacDonald on March 3, 2011

Content elephantI think most of us can agree that optimists tend to be happier than pessimists, but in real estate investing it is important to balance optimism with a degree of conservatism. Being overly optimistic usually leads to disappointment when reality does not unfold the way we expect. Conservative optimism will help you “keep it real”.

Curb Your Optimism

The Oxford English Dictionary defines optimism as having “hopefulness and confidence about the future or successful outcome of something; a tendency to take a favourable or hopeful view.”

With any project as real estate investors, we should have confidence about achieving a successful future outcome. Without a positive outlook for the future of the project, why invest?

It is important to apply a degree of conservatism to our optimism to make sure our expectations remain realistic. Without a little conservatism to keep ourselves grounded, we may be overly optimistic and unknowingly set ourselves up for financial disaster. Adding a little conservatism to “curb your optimism” will allow you to maintain a positive outlook which is still firmly rooted in reality.

3 Ways to Apply Conservative Optimism

1. Use Conservative Assumptions

The simplest way to apply conservatism optimism is to be conservative with your assumptions. When analyzing a property, use realistic rates for items like appreciation, interest, vacancy, and repairs and maintenance. Being conservative here means looking at the long term rates for each of your assumptions and seeing if your deal will work with these long term averages (or slightly worse).

As a personal example, the average price of Canadian real estate has appreciated by approximately 5% over the past 35 years. My investment strategy allows me to select areas that I expect to do better than average, but I still use only 3% appreciation when creating my projections because I like to be very conservative.

On the expense side, it is important to factor in vacancy, bad debt, and repairs and maintenance so your projections aren’t completely off when the inevitable vacancies and repairs arise. In addition, the price of just about everything rises over time along with inflation, so make sure to factor in an annual increase for operating costs. Considering these details is just part of forming conservative assumptions.

If your deal works with conservative assumptions, then maintain your positive outlook and get ready for a pleasant surprise at year end.

2. Manage Expectations

Another important way to apply conservative optimism is to manage expectations. This means managing both your own expectations, and those of any partners you may have. By curbing your optimism with a little conservatism you’ll keep expectations realistic which is a big part of ensuring you enjoy real estate investing for years to come. More importantly, if you work with partners, it is much easier when their expectations are realistic and match your own.

3. Create Contingency Plans

One trap of being overly optimistic is that you may fail to consider the risks involved in a project since you are so focused on the positive future outlook you have in mind. Take some time to address the potential pitfalls which may impact your deal and then figure out possible contingencies for each. Identifying the downside risks and thinking through the best solutions for each will give you a realistic idea of what could go wrong, but also show you how to make the best of each potentially bad situation.

Be a Realist

Most investors wish they had a crystal ball where they could predict exactly what would happen in the future. The closest we can get to that is to study trends and economic drivers and then make our own best guesses. Rather than being overly optimistic and setting yourself up for disappointment, be a realist and see how well you can hone your best guesses over time. Remember, if you err on the side of conservatism you’re more likely to be pleased with the performance of your investments down the road.

Creative Commons License photo credit: Tambako the Jaguar

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