January 24, 2022
Best Ever CRE Team

How to Calculate Risk Like a CPA

As a CPA for the last 25 years, Joel Jensen has worked extensively with a wide range of players in the real estate world. He initially started working at Ernst & Young, but he branched off to provide a higher level of more personalized service to clients through his own business approximately two decades ago.

Notably, Joel is also a real estate investor. Unlike many other seasoned investors, Joel has had great success with all of his investments and does not report losing any money throughout his portfolio. Recently, he sat down to speak with Joe Fairless about his approach to selecting and managing properties.

Joel has been able to find many great opportunities in commercial real estate through his personal interactions with tax clients. For example, he has learned about fix-and-flip deals through general contractors he has been involved with.

Mostly, he focused on commercial office buildings that have roughly 2,000-square-foot office condos. He currently offices out of one of the units in a building he owns and manages. While some people believe that property management is a hassle, Joel finds it easy to manage this building because he works out of it every day. However, he does hire commercial real estate managers to run his other properties.

As a CPA, Joel is used to analyzing numbers, and he takes this approach to determine which investments to throw his money at. Likewise, he looks at numbers to determine if he needs to take on a partner for a deal. For him, flips usually require a partner. For rentals, he only moves forward on properties if they produce an adequate amount of cash flow.

Joel recognizes that unexpected expenses always crop up on real estate projects, and prepares for those expenses by using a slush fund. He regularly sweeps some of his profits on each property into a slush fund so that he has enough money on hand to make repairs and to address other situations that arise.

Joel believes that one of the main reasons he has not lost money on real estate transactions to date is his ability to calculate risk. In his professional line of work, Joel is on the hook for any accounting errors he makes with tax returns. Because errors are more costly with higher wage earners, he takes on more risk for those clients. He uses this same line of thinking to calculate risk for his real estate investments.

He specifically talks about the risk that drove him away from a flip in Salt Lake City. The house was in need of attention, and it looked like a profitable deal initially. However, it had water pipe issues that had to be addressed. While these would only cost another $40,000, Joel backed away from the deal. This is because he saw that his exposure to risk shot up after the water pipe issue was found.

Joel also talks about his efforts to calculate risk on rehab deals. As a CPA, he often feels pretty good about the budget he creates for these deals. However, he recognizes that a budget is a projection or an estimate rather than a firm figure.

Often, rehab deals in commercial real estate have snowballing expenses. Partners decide that they need to fix one item that they overlooked or discovered. To make that fix, they need to make other fixes. All of these snowballing expenses eat into the profit margin.

This does not mean that Joel passes over rehab deals that look great on paper. Instead, he does his best to create a workable projection up front, and he takes everything he learns on one rehab deal with him to the next one. By doing so, he uses his newfound knowledge to decrease his exposure to risk on future deals. Even if he did not financially profit as much as he planned at the start of a deal, he still gained true value from the transaction.

One of the important lessons that Joel has learned as a professional accountant has helped him to be a better investor. He states that he is able to provide better tax advice and planning services to filers who have been diligent about keeping records. Those who have thrown together documentation at the last minute, however, are often unable to fully track their spending. This makes it far more difficult to determine areas to improve.

There is only so much room in tax compliance and code to manage numbers. The true savings in taxes comes when you can apply what you glean from your tax returns to the next year’s activities.

Another important lesson that Joel has learned from working with his accounting firm’s clients is to focus on the margin rather than the gross income, and this can translate to real estate investments as well.

For example, he has seen self-employed individuals whose business makes $500,000 per year with a 50% margin. They take home $250,000 at the end of the year. This is compared to an individual with a $2 million-per-year business with a 5% margin. That person takes home $100,000 at the end of the year. The important factor is how much the individual walks away with at the end of the year rather than what the company’s gross income for that year was.

Looking forward, Joel advises investors to optimize the power of the tax code. It offers deductions for self-employed individuals, real estate owners, and others. You have to know the tax code or work with an accountant who does in order to take advantage of all of the tax deductions available.

Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.
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