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As a 17-year real estate investor, I could also be the northernmost real estate professional you know. You might have heard about the magnitude 7.0 earthquake that recently struck my hometown of Anchorage, Alaska.
It made world news: Highways collapsed; structures crumbled; power went off. Water mains broke across this city of nearly 300,000 people; over 300 gas leaks were reported; residents needed to boil drinking water for safety; many Anchorage television stations went off-air. The hits just kept on coming. Soon, a tsunami warning threatened our sea-level city, but it was lifted.
When it struck, I was at home. My house and body rattled violently for what seemed like an eternity. My wife was across town. Was she all right? Once it ended and loved ones were accounted for, it felt miraculous that our own home only suffered broken glass and knickknacks. No one died. Some schools and businesses were damaged such that they needed to close for the long term. Many homes were rendered uninhabitable. The president tweeted support.
The quake and its aftershocks made us feel dispirited, small and vulnerable. I faced an undeniable realization that a power greater than me controlled my body, family and property.
The astounding fact that this was a zero-fatality event is a tribute to seismic construction and engineering standards. For comparison, a tragic 2010 Haitian magnitude 7.0 event resulted in hundreds of thousands of deaths.
When it was all sorted out, my Anchorage-area apartment buildings’ interior walls showed surface cracks. The properties sustained perhaps $20,000 of superficial damage — not structural. I felt lucky; things could have been far worse. A 1964 earthquake in the region jarred the earth with an incomprehensible magnitude of 9.2, the second-most powerful in world history. Southcentral Alaska lies in an area of tectonic plate movement. The Pacific Plate keeps subducting beneath the North American plate. It will happen here again.
Even if you don’t live in an earthquake-prone area like Japan, California or Alaska, there’s a big real estate lesson in this for you.
I am intentionally completely uninsured for all this. Here’s why:
• Earthquake insurance (EI) is not a standard part of homeowner’s or landlord’s insurance. It’s a separate catastrophic policy.
• Premiums for EI are somewhat pricey. In my experience, insuring a $500,000 home for earthquake damage costs about $1,750 annually, on top of regular homeowner’s insurance.
• Deductibles run about 10-20% of the property value. That means that before a claim could even be made, a policy holder would have to pay $50,000 to $100,000 out of pocket on a $500,000 home.
• Mortgage companies don’t require EI.
• Few Anchorage residents carry EI.
• As expected, the governor promptly declared a state of emergency. When this happens, you may be able to apply for a government grant to pay damages on your primary residence. So why would anyone who pays attention to “how the world works” buy optional EI?
Details of my personal situation factored into the decision to skip EI, too: I strategically keep low equity positions in my properties, say 20%. This way, even if the properties were flattened, the bank can be an enthusiastic aide in my financial health. They’ll advocate on my behalf with insurers and grant administrators, because the bank has 80% skin in the game, and I have 20%. They have four times as much to lose as I do. You might say I’m “self-insured.”
Certainly, there are more complex issues of LLCs and recourse loans, etc., but let’s keep this discussion simple.
Maintaining a low equity position locally also means that you have more equity that you can use to diversify into holdings in multiple geographic markets. For example, owning property in diverse cities, states and countries hedges you against natural disasters, local recessions, government policy change and more. Perhaps the greatest mistake that real estate investors make is that they’re only invested in one geographic market.
During the earthquake, my wife’s and my nerves were rattled, and still are with each aftershock — but my investing strategy wasn’t rattled at all. In fact, it might be the only thing that Anchorage’s awful earthquake solidified. Here are five key takeaways for smart investors from a harrowing experience:
1. Be invested in multiple markets for diversification.
2. Earthquake insurance is often a waste of your money.
3. Home equity is unsafe and illiquid, and its rate of return is always zero. So why accumulate substantial equity in any one property? Don’t discount renting your home: Paying rent is not the same as throwing money away.
4. Low equity positions mean you can own more property with the same equity.
5. Low equity means high leverage ratios. With positive cash flow, leverage creates wealth faster than compound interest.
Real estate risks are everywhere: hurricanes, floods, economic downturns, law changes that suddenly benefit tenants over landlords or new rent control measures. Consider how much equity you place in any one property, and be sure that your real estate empire spans multiple markets. Even the best investors don’t eliminate risk. They manage risk well.