Understanding The Risks Associated With Real Estate Investing

By
Naga Sulakshmitha Bezawada,
Understanding The Risks Associated With Real Estate Investing

The real estate market, an enduring global business peddle, has been growing quite well over the past few years. Many enormous tactics and artistries have been uncovered which led to the ultimate development of this sector. As a consequence, real estate investment has become a paradigm in the market as many stakeholders have availed a great payback through it. So, since we all are much aware that every business has its own risks and shortcomings, Real estate investment is no exception. It falls into this category as well.

A famous saying goes as “The reward is within the risk”. This is ideally appropriate in the real estate field too. We have to dive into something to obtain our desired requisites.

Undoubtedly the majority of people are turning to real estate investments since they consider them safer and more secure than many other investment opportunities. Of course, it cannot definitely assure us a zero risk investment yet there are some intrinsic aspects to be considered which might help us to confront those risk factors.

Major Risks In Real Estate Investment:

Just like any other type of investing, there are a few risks associated with real estate investing which both the property investors – an experienced one or a new individual should be aware of and know how to avoid to benefit and succeed in the business. Here goes the list of types of investment risks in real estate:

1.   Ever-Changing Market Risk:

Just like every other business, there are ups and downs in the real-estate market also due to the ever-changing economic conditions. For example, if you buy an investment asset when there is a high demand for real estate investing, you might fall at risk of selling them for a lower price(than the purchase price) because the housing market is unpredictable and it always changes its economic graph. So, in order to avoid this, all the realtors should be aware of this dynamic, comprehend and stay up-to-date with the market economy and should be able to foresee possible real estate market plunges. The best thing to do to overcome this risk is to follow up on the current market trends by keeping track of real-estate influencers and publications and maintaining a close circle of advisers.

2.Asset Risk:

Location is everything that matters in real estate investment. Expert real estate investors also agree that Location should be the top priority when you are planning to purchase a real estate property. It may be appealing to buy an inexpensive investment property, but in many cases, the danger is not worthwhile. So always choose such a wise location that everyone would compete to own that spot. For example, the locations around IT hubs are majorly identified as high-value assets as mostly everyone would show keen interest to invest in such places. Hence, be very mindful of an asset’s location very much before investing in it.

3.Risk of Debts:

This actually happens if the investors fail to raise the necessary capital to finance the project i.e if he cannot raise sufficient funds for the project, he will have to go for a loan. And in the worst-case scenario, if it doesn’t turn out well, he has to repay that loan by taking another loan and that process actually makes the investor dig his own pit. So, when you are investing in an asset, try to predict the revenue and expenses, analyze the cash flow of the project and then move forward for investment.

4.Risk of Negative Cash flow:

Technically, cash flow is the net amount remaining after subtracting income and expenses of an investment property. The investor is expected to get profits despite paying all the mortgage and expenses. There is a risk to the investor that the money he spent would be more than the profit he gains. To avoid such risk, one should be able to predict all the expenses approximately(by auditing the prices of their earlier projects or similar kinds of projects) so that he could plan and invest accordingly. Basically, cash flow can be calculated by using some simple metrics/ rules like the 1% rule. This rule states the property's rental rate should be at a minimum of  1% of the purchase price. That means, if a property is for sale for some Rs.5,00,000 it should produce a rental income of at least Rs.5000.

However, this can’t be applied in all cases as if the rental property is in a city where real estate is expensive or a state with high property taxes, etc. The investment property calculator is the best tool an investor can probably use to calculate the cash flow. Simply it requires some input variables from the investor, which then calculates the cash flow immediately. The result tells you how much cash flow is good for a rental property.

5.Risk of Structural Problems:

Sometimes the investor may end up investing in a property that has hidden structural issues. This might lead to many problems for the investor financially and affects the growth of the business. To avoid this the investor should make a good evaluation of the property even if the investor is going to rent it. Before buying the property, you should fully investigate it for potential problems that could cost major money to fix after you've moved in, and verify that you still want to buy the property(also known as Due- diligence technically).

6.Risk of Liquidity:

Liquidity is the ability to access the money you have within an investment. One risk of real estate investment is you can’t easily convert them into cash. Selling a property is neither a quick nor a simple process, and selling quickly or under pressure will most likely result in taking a loss on your investment. And that too if the asset is an ordinary location(not so renowned place) then selling that would definitely incur a loss. So, picking up assets in a good location(of high demand) will aid us to sell quickly and ensure our liquidity as well.

7.Risk of Entitlement:

Entitlement is a process of getting approval from the authorities. This risk generally shows up for new constructions. Some properties would need to get access from the authorities like municipalities which is referred to as the entitlement process. This would be a lengthy and burdensome process yet can be erased in dimensions like maintaining all the necessary documents  and following the required legal procedures will accelerate this process and the property entitlement can be approved a little sooner. Make sure you cross-check all the documents prior to the investment. Also, stay up to date with your realtor on market terms.

8.Risk of Vacancy:

The vacancy is a major issue that affects the investor who depends on rental income for paying the mortgage and expenses. The vacancy will not always be the same. The investor couldn't expect to have high occupancy. This may incur a loss for the investor. Also getting many tenants doesn’t always mean gaining profits. Having bad tenants who refuse to pay the money in a row of many months would lead the investor to a financial crisis. This would lead to the situation of the vacancy again. So, to avoid these risks, the tenants are asked to sign agreements including a lockin for several years. This ensures the elimination of the uncertainty factors ensuring investment safety.

9. Risk of Depreciation:

Technically, depreciation is the antonym of appreciation and is referred to like the same in the real estate market too. Basically, real estate properties are expected to increase in value over the years (appreciation). However, not all properties are guaranteed to observe growth. Therefore, a hidden risk of real estate investing is investing in a rental property whose value drops in the future. So again, the best way to avoid the risk of depreciation is to be very careful in your research and analyze the real estate market and study the economic growth of the real estate market to seek out a location with strong positive appreciation by the realtors.

Now let’s talk about actualities, it’s almost impossible to predict outcomes from real estate investments and nobody can guarantee huge profits/returns. Therefore, the risk is a part of any investment and commercial real estate is no exemption. Instead of confronting the actual fact, one must wisely deal with the risky parts of investment procedure (How and where to invest?), etc. Firstly, the investor must be good enough to identify risks and he must be able to tackle faulty areas of investments. By tactfully dealing with situations he can overcome huge losses and on the bright side, he can also be able to earn little profits. All that matters in real estate investment is experience. So, taking the side of a skilled investor in the initial stages of investment actually helps.

Assetmonk’s careful asset curation and due-diligence process helps in risk mitigation and ensures tension-free investment. Explore our properties page for high growth potential properties.

FAQs:

The first step in mitigating risks is being able to identify what they are. In the world of real estate, there is no low risk investment and hence there’s no “set it and forget it”. Risk management for real estate investments requires ongoing diligence and a strategy that needs to be constantly monitored and adjusted accordingly. So, firstly we should consider various kinds of risks that can pop-up to affect our real estate investment.

Tenant risks can be divided into two categories namely - rent power risk and rollover risk:

Rent Power Risk-

It’s a kind of risk that depends on the paying and staying capabilities of the tenants. Whether the tenants have staying power or whether their businesses would force them to close or default on the lease are paramount issues that you should consider.

Rollover Risk–

It refers to the term remaining on leases of a certain property. An investor should understand the type of lease on the property they are targeting to invest in as they will pay a premium on the lease’s value which may turn to a loss if the tenant defaults on the lease.

Real estate is traditionally considered as a sound investment, and the investors can enjoy a passive income, excellent returns, tax advantages, diversification, and the opportunity to build wealth. But just like the other kinds of investments, however, real estate investing can be risky. Yet, you can limit your risks by doing your due diligence and conducting a thorough real estate market analysis and rental property analysis. Also, be sure to hire pros to inspect the property, screen potential tenants, and learn everything you can about the real estate market.

Generally, Rental properties are considered as low risk investments in the real estate market. The following are the reasons supporting the afore statement:

Rental properties are tangible assets- The value of real estate often appreciates naturally, which acts as insurance in case you decide to sell the property or stop investing in real estate. Even when a housing market takes a hit and value drops, historically it always rises back up. It’s a kind of risk that depends on the paying and staying capabilities of the tenants. Whether the tenants have staying power or whether their businesses would force them to close or default on the lease are paramount issues that you should consider.

Demand for rental properties- This is an evergreen phenomenon in the real estate market as there’s always a high scope for rental properties since people keep migrating from one place to another as a part of their livelihood. Also, they prefer to reside in rental properties rather than buying a new house.