Real estate is the most important asset class in many countries, with a higher share of people’s wealth devoted to it than in other assets. This is in part a result of the perceived simplicity of this asset: everyone lives in a house and has a sense of understanding of residential properties, and some high net worth individuals (HNIs) also feel comfortable with investments. commercial real estate.
While real estate seems to tick all the right boxes, not all real estate investors have equal luck in the results of their real estate investments – some are able to talk about their huge real estate profits, while others have stories. less happy to tell. Here are seven ways a real estate investor can minimize the risk quotient of a real estate investment to ensure that it generates good, predictable returns.
1. Find out more about the real estate market in several cities
Most of us invest in real estate in a very different way than how we invest in anything else. If you were to buy a stock, you wouldn’t consider buying only the stock of companies located in your city or neighborhood. Likewise, you wouldn’t open a bank account only at a bank headquartered in your city or buy insurance only from a local insurance company.
But when it comes to the biggest investment of all – real estate – we all tend to become very parochial and prefer to invest close to home. In the past, this made sense as it was difficult to access real estate market information in other cities, and a local investment was often the only one that the investor knew enough to do so with caution.
In today’s digital information world, it just takes a little extra effort to learn about other markets and cities and get the big picture before investing in real estate. The reason this is important is that real estate is a highly cyclical industry where the right time and the right location for its investments can significantly reduce risk and increase returns. A broad perspective will allow you to avoid mistakes in both when and where to invest.
2. Select the right city to invest in
In the long run, house prices tend to follow median household incomes. As the median household income increases, so do house prices. However, like any other asset class, real estate is also subject to boom and bust cycles and there will be times when house prices exceed their normal multiple of household income, and there will be times when house prices exceed their normal multiple of household income. times when they will be a little lower than they should be. .
The best investments, of course, are in cities where incomes and population are increasing and yet house prices are not too high as multiples of current incomes. But a typical investor makes real estate investments in places close to where he lives or grew up, or where his family lives, because most of the information about investment options is obtained through conversations with his friends, his family or colleagues.
The performance of such investments is a success or failure because it does not take into account the prospects of that location. If the city is growing at a rate lower than the nominal GDP growth rate, then the investment may be underperforming. Likewise, if current prices are sparkling, future returns will not.
In order for your investment to do predictably well, you need to invest in cities that are growing rapidly, have lots of well-paying white-collar jobs, and have reasonable current property prices as a multiple of household income.
3. Understand the micro-market and its trends
In addition to city selection, micro-market selection is also important for asset performance. Locations on or near major arterial roads, or connected to efficient public transport, are preferred by end users as they facilitate travel to other parts of the city.
The availability of good socio-cultural infrastructure such as schools, shops and hospitals are additional factors that need to be considered in micro-markets to make them less risky. Investors should also keep in mind that well-established areas are less risky but may offer lower returns, while promising locations with new infrastructure planned may offer better returns, but with more uncertainty as to when. the realization of its profits.
A well-informed investor must ultimately make the decision to choose a location, keeping the above factors in mind.
4. Select a project according to its functional attributes
Historically, Indian real estate had all the wrong attributes – uncertainty over regulatory issues, land title disputes, etc. Because of these factors, buyers preferred to buy from developers who had the resources to iron out these inefficiencies at the ground level. However, as this sector gradually becomes like the rest of the economy, increasing importance is attached to the product offered. Instead of focusing on a developer’s ability to handle regulatory uncertainty, focus on the developer’s ability to deliver a high-quality product to buyers.
Once a project is completed, its market price depends on the quality of the product, its location and its specifications, and it is this future market price that determines the investor’s profit. An unimpressive cookie cutter design can become irrelevant in a few years and not yield good resale value. Thus, an investor should consider the functional aspects of the design of each project in which he invests in order to reduce the risk of the property becoming obsolete in the future.
Superior design, floor plans, specifications and the number and density of equipment are important factors when selecting a property in the residential sector.
5. Select a project at the right stage of development
Real estate projects are, as the name suggests, projects that must be executed. They take a lot of capital, are associated with regulatory risks, and take many years. And like most things in life, there are tradeoffs between investing early and investing at a later stage of a project. If you invest in a project early on, you may get higher returns, but you will also face more regulatory and enforcement uncertainties.
On the other hand, if you invest towards the end of the project or after its completion, most of the profit would have already been made by previous investors and you could end up with lower returns but with less uncertainty about the timelines.
Uncertainty about how long it will take to get all the necessary regulatory approvals is a factor to consider when considering projects at an early stage. Once the developer obtains the necessary regulatory approvals, the duration of construction and completion of the project is much more under the developer’s control. So look at the project stage and the list of pending regulatory approvals at any stage of the project before making the investment.
If one is unwilling to take these risks, it may be prudent to stick with the Real Estate Regulatory Authority (RERA) registered, under construction or completed projects to make one’s investment.
Once the construction of a real estate project begins, it takes three to five years to build it depending on the scale of the development. During this period, factors such as escalating raw material costs, rising interest rates and stopping construction due to local lockdowns increase the overall cost of project development.
Although these external factors cannot be eliminated in any market, an investor should pre-select projects that are well funded or developed by groups with solid financial experience. This will ensure that, regardless of escalating costs, the project will be completed.
6. Select the right type of real estate asset
Different subclasses of real estate assets do not have equivalent risk factors and may have different performance in the same place. For example, in the commercial sector, Class A offices in high demand markets tend to be relatively less risky compared to the retail and hospitality sectors in the same location.
This is especially true in the short and medium term. Renter companies usually take a long-term view of their plans and requirements and cannot cancel their leases. However, seasonal consumption trends and occupancy in the retail and hospitality sectors have a direct impact on their income, making it more difficult for investors to predict their results.
The residential sector is perhaps an even safer place to invest, partly because of the reduction in the size of its tickets, and partly also because of the lower potential vacancy periods in the event of a departure. tenant. But here again, nothing is free and the fall in the risk of vacancy in the residential sector is also accompanied by a fall in rental yields.
7. Understand your own financial time horizon
Real estate is a big purchase and lacks the liquidity of typical financial assets such as mutual funds and bank accounts. Therefore, investors should understand their personal financial situation and plan for a holding period that is comfortably longer than the expected project completion and exit times.
Finding the right selling price can take time, especially with the prevailing demand and supply in mind. In the current scenario, one must also take into account the occurrence of unprecedented events such as a pandemic to allow sufficient time for the asset to function.
Real estate is a massive asset class and its popularity with investors is well deserved. An investor who exercises caution and diligence before investing, as noted above, can benefit from the safety, security and low volatility of this asset class while avoiding undue risk.
While most investors aspire to own a real asset as the basis of their investment portfolio, it is important to assess the underlying risks before making the investment. If you invest in real estate with the right knowledge and the right perspective and give your investment the time it deserves, it could be not only a successful investment, but also an enjoyable trip combined with the pleasure of owning an asset. tangible and no other asset class can match.