Investment and Risk factors in real estate

Investment and Risk

Risk taking is an integral part of real estate industry. There are so many variables to contend with – recession, economic downturn, rising interest rates and inflation being just a small sample of them. However, there is a bright side to it too. For the risk taker, this is the best time to invest in real estate because the returns on risk today are the highest that has been seen in a long long time. Here are some of the investment and risk factors that real estate agents take and navigate successfully.

Taking risk on purchase of property

In the majority of cases, investors in real estate deal with property that is not new. Even otherwise, for new properties too meticulous inspections with regard to wiring, flooring and lighting need to be carried out. Here are some of the primary risk factors that need to be considered if you are a real estate investor.

  • Quality of construction – Mobile and prefabricated homes are generally of inferior quality than new or conventional homes. However, whatever may be the type of home, check on the materials used during construction. The skill and expertise of the builders can be judged by the architecture of the home.
  • Climate and location – Properties in locations that are subject to extreme temperature fluctuations, storms and cyclones as well as those in seismic zones age faster than normal. Further, a house in a difficult-to access area like a top of a hill is difficult to sell.
  • Renovations and additions – Any additions or renovations should be thoroughly scrutinized as these can hide faults in construction or something else. If you are buying commercial property you should be more careful. For example suppose you are purchasing property that once housed an accredited service station and garage that issued roadworthy certificate in Melbourne. You have to look for stability of the foundation which might have been weakened by vibration from heavy equipment used there.
  • Structural problems and roof – Foundation problems can cost you substantially to repair so avoid buying houses that have a weak structure. Some of the visible signs of this are doors that jam and constantly stuck windows, cracked tile or concrete floors and cracks on the walls. For the roof, check for damaged roof gutters, pest infestations and interior water damage. These can cost you thousands of dollars to fix.

Taking risk on financing of property

There are some things here that may not be in your hands. Unlike risks in the type and quality of property, factors like inflation or interest rates are beyond your control. Hence you should move carefully on taking risk – aspects that you cannot avoid but can surely minimize.

  • Interest Rates – The biggest risk factor is trying to forecast interest rates and where it will be in the next two to three years based on today’s figures. If you feel that interest rates are likely to rise, there will be slow sales cycle and hence you should desist from investing in real estate. Getting calculations wrong is a very real risk factor that should be avoided.
  • Inflation – Even though rents do rise, net operating income dips sharply during high inflationary trends because of increased expenses. High inflation can quickly erode profits. This is true for all sectors. Even if you take your vehicle for car air conditioning regas, you will find that rates have risen because garage owners have to cover the increase in cost of spare parts. In such times, you should finish all renovation work when you still have some cash flowing in as surplus.

Taking risk on Rentals

This is where it all boils down to and your source of income. Acting judiciously can help you minimize the risk taking factor.

  • Rent Roll quality – This refers to your tenants. Generally for residential properties, it is 100% leased to a particular tenant but for commercial properties it is advisable to take in multiple tenants. Hence your property will not become fully vacant if one tenant leaves or goes out of business. Further, even if you conduct a thorough due diligence of your tenants before renting out, there is no guarantee that they will not face any financial problems in future and default on rents. That is a very possible risk that you have to take.
  • Rollover risk – This refers to the term left on leases at a property and is especially relevant to commercial property. If you have acquired a property with a tenant on a long term lease and there is a default, there can be nothing worse than that. You have probably paid a premium when acquiring the property after factoring in the lease and now there will be a lowering of your asset value. This is a risk that is very relevant for commercial property.

Risk taking is a big factor in the real estate industry. All that you can do is to reduce its effects without being able to eliminate it altogether.

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