Investors often refer to a safe investment by saying, ” As safe as houses. ” This is a traditional view that real estate investment is a safe option.
Old-school thinking holds that real estate investment is relatively risk-free and the best way to hedge against inflation.
It has been discovered that after several real estate crashes, the houses were not as safe as they had been thought to be.
This article lists the risks an investor faces when investing in real estate. The following are some of the most common threats:
Risk #1: Bad Tenants
Many people invest in reality to receive the cash flow from it. These cash flows are received as steadily increasing rental payments. These cash flows are based on the assumption that investors can always find good tenants. Good tenants are reliable, pay on time, and don’t cause any legal problems.
Research has shown, however, that statistically, there is a high probability that investors will only sometimes be able to find a quality tenant. Most experienced real estate investors rate bad tenants as their number one risk.
Even though only a few investors will likely encounter bad tenants, you could pay significant legal fees if this happens. Real estate investing is a business that involves people. For this reason, landlords check credit scores and police records before leasing out their properties. It is essential to minimize these risks.
Risk #2: Liquidity risks
Real estate investment is the least liquid of all investments. The amount of money needed for real estate investment is significant and requires a big commitment from the investor.
If you’re a real estate investment and wish to sell a property, there isn’t a market that will give you a quote on a minute-by-minute basis. The buyers willing to make such a significant transaction are also few.
Stocks, bonds, and even gold can all be liquidated within minutes by an investor. Real estate, on the other hand, takes a long time to sell. To avoid making a bad investment, investors must factor in the illiquidity of real estate.
Risk #3: Leverage Risks
We stated in the previous point that most real estate investments require significant capital commitments. Most people who buy real estate need more capital to invest. Over two-thirds (or more) of all real estate purchased and sold on any given market has leverage attached.
Most people buy their homes using a mortgage. The mortgage is usually for an extended period, say about 30 years. The interest due on a mortgage can be several times as much as the amount initially borrowed.
The first mortgage payments almost entirely interest. Over the first four years, you will barely pay back any principal!
Real estate relies almost exclusively on property prices increasing continuously because it is so leveraged. Property prices don’t need to drop. Even a slight stagnation could lead to unsustainable interest rates and put the investment into the red.
Contrary to popular belief, serious risks are associated with real estate investment.
Risk #4: Counterparty risks
Unfinished units are often purchased by many people who buy real estate. Unfinished units are cheaper, and developers will offer more favorable financing. Under-construction units are not without risk.
Investors are vulnerable to the default of developers. Developers often need help to obtain the necessary permissions from local authorities. The project is therefore delayed. This delay causes buyers to lose a part of their investment because they are forced to pay rent.
Real estate investments are, therefore, prone to counterparty risk. Investors must be vigilant and develop a plan for mitigating such risks.
Risk #5: Information Risks
Comparing the real estate market to other markets, it is very opaque. There is accurate and up-to-date information in markets such as stocks, bonds, and bullion. Data can be used to make informed decisions and gauge trends within an asset class.
Local brokers are the only source of data when it comes down to real estate. They have vested interests and need to be able to give reliable information. The data relating to ongoing rental and capital values are mostly guesses!
The buyers must therefore have several sources of information to verify the accuracy of the data. This risk has been dramatically reduced with the introduction of online real-estate portals and direct transactions between sellers and buyers. The price discovery mechanism is still largely opaque.