“The greater the risk, the greater the reward,” says the old adage, but any investor knows that striking a balance is essential to effectively manage your portfolio—especially in the world of real estate. When it comes to real estate investing, it’s comforting to know that every dollar you put into a project is secured by real property, but that doesn’t mean it’s without risk.
Whether you’re new to real estate investing or thinking about managing more of your investments on your own, now is a great time to delve into the risks associated with real estate and understand how you can manage them. Let’s get started!
General market risks
General market risk is considered the most fundamental risk of all and it’s present no matter what sector you’re investing in. When it comes to real estate, general market risk is directly reflected by national trends in employment and interest rates along with local trends in construction, rent prices, and sales prices.
The market will always pose risks but failing to consider them at a local and national level before making your real estate moves could cost you greatly. Take some time to understand the real estate cycle, which will help you identify when it might be a good time to buy a property or sell it off.
Likewise, a lot of real estate investors find success by expanding to new markets. The great thing about real estate is that you could have properties across the country, even in towns and states you’ve never stepped foot into. However, to manage the risk there, you should find reputable local resources to make sure you’re timing things right, choosing the best area, and not overpaying for properties.
Asset type risks
The average real estate investor seeks to diversify their portfolio, both in location and asset type. However, when considering the risks associated with a given asset, you must consider how different market scenarios will impact your returns. For instance, multifamily properties are considered lower risk because you only have one mortgage payment, but multiple tenants to help you cover it.
Since multifamily housing also rents at a lower rate, it’s also easier to keep it filled even when the economy suffers. Meanwhile, single-family housing can be harder to fill during times of economic turmoil. Short-term rentals that are most appealing to vacationers are even riskier. Plus, gaps between tenants can greatly diminish your annual returns for the property.
If you invest in commercial real estate, there are differences there as well. A shopping mall would be considered quite a considerable risk given trends over the past decade, and any sort of retail store would be harder to fill if the economy takes a hit. Meanwhile, office buildings tend to present less risk, but they also tend to produce lower returns.
Idiosyncratic risk, which you could also refer to as property-specific risk, includes all variables for a given project that could impact your returns. For instance, purchasing a single-family home in need of repairs is riskier than buying a comparable home that’s ready to rent as-is.
Some factors that increase idiosyncratic risk include how long you have to wait before you can start realizing returns (e.g., repairs, construction) and the amount of money you have to invest in the property (e.g., improvement, financing method, desirable neighborhood).
With these factors in mind, high idiosyncratic risk almost always comes with higher potential returns. For instance, purchasing a home in a highly desirable neighborhood will cost more, but can get you a lot more in rent or eventual sales price. Likewise, investing money into improvement projects will increase the property’s value, potentially allowing you to walk away with major returns.
The liquidity factor
When considering all the risks you take on as a real estate investor, one of the final factors you need to include in your equation is liquidity. Liquidity refers to your ability to sell your property so you can walk away with cash. A highly liquid property is one that can be sold quickly (i.e., it’s in an extremely desirable area) while an illiquid property is one that will take more time to sell for a profit (i.e., it’s dilapidated or under construction).
Many real estate investors are comfortable with taking on moderate to high-risk properties so long as they believe that the liquidity factor is high. So, you might be okay with buying that luxury rental property because you stay on top of local trends and you feel that you could sell it for a profit before the market takes a downturn and threatens your rental prices.
Of course, one thing to note about the liquidity factor is that it will change with time. If you fail to “time the market” right and sell off what you thought was a highly liquid investment, you could end up having to wait it out as luxury homes become less desirable in times of economic turmoil. That’s why knowing your market is key.
Getting to know an investment
New investors can easily feel overwhelmed by the sheer amount of risk associated with real estate, but it shouldn’t overshadow the potential for returns. Just like with any other investment vehicle, there is a fantastic opportunity to diversify your portfolio and manage risk at the level that’s most comfortable for you.
What matters most when getting involved in real estate is to do your research. Know how to run the numbers, examine the local market, and look for national trends to decide what fits your portfolio best. Additionally, instead of buying a property outright, consider using fractional real estate investing to get involved in multiple projects with less capital up-front.
Lastly, if you’re using a fractional real estate investing platform, make sure it’s one that offers transparency. As an investor, it’s important that you know and understand all risks so that you can make an informed decision. That’s why Ark7 provides complete documentation and detailed information for every property on the platform.
Investors can never avoid risk entirely, but learning how to recognize and mitigate it is crucial to finding success with real estate or any investment vehicle. As a real estate investor, it’s essential to remember that more risks often exist than first meet the eye, including property-specific risks like the number and type of tenants you’ll be working with.
What matters most for new real estate investors is that they carefully scan the landscape to understand both local and national market factors, while also thoughtfully examining each opportunity that comes their way. By taking the time to evaluate risks in this way, you’ll prepare yourself for a lifetime of profitable investing while also giving yourself added confidence and peace of mind next time you approach a deal.