7 Ways to Minimize Risk in Real Estate Investing – Forbes Advisor INDIA

Real estate is the largest asset class in many countries, accounting for a higher proportion of people’s wealth than other assets. This is partly a result of the perceived simplicity of this asset: everyone owns their own home and has some understanding of residential real estate, and some high net worth individuals (HNIs) are also comfortable with commercial real estate investing.

While real estate seems to tick all the right boxes, not all real estate investors are equally fortunate with the results of their real estate investments — some can talk about their huge real estate gains, while others have less fortunate stories to tell. Here are seven ways a real estate investor can minimize the risk quotient of a real estate investment to ensure it produces predictably good returns.

1. Find out about the real estate market in several cities

Most of us invest in real estate very differently than anything else. If you were to buy a stock, you wouldn’t just be buying the stocks of companies that are based in your city or neighborhood. Likewise, you would not open a bank account only with a bank headquartered in your city, or buy insurance only with a local insurance company.

But when it comes to the biggest investment of all – real estate – we all tend to get very narrow-minded and prefer to invest closer to where we live. In the past this made sense as it was difficult to get information about the real estate market in other cities and local investment was often the only thing the investor knew smart enough about.

In today’s world of digital information, it takes just a little more effort to get to know other markets and cities and to get a comprehensive overview of the overall market before investing in real estate. This is because real estate is a highly cyclical industry where the right timing and location of one’s investments can significantly reduce risk and increase returns. A broad perspective allows you to avoid mistakes both in terms of the timing of the investment and in terms of the investment itself.

2. Choose the right city to invest in

In the long term, real estate prices tend to be based on the median household income. When median household income rises, house prices rise too. However, like any other asset class, real estate is subject to boom and bust cycles and there will be times when house prices exceed their normal multiples of household income and there will be times when they are quite a bit lower than they should be .

Of course, the best investments are in cities where incomes and population are increasing and property prices are still not too high in multiples of current incomes. But a typical investor makes real estate investments in places close to home, childhood, or family, since most information about investment opportunities is obtained through conversations with friends, family, or co-workers.

The performance of such investments is hit or miss as it does not take into account the prospects for that location. If the city is growing at a rate lower than the nominal GDP growth rate, the investment may underperform. If current prices are high, future returns will not be either.

For your investment to perform predictably well, you should invest in cities that are growing rapidly, have many high-paying employees, and have reasonable current real estate prices in multiples of household income.

3. Understand the micro market and its trends

In addition to the city selection, the selection of the micromarkets is also important for the performance of the asset. Locations that are on or near major arteries or well connected to efficient public transport are preferred by end-users as they facilitate commuting to other parts of the city.

The availability of good socio-cultural infrastructure such as schools, shopping and hospitals are additional factors to consider in micro markets to make them less risky. Investors also need to keep in mind that established areas are less risky but may offer lower returns, while emerging locations with new infrastructure planned may offer better returns but with greater uncertainty over the timing of realizing one’s gains.

Ultimately, a well-informed investor must decide on the choice of location, taking into account the factors mentioned above.

4. Select a project based on its functional attributes

Historically, Indian real estate had all the wrong attributes – uncertainty over regulatory matters, disputes over land titles, etc. Due to these factors, buyers preferred buying from developers who had the resources to iron out these ground-level inefficiencies. However, as this sector gradually becomes like the rest of the economy, increasing importance is attached to the product on offer. Instead of focusing on a developer’s ability to deal with regulatory uncertainty, one should focus on the developer’s ability to provide buyers with a quality product.

Once a project is completed, its market price depends on the quality of the product, its location and specifications, and it is this future market price that determines the investor’s profit. A nondescript, cookie-like design can become irrelevant in a few years and not have good resale value. Therefore, an investor must consider the functional aspects of the design of any project he or she invests in to reduce the risk of the property becoming obsolete in the future.

Superior design, floor plans, specifications, and the number and density of amenities are important factors when choosing a property in the residential sector.

5. Select a project at the right stage of development

Real estate projects, as the name suggests, are projects that need to be executed. They require a lot of capital, involve regulatory risks and take many years to complete. And as with most things in life, there are tradeoffs between investing early and investing later in a project. Investing early in a project allows you to earn higher returns, but you also face more uncertainty around regulatory and execution aspects.

On the other hand, if you invest towards the end of the project or after its completion, most of the profits have already been made by previous investors and you may earn lower returns but have the benefit of less uncertainty about the time frame.

The uncertainty of the time it will take to obtain all necessary regulatory approvals is a factor to consider when considering early stage projects. Once the developer has obtained the necessary regulatory approvals, the duration of construction and completion of the project is much more under the developer’s control. Therefore, one must look at the phase of the project and the list of regulatory approvals pending at a particular phase of the project before making the investment.

If one is not willing to take these risks, it may be wise to stick to the properties under construction or completed projects registered with the Real Estate Regulatory Authority (RERA) to make one’s investment.

Once construction of a real estate project has started, it takes between three and five years to build, depending on the scale of the development. During this time, factors such as escalating raw material costs, rising interest rates and halts to construction due to local lockdowns increase the overall development cost of the project.

Although these external factors cannot be eliminated in any market, an investor must shortlist projects that are well funded or developed by groups with solid financial backgrounds. This ensures that the project will be completed regardless of cost increases.

6. Choose the right type of real estate asset

The various real estate sub-asset classes do not share equivalent risk factors and may perform differently in the same location. For example, in the commercial sector, Class A offices in high demand markets tend to be less risky compared to retail and hospitality sectors in the same location.

This applies in particular to the short to medium term. Corporate tenants typically have a long-term view of their plans and requirements and cannot terminate their leases. However, seasonal consumer trends and occupancy in the retail and hospitality sectors directly impact their earnings, making it harder for investors to predict their results.

The residential sector is perhaps an even safer place to invest, partly due to its smaller ticket sizes and partly due to reduced potential vacancy rates in the event of tenant evictions. However, nothing comes for free and the lower risk of vacancies in residential construction is also associated with lower rental yields.

7. Understand your own financial time horizon

Real estate is a big ticket buy and lacks the liquidity of typical financial assets like mutual funds and bank accounts. Therefore, investors should understand their own personal financial situation and plan for a holding period that is significantly longer than the expected project completion and exit times.

Finding the right selling price can take time, especially considering the prevailing demand and supply at the location. In the current scenario, one must also consider the occurrence of unprecedented events like a pandemic to give the asset enough time to perform.

bottom line

Real estate is a huge asset class and its popularity with investors is well deserved. An investor who practices caution and diligence before investing, as described above, can benefit from the safety and low volatility of this asset class while avoiding undue risk.

While most investors strive to own a real asset to base their investment portfolio on, it is important to assess the underlying risks before making the investment. When you invest in real estate with the right knowledge and perspective, and give your investment the time it deserves, it can be not only a fruitful investment, but an enjoyable journey combined with the pleasure of accessing a hard, tangible asset no other asset class can match it.

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