Real estate investments are often considered safer than some other types, such as stocks. But there are investments with higher and lower risks within the real estate category. Typically, higher risks are correlated with potentially higher returns, so investors must evaluate their risk appetite when pursuing specific opportunities.
The spectrum of investment risks and returns
Some advisors offer a spectrum of risk levels for various investments, ranging from a low end of fixed-income products, followed by core real estate, core plus real estate, value-added real estate, and stocks, with opportunistic real estate at the high end of the risk range.
Real estate investments along the risk spectrum
Core real estate investments are often stable, class-A properties located in strong primary markets. These low-risk investments may offer a return of 7-9 percent and typically return current income as well as appreciation.
Core-plus investments include older buildings in primary markets or class-A properties in secondary areas. These opportunities are viewed as low to moderate risk and may provide cash flow plus a return between ten and twelve percent.
Value-added real estate investments need renovation and repair but don't require use changes. The improvements range from cosmetic needs, like paint, carpeting, and landscaping, to more significant remodeling or reconfiguration upgrades. A value-add investment may offer limited upfront cash income but can return between thirteen and sixteen percent.
Finally, high-risk opportunistic real estate projects are generally either ground up from vacant land or require extensive use change modifications (like turning a residential property into an industrial building). These may be distressed, abandoned, or empty buildings. Due to the higher risk, opportunistic investments have higher potential returns of more than 20 percent.
How to evaluate risk
Every investment has risks, and real estate is not an exception. Investors must calculate how much risk they want to accept in their pursuit of returns. Real estate investors may face a lower return than anticipated, which is one financial risk. Furthermore, if a project fails, participants may lose their invested capital. Real estate has several financial risks, including liquidity risk (when the investor can't sell quickly if they require cash) and credit risk resulting from a tenant not paying rent.
Do opportunistic real estate investments make sense?
Opportunistic investments involving ground-up development or substantial renovation and improvements may be attractive to real estate investors seeking greater returns and also willing to accept higher risks. Such investors should be aware that these projects often have a long lead time, during which the investment may return no income and even require additional expenditures.
Opportunistic real estate projects may appear when a growing market expands its geographic footprint or when a new business center is a springboard for housing additions. In other cases, the renewal of a distressed area may prompt significant opportunities for use changes and complete remodels, which also belong in this category.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Risk tolerance is an investor’s general ability to withstand risk inherent in investing. There is no guarantee a recommended portfolio will accurately reflect your tolerance to risk.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
Programs that depend on tenants for their revenue may suffer adverse consequences because of any financial difficulties, bankruptcy or insolvency of their tenants.
