What Risks Are Involved In Real Estate Investments?

What Risks Are Involved In Real Estate Investments?

Posted by on Aug 20, 2020

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Yes -- Risks Come with Real Estate Investments

If you type the term “safe alternative investments” into a search engine, you’ll likely find that “real estate” comes out on top of many search results. However, if you input “safe alternative investments during a recession” into your search engine box, the results could be mixed.

Some of what pops up might indicate that real estate is THE ideal alternative investment during an economic downturn, and NOW is the time to buy. Other blogs, sites, and information will point out that throwing money at an apartment complex in the midst of a recession, just because a get-rich-quick “expert” tells you to do so, isn’t a good idea.

In truth, a restrained approach when it comes to putting money into real estate is a good idea, even with all of the accolades attached to buying a single-family rental, medical office building, or retail center.

Regardless of the shape it takes, real estate is an investment. And, there is no such thing as a risk-free investment, whether the focus is on a “hot” corporate stock, or a suburban duplex.

About Alternative Investments

What exactly are alternative investments? Quite simply, alternative investments consist of any kind of investment that isn’t a stock, bond or cash. Your coin or stamp collection is an alternative investment. Mineral rights in your backyard can be considered an alternative investment, as can your hedge fund. Do you own copyrights, song rights, and trademarks? Also, alternative investments. And, real estate is an alternative investment.

While alternative asset types vary, they share several things in common. They are illiquid, meaning they can’t immediately be sold for cash. Additionally, they typically don’t correlate to stock market ups and downs, which can help add diversification to your portfolio. So, if Wall Street is going through a slump, it doesn’t mean that your self-storage property-focused Delaware Statutory Trust (DST) investment will perform in the same way.

The Risks of Real Estate

But before putting your capital into any kind of real estate, it’s important to understand the potential downsides. Whether you are a passive real estate investor targeting a DST, or an active investor who wants direct ownership of your real estate asset, it’s important to understand the following risks.

Location/market. One issue we continually stress is that real estate is highly local. An apartment property in Nashville, TN, will perform differently than one in Chicago, New York, or Lubbock, TX; the potential rates of return, asset appreciation, and pro formas will vary. Your real estate property will be at the mercy of many local market fundamentals, including demographics, supply and demand, taxes, politics, and other factors over which you have no control.

Asset. “Real estate” is a broad category, and can range from a summer vacation rental home in Colorado Springs to a portfolio of institutional-quality office buildings in Manhattan. Because the assets within this category differ, they are subject to different economic cycles, as well. Warehouses were considered low-value investments immediately following the Great Recession. There wasn’t much demand for the space. The growth of e-commerce and focus on the last-mile delivery has changed that demand, however, meaning warehouses and distribution centers are considered hot-ticket investment items these days.

Structural/financial. The debt used to buy or refinance a property can increase its investment risk, depending on payout requirements, interest rates, and maturity dates. A mezzanine loan is riskier than its senior-secured counterpart because it carries a shorter term and higher interest rate. An earlier maturity date means you’ll have to refinance sooner rather than later, while the higher interest rate will mean more cash will be required to pay off the loan.

Idiosyncratic. This involves risk specific to a property, outside of the type of asset or location. A property on which construction has yet to begin carries a high degree of risk, as it could be at the mercy of entitlement or environmental issues, each of which could delay groundbreaking. A stabilized real estate asset -- one on which construction has been completed, and is close to being fully occupied -- is less risky, as tenants are in place, and are starting to generate cash flow.

Managing the Risk

The purpose of this blog isn’t to scare you off from real estate investments. Real property can be a great addition to your portfolio. But all investments carry risks, and real estate is no exception.

When it comes to funneling your cash into an office building, multi-family property, or self-storage facility, you should consider two things. First, know your own risk appetite and tolerance. And second, be sure to conduct in-depth due diligence on the real estate asset of interest, so you understand -- and are prepared for -- potential investment risks.

To learn more about the steps to take when it comes to real estate investments, contact Realized Holdings for a no-obligation consultation. Log on to realized1031.com, or call 877.797.1031.

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.

There is no guarantee that the investment objectives of any particular program will be achieved.

The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that they will be able to pay or maintain distributions, or that distributions will increase over time.

 


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