Real Estate is one investment avenue that yields higher profit as compared to the initial cost it demands. The appreciation in the price of the property over the years is anytime bigger than the profits one can extract from other sources of returns such as mutual funds, etc. But, all is not so easy with real estate investment. There are certain factors that can make real estate a pain in the neck. Many of these factors are unplanned and unforeseen too. Thus, it is essential to listen to the other real estate investors’ stories with open ears to ensure that you do not ignore the potential risks in real estate investment.
Mostly, the property investment profits can face severe blow due to Government’s policies. To understand the risks involved in investing in property, it is essential to understand what are the popular types of risks associated with investing in real estate.
Risks in Real Estate Investment – Important types of investment risk relevant to property sector too
1. Liquidity risk: The investment has to be sufficiently liquid to let the investor enjoy its benefits. The liquidity risk is nothing but the possibility of getting the price for the property less than expected, and sometimes, complete inability to convert the asset into liquid. This risk is quite prominent in the real estate investment. If the property is inherited, there can be ownership and legal rights issues associated with it, in case a clear will is not present. Thus, the owner of the property may not be able to extract even a penny off the property if the clarity in title becomes a matter of dispute.
Market conditions also play a crucial role in assessing the liquidity risk. With the power changing hands in the country, followed by the change in policies, the owners may require waiting for the property to attain favourable price as expected off it. Volatility of the economical and political conditions in the country creates liquidity risk, so this risk should always be factored while taking decisions pertaining to investing in property.
2. Concentration risk: Property investment risk cannot be spread over multiple options like one gets to do in shares and mutual funds investments. It is not common to buy multiple properties simultaneously, nor the process is quick enough to get the numerous selling contracts signed in one go. A major chunk of savings goes into real estate investment, or in case of commercial buying; a considerable amount of capital has to be kept on hold to complete the process. And to add to the discomfort, all the capital kept on hold has to be invested in a single property unit. Thus, the returns are totally dependent on how that property fares in the long run.
3. Horizon risk: Horizon risk means the buyer may require selling the asset before the period of holding as planned originally. Luck plays major factor in enjoying the true worth of the property. Property investment risk is attributed to the uncertainty of the future. The real estate investment made using loan facility is the riskiest of all propositions. If the source of income on the basis of which the loan is taken is lost due to any unforeseen reason, the inability to pay EMIs can force the person to transfer the property to more capable buyer at low price. Thus, real estate investment is seen as a bankable resource to tackle life and its issues and the owner is forced to sell it off before the intended period if things go haywire financially.
Other sources of property investment risk
Properties are of various types and so are the risks associated with them. Also, not only buyers are at risk-bearing end of real estate investment; the builders have to prepare themselves for different kinds of risks too.
The builders are exposed to risks like asset management and property management risks. These risks are more impactful when the inventory lies unused. The builders need staying on toes all the times to win and maintain sponsor’s and promoters’ trust. If they fail on any aspect as desired by their promoters, they may lose substantial capital support that comes from these entities.
Changes in Government policies are another source of risk for realtors. The realtors need to have all approvals in place, to carry out the project smoothly end-to-end. If there is any loophole left anywhere, it may cost them the whole project and the legalities involved prove to be the salt on their wounds. Such cases are categorized as construction risk. Both the buyers and the builders suffer heavy loss when the construction halts due to any reason or is left incomplete forever.
Owners of the houses and commercial properties face risks related to tenants. The tenant risk poses trouble two-ways. The tenant profile can prove to be problematic and may drag the owner into unwanted legal soup. Also, tenancy rates can hit dismal low due to market rate conditions and may not give returns as the property ought to deliver.
In case of commercial tenants, the possibility of the lessee filing for bankruptcy and not fulfilling the payment terms of lease comes as one of the major risks in real estate investment. This threat is always there and there is no alternative to it too. Thus, to avoid such risk, the owners prefer giving the property to established ventures like Banks, or they divide the property into multiple rentable units and settle for multi-tenant arrangement.
To conclude, risks in real estate investment are as real as these immovable assets are and need proper planning for ensuring its safety. A close inspection reveals that real estate sector comprises of buyers, sellers, promoters, builders and other similar entities. All these entities need an alternative support to level the loss when the risk turns out to be an ugly reality. So, it is better to gauge all risks well and find the alternatives in advance, too, to tackle property investment risk at the budding stage itself.
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