Could this be true? Is anything guaranteed in real estate?
Short answer? No. Real estate assets, like assets in any other investment class, are not all profits and gains. While real estate investments tend to perform as well or better than equities in the long-term, there is no such thing as a sure bet.
Successful real estate investing requires diligence and the ability to mine insights from local, regional, and national data relating to the commercial real estate space. It also requires the ability to identify and quantify risk—to hopefully avoid losses or unimpressive returns.
The fool learns from his own mistakes, and the wise man learns from the mistakes of others. With that in mind, let’s take a look at some of the potential pitfalls you may run into with investments in commercial real estate.
Real estate investors tend to suffer during recessionary periods. As the real estate sector closely mirrors the economy as a whole, contractions are felt by real estate investors far more than other recession-resistant investments, like precious metals, T-Bills, and certain equities. As businesses fail or downsize, property owners can expect interruptions in their rental income and a harder path forward when it comes to filling vacancies in commercial spaces.
Recessions may also cause property prices to drop, which may decrease their ROI from price appreciation. Some real estate types, multifamily residential in particular, are somewhat resistant to recessionary pressures. When the economy drops, people still need a place to live. A similar line of thinking is why investors buy utility stocks when they feel a downturn is coming—no matter what, the electric bill needs to be paid.
Real estate investments are highly dependent on the communities in which they reside. Local metrics like population growth, average income, employment numbers, and many other data points can make or break your investment in an area. For example, cities with a high dependence on one employer may be prone to substantial volatility and losses if that employer decides to leave the area.
The existing and planned housing supply in an area can also introduce a measure of risk to a property acquisition or development. Supply risk in real estate is affected by the total amount of competing buildings in the area, plus those planned for construction in the near term.
Imagine you are planning to develop a multifamily building in a small suburb of Kansas City. Before entering that market, you should examine both current residential housing supply—both single-family homes and multifamily—to ensure that you will be able to attain and maintain your necessary vacancy rate for generating a return on your investment.
These are just two examples of market factors that can introduce a fair amount of risk into a real estate investment. Before developing or investing in an area, do a deep-dive into local property stats, which are published by private entities and the local, state, and federal governments.
Blazing Your Own Path
While there are few guarantees in the real estate investment world, commercial and residential properties do offer investors an almost unmatched ability to “steer their own ship” and make decisions that can positively impact the ROI of a real estate assets. The same level of control is not possible with traditional equities, bonds, precious metals, and other investment classes where your investment is at the mercy of the market.
Most of this ability to change the course of your investment comes before breaking ground on a project or making an acquisition, but even if you are holding an under-performing asset, there are ways to increase returns. Upgrades and renovations can help increase cash flow and can be used to defer, reduce, or eliminate your eventual tax bill. The fact that you can make these changes directly is why many active investors gravitate toward real estate.
The Bottom Line
Nothing is guaranteed, in life and in real estate. Real estate investments hold real risks that should be taken into account and certainly not discounted without due diligence. Despite the potential risk, the right real estate investment has the potential to generate substantial returns, beyond most asset classes. This fact, combined with real estate’s tax-advantaged status and government incentives, make real estate a solid addition to many investment and retirement portfolios.
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