Hai Mansion Case Study

Real Estate Investments: As Safe as Houses?

Investors usually refer to an extremely safe investment with the phrase “
As Safe as Houses”. This shows the traditional mentality that real estate is one of the safest investment options.
The old school chain of thought believes that real estate investing is largely risk-free and provides the best hedge against inflation.
However, the world has recently discovered after multiple real estate crashes that the houses aren’t as safe as they were considered to be.
This article enumerates the various risks that an investor has to face while investing in real estate properties. Some of the common risks are as follows:

Risk #1: Risk of Bad Tenants

A lot of people that invest in real estate usually invest for the sake of cash flows that are received from real estate. These cash flows are received in the form of steadily rising rental payments. The assumption behind these cash flows is that investors will always be able to find good tenants. Good tenants pay up on time, do not destroy property and create no other legal hassles.

However, research has shown that there is statistically a good chance that investors may not always find a good tenant. Bad tenants are rated as the number one risk by most seasoned real estate investors.

Although only a very small percentage of investors will face bad tenants, there is a good chance that you may end up with significant legal costs if one comes your way. Hence, real estate investing is also a people’s business. This is the reason why landlords want to look at credit scores and police records before they lease out their property. The idea is to mitigate these risks.

Risk #2: Liquidity Risks

Real estate investments are probably the most illiquid as compared to all other investments. This is because the amount of money required for real estate investments is huge and it takes a huge commitment from the personal finances of any investor.

Therefore, in case you are a real estate investor and want to exit a property, there is no ready market which will provide minute to minute quotes regarding your property. Also, the buyers who are willing to enter into such a huge transaction are few and far between.

Hence stocks, bonds and gold can be liquidated in a few minutes if an investor has to. However, real estate takes a very long time to liquidate. This illiquidity needs to be priced into the real estate investment to ensure that investors are not making a bad bet.

Risk #5: Information Risks

The real estate market is extremely opaque when compared to other markets. There is up to date and accurate information available in markets like stocks, bonds and bullion. One can use the data to gauge the trends in the asset class and make informed decisions.

However, when it comes to real estate, the only data that is available is from local brokers. These brokers have vested interests and therefore have no reason to provide reliable, actionable information. Data related to the ongoing rental and capital values is therefore largely a guess!

Buyers, therefore, need to have multiple sources of information so that they can corroborate the validity of the data they receive. This risk has also been largely mitigated with the advent of online real estate portals and direct transactions between buyers and sellers. However, the price discovery mechanism remains largely opaque.