Property Futures

Real Estate News, Reviews and Investment

Real-Estate Investment: Risk v Return

Article: how to assess the risk versus return with real-estate investment.

Any investment can lose money, whether in the stock market, in real estate or even in a standard savings account. The chance that this will happen is the risk while the profit the investment may make is the return.

A successful investor will need to weigh the probable risks and possible returns when investing in a new venture. Generally, any investment that offers high returns at a low risk will usually be a better bet than one that has high risks and low returns.

investments---risk-return

Risk

While risks will vary, more information makes it easier to assess whether the risks are the right ones for you. For example, if you’re a trained electrician you may be happy taking on a property with faulty wiring where other investors might not.

Assess the risks

Although it is well worth consulting experts along the way, ultimately the decision of whether to invest in a property is down to you. Here are a few things to consider:

  • Hazards
    • What’s the crime rate?
    • Is flooding or storm damage likely?
    • Can you deal with the possible hazards?
    • Market stability
      • Is there demand for properties of this kind?
      • Are there many buildings standing nearby?
      • Planning or zoning permission
        • Do you need a permit or license?
        • What if a necessary application or permit is denied?
        • Inspection results
          • Pay a professional surveyor and valuer to assess the property’s condition and its value.
          • Worst-case scenario: the property loses value (below what you paid)
            • Can you afford the loss?

How to reduce risk

It is often possible to reduce the cost to you of certain risks, although this can be expensive in some cases.

  • Do research
    • Missing information can be expensive further down the line
    • Hire an expert
      • A security specialist may be able to help you reduce the risk of crime, for example.
      • A qualified surveyor may help you avoid unnecessary risk altogether.
      • Use your own specialist knowledge
        • You may spot hidden costs or benefits thanks to your professional qualifications.
        • Buy insurance
          • For rental properties, fire and building insurance are often required by law (check if the cover includes expensive items such as carpets and appliances).

There may be other ways you can reduce risks, such as fire alarms and flood defenses. While some will be essential others may not be necessary and any expenses you incur will lower the profits of your investment.

Returns

The money you make on an investment is what makes the investment worthwhile. A good return will allow you to make further improvements to a property, go on vacation or possibly move your retirement forward a year or two.

However, it isn’t always easy to predict whether a particular investment will give a good rate of return or not. As with assessing risk, it’s best to be informed: you may uncover information that shows the investment isn’t the right one for you.

Calculating returns

The returns on an investment are usually indicated as a percentage and are calculated as follows:

(profit) / (initial investment) x 100 = (returns %)

For example, an investment of US$100,000 with an income of US$2,500 at the end of the year has a rate of return of 2.5% per year.

When investing in real estate, returns are usually a combination of rental income and capital gains (any rent paid and any profit made when the land is sold).

What can affect returns?

Many factors may increase or decrease an investor’s profits. If we consider a rental property, these may include:

  • Operating costs
    • Paying the salary of a property manager, the landlord’s insurance and local government taxes.
    • Tenant availability
      • If the house is empty for months between tenants, profits will drop.
      • Infrastructure
        • Good schools, public transport, paved roads and jobs nearby all make a property easier to rent/sell.
        • Repairs and maintenance
          • Damage caused by tenants, by crime or with simple wear and tear.
          • Updating appliances or fixtures.
          • Operating costs
            • Drawing up a contract or cleaning the house between tenants.

Is this a good rate of return?

A rate of return is a good one if it’s better than other investment opportunities available to you. Some basic measures for comparison are:

  • The return should exceed operating and maintenance costs
  • The return should at least be better than the interest earned on a standard savings account, a very low-risk investment.
  • To make a profit in real terms, an investment should give returns which beat inflation.
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This entry was posted on April 28, 2013 by in Investment and tagged , , , , , .

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