Publication: Construction Week Online, 11th March 2021
Nishit Jalan, CEO, Grovy India, shares his views
The real estate industry has always been associated with risks just like the finance industry. It won’t be wrong to state that these are indeed risky markets and come with their fair share of profits and losses. However, the major challenge lies in measuring the associated investment risks especially in the rapidly changing real estate industry. The primary reason for this is that there is no specific unit of risk assessment in real estate and hence it becomes tough to draw a comparison between the different investment options.
Impact of macroeconomic events on real estate investment and the associated risks
Another reason why risk assessment is a hurdle is because major economic events or disruptions cause varied impacts across the real estate industry. This is dependent on the sector of real estate industry and its location. For instance, various reports state that the pandemic affected the real estate industry and its overall growth. However, the impact extended by COVID-19 on the properties was not uniform across the various sectors and geographical location of the property.
Be it commercial buildings, residential accommodation, hotels, cell towers, medical institutes, all of them experienced an impact of the pandemic but it was indeed varied. While the commercial sector and hotel industry witnessed a dip in their occupancy, medical offices, and cell towers exhibited a significant growth due to the lockdown and work from the home scenario.
The core of any real estate investment and its management lies in correlation. This aspect refers to the way the transactions are connected with each other. Opting for investment deals that are not related directly or are not correlated in terms of the type of property or geographical location can eventually help in diversifying the risk exposure. This further aids in reducing the impact of the overall investment risk.
Diversification is a concept that is present since quite a few years and reduces risk by allocating investments across various properties. The overall idea is to maximize returns by investing in different units that would react differently to the same event. Owing to its benefit of mitigating unsystematic or unpredictable risk, it has become an important part of the financial strategy of real estate investors.
The concept is simple- if you invest all your finances in just one real estate market or one type of property, then you can clearly imagine a lot of things and situations that could go unplanned or unaligned. This could eventually disrupt your financial planning and you would find yourself bearing huge losses. Hence, it is important and strongly advised to opt for the route of diversification in your investments portfolio.
How to ensure diversification to manage real estate investment risks
Diversification can be incorporated into your real estate investment portfolio by introducing diversity in three ways listed below-
Focusing on a single location may be beneficial short term but opens one up to huge exposure in case of unpredictable events. Investing in different units that offer varied value and respond distinctly to situations will help in reducing the investment-related risks.
Expanding your geographical reach will reduce your financial stress as you won’t be dependent on just one area. You will be able to manage and modify your strategies in real-time according to the present situation in case you would have diversified your investment.
Another feasible solution to enforce diversification is by investing in multiple classes of assets. For instance, you could invest in a single-family residential building, a multi-family residential society along with a commercial complex, hospitality industry etc.
Remaining limited to one type of asset class will infact make your portfolio all the more risky. Diversification in different classes of assets will help maximize your profits and reduce the risk rate as each property is different and will react differently. As investors, we should be open and flexible to new ideas, new asset classes and ready to step out of our comfort zone.
This is another effective way to reduce real estate investment-related risk. Risk profile refers to the situation and stability of the investment profile. The potential of the cash flow generation by the property during the time of acquisition is something that will define your asset risk profile. Real estate investments comprise of three levels of risk profiles- turn-key, value-add, and distressed assets.
The turn-key assets are stable and the core of the risk profiling process. This is the ideal solution for investors who are unwilling to take risks or are new to the real estate business. They are simplistic and stable units with good tenants and compliant leases. Everything is organized and the rental cash flow is immediate and smooth. These properties come with fewer risks and more returns.
Value-add risk profile comprises of buildings that may require updating or renovation. Along with investing in property purchasing, you will also have to invest some time, efforts, and finances to refurbish it so as to increase its market value. Indeed they come with considerable risks of planning and implementing your strategies but once these units are renovated and reach the desirable property rates, they will help garner huge profits.
Distressed assets are the properties that require investment in terms of finances and time before you can consider renting them out. You would require a proper strategy in place to bring the unit back to its market value.
The only benefit of adopting this idea is that you will be able to gather such properties at high discounts. Since you will spend less on purchasing, you can invest a considerable amount in its revamping and prepare it for the market. Eventually, you will receive returns once the tenants will be on-boarded and they will be timely paying the rental amount.
Diversification is indeed one of the feasible solutions to handle real estate investment-associated risks. However, in some cases, the investment options can be a challenge. Of course, financially well-off investors will be able to make such diversification decisions quickly and easily while the average earning investors would need time to make such huge decisions. In the present times, real estate investors have a plethora of investment options and varied choices of property which makes the process of diversification all the more easier for them.
However, in the case of diversification, it is the investor who will be managing the various stages at his end. Right from communication, financing, legal work, to leasing their property, everything has to be taken care of by the investor. Hence, the investor should be prepared for managing all the tasks independently. Due to this, there is a certain section of investors who don’t wish to be involved in this micro and macro managing or don’t have the required funds in place. In such cases, they opt for private and public real estate markets that will ensure a comparatively less hassle-free investment experience.
It is an undeniable fact that diversification can be a cumbersome, complicated, and an expensive strategy. However, its benefit of reducing the losses overpowers its cons and makes it one of the feasible solutions for real estate investors.
Diversification is not a sure-shot solution to eliminate the risks. Rather it helps in managing and reducing the real estate investment-related risks. However, owing to its effectiveness, it is increasingly preferred and utilized by real estate investors in their investment strategies and will continue to maintain a place in the real estate investment strategies in the coming times as well.