Should we consider real estate investment low, middle or high risk?

Question

Should private investors investing in a specific (that is, not through some fund) real estate treat it as low, middle or high risk?

Issues I consider:

• It's true that things move slowly in real estate, but that also implies that you positions are less liquid that anything else.

• if it's rented, it generates investment, but if it's run-down, it has potential being renovated, adding value. Difficult to have both.

• It makes me anxious is that you can never truly know if you are in a bubble-kind of scenario.

• Occupying a big chunk of a portfolio (say, 75%).

Answer 1

Even if you own a roulette wheel, letting a gambler bet you your entire net worth (or even sizeable % of it) in a single wager is a very high risk thing to do, despite the fact you have a clear edge and will win over time in a very stable manner as they make repeat bets.

The main problem for investors outside of people already sitting on millions+ is it is very hard to diversify real estate properly across geographies. Anyone sitting on a single house in suburban Detroit will have a very different opinion on the risk of real estate vs someone who bought a house in the Bay Area twenty years ago.

The great lure of housing is it often looks much more stable than things that are traded by the second, but this stability is often purely ephemeral and driven by the fact people just buy and sit on them for ten years+ without asking for a bid on their house so just see a (often mostly inflationary) gain of x% after y years and think it's very low risk vs the wild swings they see in stocks day to day.

Generally though, a random single house bought and held over ten years will often have a more volatile profile than a basket of stocks you just bought and forgot about for ten years. The great advantage of stocks in this context is you can easily buy the equivalent of 30+ 'houses' even on a very low budget and manage your risk better - something hard to do with houses on any net worth sub millions+.

Houses also have very high transaction and upkeep costs, which also heavily eat into rental incomes and overall growth (which lowers your return and increases your risk), and in the case of bad tenants can massively add to the risk of the investment (talking here of people pulling out the plumbing for scrap, vacationing and leaving the upstairs bath tub overflowing for days etc).

In short, a single house (particularly bought with large amounts of leverage) can be unbelievably high risk. A well diversified and well managed real estate portfolio can easily be very low risk, with a huge amount of options in between, so it's hard to say much more of note without knowing more about what you're intending to do and your net worth etc.

Answer 2

It terms of level of risk, from what I've seen the broad risk is comparable to broad equities (returns in the 7-15% range), but rather then the level of risk, real estate presents different risks than bonds of equity. The benefit of this is that real estate is a diversifying asset when combined with bonds and equity, since the odds of "bad things" happening to both assets is relatively less.

Real estate has market (price) risk like bonds and equities, but they also have things like income risk (what happens if it goes unrented for 6 months?) and idiosyncratic risk (HVAC needs to be replaced). It also requires active management, which bonds and equities do not. Many of these risks are diversifiable if you buy lots of real estate, but that obviously takes a lot of capital.

Some of these can be mitigated by increasing cost (reducing return), such as hiding a property manager to handle minor repairs and deal with payments, or buying REIT ETFs, but buying a single income property, like buying a single stock), can be risky.

Another thing I've heard is that the profit in real estate is made when you purchase it, meaning that if you want to make money in real estate you need to find properties that are selling for 80% of what they're worth, for an "instant" 20% gain.

Answer 3

Any investment can be high risk if you don't understand the investment and how it works. Professional stock market investors looking for long-term investments will examine the fundamentals of a company, its balance sheets, board meeting minutes, and perhaps even meet with the president and get a tour of the operation before making a decision to purchase stock.

An investment in real estate should be considered the same way. Note the condition of the building and what repairs it may need. Are there any bylaw infractions that need to be addressed? Are there any liens against the property? If it's rented, is the tenant a good tenant that wants to say or a nightmare tenant? Are you prepared to solve the problem of a nightmare tenant if such exists? Does the income exceed all expenses, including heat, hydro, water, sewer, grass & snow, maintenance, vacancy & delinquency, taxes, management, insurance and mortgage? is it likely to continue doing so in the foreseeable future should the cost of the expenses rise?

Doing your homework on an investment and deciding how to mitigate risk allows you to separate high and low-risk investments.