Real Estate Investment and Financial Risk Strategy

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Introduction

All real investments tent to be inherently risky due to the several risks involved during the property development procedure (Manganelli, 2015). Risk assessment and measurement is hence critical in coping with risks involved in real estate investments. Past scholars attempted to compare and contrast uncertainty and risks in real estate investment (Isaac & O’Leary, 2013). From these studies, it could be deduced that insufficient knowledge and imperfect information contributed to uncertainty. Moreover, the longer the period of future analysis involved, the higher the uncertainty. Risk, on the other hand, refers to the variation between the actual and the projected returns. Therefore, a real estate investment risk refers to all the likely outcomes as well as their probabilities.

Risk can be defined as the likelihood that an anticipated rate of return on investment will not be attained. In conventional finance and investments, real estate risk is perceived as the volatility, measured through standard deviation or variance of its earnings. Real estate investments can be classified into property-oriented risks, lease, and tenant risks, financial risks, legal and fiscal risks, and market risks (Manganelli, 2015).On the financial side, the three main risks include risk premium, risk-free rate, and yield and growth risks. From the basics of finance, the return on an investment comprises of two parts: the risk-free rate and the risk premium. The risk-free rate refers to the return rate on the UK Treasury Bonds while the risk premium refers to the additional returns an investor generates from taking extra risk. If there is an increase in the risk-free rate on an investment, an investor gets a lowered risk premium on the similar asset. In other words, when the risk-free rate goes up, then an investor in the real estate would prefer to invest in an asset that is capable of generating extra risk premium.

Market growth risk is associated with the potential that the value of the asset may increase with time. It is used in comparing the value of an asset to the growth rate of the entire market. Finally it is important that an investor looks for places with a high potential to grow in the future when investing in real estate. Therefore, a good strategy could be purchasing old property in the city suburbs then improve them to meet the demands of the consumers.

Financial instrument to mitigate risk

Risk mitigation strategies in the real estate depend on informed execution of the right decisions aimed at generating profits. Financial risks in the real estate can be reduced using several mechanisms.

One, the investor is supposed to identify the below-market property when buying. Properties that are below the prevailing market rates are easier to standardize to meet the prevailing market rates with reduced investment risk.
Second, it is important that an investor identifies a favourable model of financing that minimizes cash flows. Such a strategy can be attained by lowering the payments by reducing the interest rate on the property.
The other strategy to mitigate risk include is by making a large down payment on the property. A high down payment tends to consume a huge chunk of cash at the beginning, but it results in reduced subsequent payments of the financed amount.
Moreover, investors should settle for the investments they can profitably improve. The value of a real estate investment can easily be improved by making improvements on it which consequently increases equity and could result in increased returns upon asset liquidation.

Isaac, D., & O’Leary, J. (2013). Property investment . Basingstoke: Palgrave Macmillan.

Manganelli, B. (2015). Real estate investing : market analysis, valuation techniques, and risk management . Cham: Springer.

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