Investors often refer to a very safe investment as As Secure as Houses. This is the traditional belief that real estate is one of the most secure investment options. According to the old school, real estate investing is risk-free and offers the best protection against inflation.
After multiple real estate crashes, it has been discovered that houses are not as safe as they once were. This article will discuss investors’ risks when investing in real estate properties. These are some of the most common threats:
Bad Tenants
Many people who invest in real property do so for the cash flow. These cash flows come in the form of steadily increasing rental payments. These cash flows assume that investors will always find good tenants. Good tenants are punctual, pay their rent on time, and don’t damage property or cause other legal problems.
Research has shown that there is statistically an opportunity that investors might only find a suitable tenant sometimes. Most experienced real estate investors consider bad tenants the most significant risk. Even though only a few investors will encounter bad tenants, you could face substantial legal expenses if one does. Real estate investing is a people-oriented business. Landlords should check their credit reports and criminal records before letting their property. This is done to reduce these risks.
Liquidity risks
Real estate investments are likely to be the least liquid of all assets. Real estate investments require a lot of money and a significant commitment from investors.
If you’re a real estate investor looking to sell a property, no available buyers will give you exact quotes. There are very few buyers willing to make such a significant transaction.
Stocks, bonds, and gold can all be liquidated quickly if needed. Real estate can take a long time to liquidate. This illiquidity must be priced to ensure investors don’t make a poor investment in real estate.
Leverage Risks
We mentioned that real estate investments require significant capital commitments. Many people who buy real estate need more capital to invest in that property. Leverage is a factor in purchasing and selling real estate in any market.
A mortgage is a loan that allows people to buy a house. Mortgages are usually for a more extended period, say 30 years. The interest due on the mortgage is often several times the amount borrowed. The first few monthly mortgage payments are almost entirely interest-based. In other words, the principal is not repaid in the first four years.
Real estate is highly leveraged and almost entirely depends on property prices increasing. Property prices don’t have to drop. Stagnation would render the interest costs unsustainable and put the investment in red.
Real estate investments can be subject to serious financing risks, contrary to what people believe.
Counterparty risks
Many people who buy real estate often buy unfinished units. Developers are more willing to finance unfinished units, which is generally cheaper. There are serious risks involved in buying units that are still under construction.
Developers can default on investors. Developers often need help to obtain the necessary permissions from local authorities. The project is delayed as a result. This delay causes buyers to lose some of their investment because they must continue renting.
Real estate investments are susceptible to counterparty risk. These risks can be mitigated by being diligent and having a plan.
Information Risks
The real estate market is very opaque compared to other markets. Markets like stocks, bonds, and bullion have accurate and up-to-date information. The data can be used to determine trends and make informed decisions.
Local brokers are the best source of information regarding real estate. They have no incentive to provide accurate, actionable data because they have vested interests. The data regarding the capital and rental values in the future is, therefore, only a guess.
Buyers need multiple sources of information to verify the accuracy of the data received. Online real estate portals and direct transactions between buyers and sellers have significantly reduced this risk. The price discovery process is still largely opaque.
Real Estate and Money Supply
The amount of money in the system directly correlates with the amount that gets into the real estate market. Real estate is one of the most popular investment types in the world. It is considered a haven and one of the best hedges against inflation.
But, only a few people realize that real estate can create more money supply. Because of how the modern fractional reserve banking system operates, this is possible. The higher the money supply, the more real estate will be created. This article explains the recursive relation between real estate supply and money supply and how they propel one another higher.
Self-perpetuating money supply
Real estate investment has created a system where real estate can increase the money supply. The increased money supply is then channeled back into the real-estate sector. The constant back-and-forth between the real estate sector and the banking system creates the environment for rising real estate prices.
The economic fundamentals, i.e., The fundamentals of the economy, i.e., income levels, are not changing, so these rising prices are often a sign of a real estate boom. The bubble bursts, bringing down costs for a brief period. Real estate investments, by their very nature, boost the money supply and create an amplifying and self-enforcing loop.
Mortgages are a way to make money
Around 80% of house purchases in developed countries are made with borrowed money. “house purchase” is often used interchangeably with “mortgage.” This may seem ordinary once you consider how modern banking works.
The banks don’t lend money out of existing capital. Instead, they create new money by making loans. Banks make mortgage loans that generate cash and pump it into the system. The system will have more money if there are more mortgages. This can be empirically proven by comparing mortgage loan growth in the banking sector to the economic money supply. These two charts move almost simultaneously.