Risks in Property Investments

Most people wish they had bought a home sooner or invested in a piece of land. Lately however the charm of property investments is waning due to three main reasons – low returns, illiquidity and completion risks. But the time tested rule in investing is that profits are made by being greedy when others are fearful. Property investors can make handsome gains amidst the current negative sentiments, if they know how to mitigate the risks.

Lowering delivery risks
Poor delivery track record and developer problems are risks that keep buyers from entering the market. In certain geographies such as the National Capital Region, delivery deadlines have been missed by over three years in many projects. Change in project specification, cost escalations and quality issues are other problems buyers had to deal with. These make buying a home, especially one that is under-construction, a risky proposition for many.

That said, the risks can be mitigated with due diligence and rating of developers. You must look at the developer’s credentials for on-time delivery, quality standards and process, customer satisfaction and financial strength to determine the likelihood of on-time delivery to the specifications given. Experts can also help you with the evaluation and rating process so that it is objective and based on data.

Liquidity issues
Property investments, due to large ticket size, uniqueness which makes comparison difficult as well as high transaction costs, are typically illiquid. But when there is good demand in the locality, solid developer credentials that makes the project a sought-after one and reasonable price expectation, illiquidity is no more a worry.

For instance, large plots or high priced homes may take a while to sell, but mid-income homes from a good developer in a well connected locality may not pose such problems at the time of selling. These may have a wider base of buyers and may be sold relatively quickly. The homework you do before a purchase – on the neighbourhood, project features; relative pricing of the property; demand and price growth aided by job growth in the area – would ensure that the property is easily saleable at or above market prices.

Ensuring returns
All these factors also contribute to price appreciation and return on your investment. Take the case of social infrastructure development. Schools, hospitals and shopping areas coming up in a place and connectivity improving over time will create demand for the property and lift prices. Job growth is a key driver of property prices and it helps to keep a watch on which companies are moving into the neighbourhood.

Usually good developers do their homework and perform a thorough analysis of these aspects before launching their project. They ensure that there will be enough demand for their project and price appreciation also happens as the development progresses. They also look at the master city development plan of local authorities and tend to be in the know of where expansions are planned and start a project based on this intelligence. You can look at the developer’s track record of location and project feature choices from their earlier projects to assess their skills and success on these aspects.

For sure, property investment, similar to any other asset class, has its share of risks. But risks are an inherent part of the system and gains can be made by knowing them and finding ways to reducing it through knowledge and expertise. This can enable earning profits over the long-term.

Risk Return

The simple truth in investment is that there is no such thing as a low-risk high-return opportunity. It is a myth and we must be careful when someone comes up with a scheme which offers high returns with no risk. The golden rule is that returns in general are proportional to risk, if the market is efficient. If you invest in a risk-free instrument, such as Government bonds, your return will be around the rate of inflation. The return you get is really just the time value of money.

By opting for high quality AAA rated corporate bond, your returns are higher; but you are taking on the additional risk, albeit minimal, of default by the issuer. And if you choose lower rating bonds such as AA or A rated ones, the returns tend to increase, along with the risks. The key really is to understand the risks, know what is suitable for you as an investor and find the investment that gives the best return for your specific risk appetite.

In the case of equity investments, investors demand higher return than what they expect from debt instruments, as the risks are perceived to be higher. For instance, the price of a stock may be volatile due to local political factors, market fluctuations, global perturbations as well as sector and company specific issues. A successful investor weighs the risks and chooses to enter into a trade only if the estimated returns are acceptable.

This is not to say that the market is very rational at all times. Mis-pricing happens all the time as investors become risk averse – they demand high returns even for a small risk. As a return prices are beaten down. Anyone who picks up the bargain when the mood is negative can earn good returns when the mood turns optimistic. Equity analysts and experts who can identify which risks are real and priced in, which are not real but priced in, can help identify such opportunities.

The same logic applies to investments in real assets such as property. When you buy a completed home, there may be limited risks, as property prices do not tend to fall substantially in the Indian markets. One can earn a rental yield of 2-3 per cent annually. Add capital gains of 4-5 per cent every year, the investor can hope to earn returns inline with inflation.

By investing in an under-construction home, you take on additional risk – of delays, quality and other changes that may happen during the duration of the project. Hence you would expect higher returns. The risks in the investment can be assessed and mitigated by evaluating developers on various parameters such as delivery and quality track record.

Likewise, investing in the pre-launch stage and exiting when the developer launches the project to the wider market can deliver higher returns. The risks may also be high – plan approvals may not be received and the market may not perceive the project as interesting. These risks are in addition to location specific supply-demand dynamic changes, but all of these can be evaluated and priced. In fact, many high net-worth investors (HNIs) evaluate the developer and the project and profit from taking calculated bets.

So, investors have to assess each investment choice with the yard stick of risk and return. You must build your overall investment portfolio with debt, equity and alternate investments, to maximise risk-adjusted returns for a given level of risk. The asset allocation must be adjusted periodically as the market shifts. This is the best way to build long-term wealth.