Specific Disadvantages To Real Estate
Although I consider the use of real estate options to be a relatively low-risk investment strategy, there are some specific risks that you cannot control when using real estate options.
1.Lack of Liquidity
Liquidity in finance refers to the ability of an asset to be exchanged for cash without loss of value. Publicly traded stocks have good liquidity.
Commercial real estate investments typically do not. If you have invested in a small office building and the time has come to liquidate that investment, it cannot be done over night, or, at least, it cannot be done overnight without great loss of value.
2.Difficulties in Determining Property Value
When investors are selling a commercial property, they are really selling a stream of income. Valuing this stream of income requires two factors to be considered. First, one must quantify the stream of income itself, and secondly, one must determine the risk associated with that stream of income. The value of a commercial real estate property depends on how much income it will generate, the appropriate rate at which that income should be discounted, and how much that future is likely to grow in the future.
3.Overextended Borrowing
Leverage is a good thing, but too much leverage can be a bad thing. Leverage increases the potential return on a project, while at the same time increasing the risk associated with that project. This is why it is better to optimize leverage than maximize it. Too much borrowing jeopardizes the success of a real estate investment as surely as too little leverage. It is a matter of balance to be decided by the investor’s taste and preference for the trade-off between risk and return.
4.Management Expertise Required
Commercial real estate investment requires active, focused, intense participation or things are likely to go terribly wrong. Commercial real estate investment is not for the detached.
Where ownership of the property is direct, the commercial real estate investor is going to need to be involved with searching for the project, evaluating the project, financing the project, and (if acquired) managing the project. Even where the commercial real estate investment involves a sale-lease-back arrangement and there is no property to search for, and the evaluation is cut and dry, the project will still not manage itself.
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