Volatility in Real Estate
Every investment class is prone to experience some levels of volatility, and real estate is certainly no different. Volatility refers to a given investment’s price increasing and decreasing over a particular period. When the price of a given asset increases, investors are happy, but the fact remains that prices can’t always increase. There are also times when an investment drops in value. These fluctuations are considered volatility, and savvy investors are those who understand how to forecast it, identify it, and invest in a way that prevents volatility from doing damage to their portfolios.
There is no escaping volatility, but it doesn’t have to be an opposing force. Some of the world’s most successful investors are those who have determined what levels of risk and volatility they are willing to accept and how to move their money in a way that keeps them a step ahead of price drops within their chosen asset class.
Is property Investment Volatile?
Property investments are volatile in the same sense that every investment class has an inherent amount of volatility. Some aspects of the volatility of the real estate market are easy to understand. For instance, if a home you own as a rental property falls into a state of disrepair, it is worth less than it would be if it were in good condition. Conversely, if you invest money into a property and make improvements, it is worth more. In that sense, the fluctuations are easy to see. However, there are other ways that real estate falls under the heading of a volatile investment.
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How is Real Estate Volatile?
Real estate is a volatile investment for several reasons. For example, the value of a piece of real estate can fluctuate based on actions that you have control over. In the same way that stock investments can fluctuate in value based on the actions of the people leading those companies, you can take steps that can increase or decrease the value of a real estate investment. For example, if you invest in Company ABC and that company decides to purchase Company XYZ, your investment will become worth more than it was before. If you own a piece of real estate and commit $40,000 to improve the property, you can safely assume that the property in question will be worth more than it was before.
Conversely, let’s assume that you own a large number of shares in Company ABC, and they decide to sell to Company XYZ. Depending on how the new company manages the buyout and their goals for the newly acquired company, your shares may become worth much less than they were before. In the same way, if you decide to stop improving and maintaining a real estate investment, the property will decrease in value.
However, there are multiple other ways in which real estate investments experience volatility through no fault of the investor. Ultimately, a piece of real estate is only worth what someone is willing to pay for it. For example, if you currently own an apartment complex or building, you will only make the amount of rent that people are willing to pay. You get to set the rent price, but if you are overpriced compared to comparable units within the area, you will likely have empty units, which decreases the value of your investment. In that sense, real estate is a volatile investment because the market largely dictates the value of a given piece of property.
When to Invest in Real Estate
In addition to knowing what piece of real estate to buy, it’s equally important to know when to buy it. As we’ve already established, the real estate market is in a constant state of change. With so many external factors to consider, you must leap into the real estate investment industry at the right time. There are times in the real estate market where the market conditions favor buyers and times when it is more favorable to sellers. Knowing how to recognize the difference and what signs you should keep an eye out for can ensure that you’re getting into real estate investing at the right time.
While you don’t have to be independently wealthy to get into real estate investing, you should wait until you are financially stable. Most homes currently for sale in the United States are costly, as the market now favors sellers. While you can certainly take out a mortgage to purchase a piece of investment property, you will still need access to the down payment, closing costs, and other fees associated with owning the property. Ensuring that you have more than enough money on hand to pay a few mortgage payments in addition to the other expenses is essential, as it can take time for your investment to start generating a profit.
It’s also crucial that you wait until you have done your due diligence on the properties you are considering and the neighborhoods in which they are found. Knowledge is power, regardless of the type of investment you’re considering. You wouldn’t purchase stock in a company without researching its performance and stock patterns. In the same vein, you should gather information about the real estate market within a given area before committing to any piece of property.
Finally, you should try to wait and invest in a piece of real estate when the area is in a buyer’s market. Supply and demand are essential principles in any industry, and real estate is certainly no different. If there are only three properties for sale in a given area and 15 people want to purchase them, the market clearly favors the sellers. However, suppose you can find a place with an abundance of inventory and a shortage of buyers. In that case, buyers can get an even better deal on a property, as the supply significantly outweighs the demand. In addition to supply and demand, you should also try to purchase a home when interest rates are low, and mortgage terms are favorable. This part of the equation does not apply if you plan to pay cash for an investment property, however.
Do you want to find success within the ever-evolving world of real estate investment? Our team of experts at Alliance is dedicated to helping investors with all levels of experience locate the best possible properties to meet their cash flow and risk goals so they can earn the profit they’re looking for.
Is Low or High Volatility Better?
The answer to this particular investment question isn’t as simple as choosing “low” or “high.” Instead, this question can only be answered by carefully examining your investment strategy, your personal financial goals, and how much money you have access to should your portfolio need a sudden infusion of cash.
Low volatility is better for investors who want to take an incredibly cautious approach to their investing. Since volatility refers to the fluctuations in the value of a given investment, those who want to take a careful approach to their investing prefer low volatility. Low volatility means that an asset’s lowest and highest potential values aren’t all that different. The primary downside to this option is that you become limited as to the maximum amount you can make from a given investment. For example, say that you purchase a piece of real estate that will provide somewhere between $1,500 and $2,000 per month. You can plan accordingly for an investment that will provide monthly income between those two amounts. You will probably never make more than $2,000 per month from the investment, but you can also assume that you will never earn less than $1,500 per month.
Conversely, high volatility is more of a high-risk, high reward proposition. The earning potential of a highly volatile investment may be much higher than a lower volatility investment, but the risk associated is that the investment has a much lower floor. For example, if you purchase a property that can generate up to $3,500 per month, that may sound incredibly appealing. However, if the same property’s lowest possible earning potential is $500, it’s obviously a much riskier proposition. While the property can make up to $1,500 more than the highest possible income of the first property we discussed above, its lowest earning potential is only one-third of the floor of the first property.
Determining which one of those properties is best for you will largely depend on how risky you want to be with your money. If you’re a conservative investor, you’ll want to choose the low volatility investment. However, if you’re not as risk-averse, the high volatility option with its higher potential monthly earning may be a sound option for you. If you opt for the more volatile investment, you must have access to enough cash to keep yourself afloat should the investment reach its lower levels of earning potential.
What is the Optimal Duration For a Real Estate Investment?
To determine the optimal duration for a real estate investment, you will need to consider your personal goals and how you plan to pay for the property. If you obtain a 30-year mortgage to pay for the investment property, you will certainly need to plan on holding onto it for a more extended period to maximize your profits. In some cases, you are obviously inclined to sell a property as quickly as possible, such as when your investment strategy is to fix and flip a home. However, if you’re investing in a rental property that you are able to mostly pay cash for, most industry experts indicate that somewhere between five and seven years would be a good holding duration.
Real Estate vs. Stock Market Volatility
The stock market is considered a much more volatile investment option than real estate. One of the most effective ways to protect yourself from stock market volatility is to diversify your portfolio as much as possible. For example, if you fill your portfolio with investment in tech companies, you are more prone to the volatility associated with a downward trend in the tech market. An increase in the correlation between industries in the US stock market has made it even more volatile than before. Obviously, stocks are an essential part of any portfolio, but they are an incredibly volatile option.
Real Estate vs. Mutual Fund Volatility
Mutual funds can either be high or low regarding volatility. As is the case with real estate, the higher the volatility of a mutual fund, the greater the potential profits it will generate. A mutual fund’s net asset value is based on its underlying securities, such as stocks and bonds, meaning that there is potential for volatility on multiple levels. Before choosing a mutual fund investment, check the historical trends to see how volatile that particular fund has proven to be.
Real Estate vs. Index Fund Volatility
Finally, index funds, which are investment funds that pool the money of multiple investors to purchase investments, are significantly less volatile than traditional stock and bond investments. This is typical because index funds do not try to beat the market instead of pooling funds to purchase established stocks. If you’re looking for an investment that isn’t extraordinarily volatile but aren’t sure about real estate, index funds are a great option.
How to Hedge Real Estate
While you can never eliminate the risk of any investment class, there are specific steps that you can take to hedge your real estate investment. One of the most effective methods involves quickly selling properties. Instead of waiting for the value of a piece of property to decrease, you can sell when the value is high before it has time to trend downward.
Related: For Real Estate (and Politics), You Need to Think Local
Final Thoughts to Consider Going Forward
Real estate, while a volatile investment class in its own right, it’s generally considered less volatile than many of its investment counterparts. With that in mind, it’s no wonder that most of the world’s millionaires have real estate investments somewhere in their portfolio. The reduced volatility ensures that there is at least some level of stability in the investor’s portfolio, allowing them to take some risks with their finances in other areas. If you are looking for a relatively stable investment opportunity, consider real estate investments today.
Are you thinking about adding some quality real estate investment properties to your portfolio at some point in 2022 but aren’t sure how to get started? Consider contacting our team of experts here at Alliance to learn about everything we can do to help you locate a property that meets your risk, cash flow, and profit goals.
POSTED BY
Ben Reinberg
Founder & CEO | Alliance Group Companies
Ben Reinberg is Alliance Group Companies' founder and CEO.
Since 1995, Alliance Consolidated Group has acquired and invested in medical properties with net leases between $3 and $25 million across the United States. With decades of commercial real estate experience, we take pride in committing to meeting the goals of our Sellers, as we consistently and seamlessly adhere to successful closings.
