What are the risks of investing in real estate?

 In Uganda when it comes to investing, the real estate sector attracts a lot of investments. And this is the reason why a large number of people are buying and putting up residential and commercial properties.

 With all the excitement about the prospects of generating some income out of the property, there is still risk involved in investing in real estate. Any type of investing requires you, as the investor, to understand the risks versus the returns, and real estate is no different. When deciding to invest in real estate, here are a few of the risks you should consider before committing your hard-earned earnings.

Liquidity risk. Liquidity is defined as the ease with which an asset can be converted to cash. Real estate has a relatively high degree of liquidity risk given the size of investment and the number of investors, which is not the case for stocks or government bonds. For example, a treasury bond or shares of Stanbic Holdings stock are incredibly liquid because they can easily be converted into cash.

Leverage risk. A real estate investment’s risk profile is directly proportional to its leverage. The more debt, the more risk. Over leveraging might single handedly be the fastest way to bankruptcy. Many investors have a good amount of debt against the property. 

But what happens when your tenants can no longer pay or when there is difficulty selling off property. The general rule for investment in real estate is to stay at 75 per cent leverage or less. So if your rental income is worth Shs1,000,000 then you should not borrow more than Shs750,000.

Credit risk. Any commercial property that rents space to a tenant has credit risk, which is the risk that a tenant will not be able to make timely payments as expected. 

Late payments can create cash flow problems for the property owner, but the situation can be worse if the tenant goes out of space. Then, the property owner faces unexpected shortfalls in income along with additional costs to get a new tenant in the space.

Market risk. Market changes can impact capital values and future cash flows of the property and ultimately returns over time. Real estate as a whole is known for its up and down market cycles. 

Good markets are characterized by strong occupancies and steady rent growth while downturns often result in lower occupancies and flat or even discounted rent. Numerous market risk factors such as inflation, interest rates, and unemployment can trigger a disparity in the supply and demand for space.

Time risk. The question of timing has a bearing on the return on investment, as it enables the best conceived scheme to be carried out at the most appropriate time, with the least risk encountered. Exceeding the planned project timeline leads to risks.

Regulation risk.  Changes in regulation or laws can impact real estate owners or tenants. These changes can include a change in tax rates. Increases in tax rates not only impact property income but also impacts the cash flows for tenants.

Idiosyncratic Risk. Idiosyncratic risk is specific to a particular property. Every property is different and they all have risks that are unique to their condition, location, and age. 

For example, a high rise property with incredible views could face a significant drop in demand if the construction of a taller building obstructs those views.  To increase demand, the owner may have to reduce the price.

In conclusion, Real estate investments in Uganda are speculative, and as such as they are prone to risks. A diligent investor or firm should consider all of the risks before deploying capital into a project. 

Once the risks are identified, plans should be developed to manage each one of them for the duration of the investment period.

Hassan Kitenda 
Investment analyst
[email protected]