23.04.2020

Real estate risk management in times of crisis

When investors panic in the face of uncertainty in the markets, the consequent volatility often provides investment opportunities. As Warren Buffet says: “Widespread fear is your friend as an investor because it serves up bargain purchases”.

When investors panic in the face of uncertainty in the markets, the consequent volatility often provides investment opportunities. As Warren Buffet says: “Widespread fear is your friend as an investor because it serves up bargain purchases”.

 

Apart from these considerations of ups and downs, there are also lateral considerations, such as which sectors may be favored or damaged, depending on the event at hand.

 

What’s important here is not to lose sight of the investment strategy. In this sense, in real estate it is common that the main purpose regarding these strategies is to look after and increase people’s assets.

 

Therefore, risk management and its application in investment strategies become critical.

 

In this regard we can work on the basis of two very important premises: that real estate moves in cycles and that it is susceptible to variations in factors such as interest rates.

 

When interest rates are high leveraged, investments become less attractive due to the cost of financing; and the opposite: when they are low, appraisals of real estate are higher, and the result is that the leveraging allows a lower cost of financing.

 

Other factors to consider are the economic results of companies and their levels of employment that usually have a direct impact on real estate.

 

In the end, as it happens with companies, investors must place their capital in those projects or investments that generate the highest level of free cash flow, using a moderate amount of leverage in accordance with the investment amounts.

 

These factors combined determine the value of assets. For the same reason we should take into account their impact in three key metrics in property development:

 

Cost of debt. Bank leverage is part of the real estate game and the decrease of interest rates means a lower cost of financing, which will be positive in short term and in the long run. Overall, a property will generate a cash flow useful to pay the cost of financing, and the lower they are more money will end up in the pockets of investors.

 

Net operating income. There is a high correlation between the results of real estate investments and the population and the increase of the employment rate. Therefore, a decrease in the economy may have an effect in the event of massive layoffs in companies; on the other hand, people always need a place to live and sectors such as multifamily must achieve better results than others. In the case of productive chains, when impacted by the law of supply and demand the building cost could be higher.

 

Capitalization rates. It is likely that these rates continue to move downward and, along with the trends of central banks, this may result in an advantage in the form of cash flow and low interest rates. This could provide opportunities to acquire new assets and refinance portfolios. In this context of uncertainty, the real danger is for undercapitalized projects or projects with a high leverage level.

 

Investing with this in mind the likelihood of unnecessary risks is avoided, and capital is more protected from the sway of economic cycles that are becoming less and less predictable.

 

In uncertain times of pandemics and commercial wars, it is hard to assess the real impact that this may have on markets and real estate investments in general, reason why we must never lose sight of our investment strategy.

 

 

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