Managing risks in real estate investment

As a tangible asset, property has long been regarded as a reliable way to build wealth and diversify financial portfolios, however, like any investment, it comes with its own set of risks that, if not managed effectively, can lead to financial losses and setbacks.

“From rental properties to commercial ventures and real estate development projects, this asset class offers significant opportunities for long-term growth and income generation,” says Arnold Maritz, Co-Principal for Lew Geffen Sotheby’s International Realty in Cape Town’s Southern Suburbs and False Bay.

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“But, although property is generally more stable than many other investment options, factors like market fluctuations, economic uncertainties and location-specific challenges can all impact returns and undermine even the best-laid plans so managing these risks effectively is crucial to safeguard assets and achieving long-term success.”

While these risks can be daunting, Maritz believes that by understanding and addressing them through careful planning, research and the implementation of the following mitigating strategies, it’s possible to significantly assuage their impact.

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Managing Economic Risks

Economic risks are among the most significant challenges in real estate investment as changes in interest rates, inflation, unemployment, and political instability can significantly influence property values, rental demand, and market conditions.

• Monitor Economic Indicators: Stay informed about economic trends such as GDP growth, inflation rates and interest rate changes. Understanding the broader economic environment allows you to anticipate market shifts and make proactive decisions, such as adjusting rental pricing or refinancing debt when interest rates are favourable.
• Hedge Against Inflation: Real estate can serve as an effective hedge against inflation, as property values and rental income often rise with inflation. However, it’s essential to invest in properties with long-term demand so be sure to choose assets in locations with robust economic activity, where demand for housing or commercial spaces will sustain value growth.
• Maintain Healthy Cash Reserves: Economic downturns can lead to vacancies or lower rental yields and having a cash reserve can help you manage unexpected expenses, cover bond payments during vacancies or fund essential repairs without resorting to high-interest debt.
• Opt for Fixed-Rate Financing: In environments where interest rates are expected to rise, fixed-rate financing provides stability by locking in predictable repayment amounts, shielding you from rate hikes that could strain cash flow.

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Selecting Resilient Locations

There is a reason the key mantra for property, ‘ location, location, location’ has endured as the success of a real estate investment is very often determined by its location. The most resilient locations are those that can weather economic downturns and maintain strong demand over time. Here’s how to identify such locations:

• Focus on High-Demand Areas: Invest in regions with growing populations, strong job markets and diverse industries. Cities like Cape Town, Johannesburg, and smaller towns like George and Plettenberg Bay attract both residents and businesses, ensuring steady demand for residential and commercial properties.
• Assess Infrastructure and Accessibility: Areas with well-developed infrastructure, public transport options, and proximity to amenities like schools, hospitals, and shopping centres tend to retain value better during economic slowdowns. Emerging neighbourhoods with planned infrastructure developments can also offer high-growth potential.
• Evaluate Market Trends: Analyse local market trends, such as rental yields, property appreciation rates, and vacancy rates in various areas before investing.  Properties in areas with consistent growth in rental demand are more likely to provide stable returns.
• Consider Tourist-Friendly Areas: In South Africa, popular tourist destinations like the Winelands or towns along the Garden Route offer opportunities for short-term rental income. However, it’s a good idea to diversify within these areas to offset risks tied to seasonal demand or economic shifts affecting tourism.

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Diversifying Real Estate Investments

Diversification is a cornerstone of risk management in real estate. By spreading investments across property types, locations, and markets, you can reduce exposure to downturns in any single sector. Here are ways to diversify effectively:

• Invest in Different Property Types: Avoid concentrating solely on residential properties. Consider commercial real estate, industrial spaces, or mixed-use developments. Each sector reacts differently to economic cycles, and diversification can stabilize your overall returns.
• Expand Geographically: Investing in different regions or cities mitigates the risk of being affected by localised economic issues. For instance, if a region’s economy relies heavily on a single industry and that industry suffers, your investments in other regions can offset potential losses.
• Incorporate REITs: Real Estate Investment Trusts (REITs) allow you to invest in large-scale real estate projects without directly owning the property. REITs offer a way to diversify into commercial or specialised sectors, such as healthcare facilities or logistics hubs, while maintaining liquidity.
• Blend Long-Term and Short-Term Rentals: Balance your portfolio with long-term leases for stable cash flow and short-term rentals for potentially higher, albeit fluctuating, income. Short-term rentals, such as Airbnb properties, work well in tourist hotspots but require active management.
• Partner Strategically: Joint ventures or property syndicates enable you to access larger or more diverse investments. Partnering with experienced investors can also reduce risks associated with market inexperience.

Mitigating Market Volatility

Property markets are inherently cyclical, with periods of growth and contraction. Volatility can be exacerbated by macroeconomic factors, such as global recessions or pandemics so it’s important to anticipate such unpredictability:

• Adopt a Long-Term Perspective: Property is generally a long-term investment. Short-term fluctuations in market value are less impactful if you plan to hold the property for years, during which values typically recover and grow.
• Perform Due Diligence: Thoroughly evaluate each investment opportunity. Assess potential risks such as zoning issues, environmental hazards, or market oversaturation. Hiring a professional property inspector or appraiser can help identify hidden pitfalls.
• Stay Insured: Comprehensive insurance protects against risks such as natural disasters, tenant damage, or liability claims. In South Africa, where load shedding and other infrastructure issues can impact properties, coverage for related damages is particularly important.
• Maintain Tenant Relationships: Happy tenants are less likely to vacate, ensuring consistent rental income. Respond promptly to maintenance requests and build good communication to reduce vacancy risk.
• Consider Property Management Services: Although it adds to expenses, using a professional property management company can help navigate volatile markets by optimising tenant placement, setting competitive rental rates, and maintaining properties to retain value.

“Managing risks in real estate investment requires a proactive and informed approach and by understanding economic risks, choosing resilient locations, and diversifying your portfolio, you can safeguard your investments against volatility and maximise returns,” says Maritz.

“While challenges like market fluctuations and economic downturns are unavoidable, with strategic planning, thorough research, and leveraging professional expertise it’s possible to mitigate their impact, enabling you to capitalise on opportunities while building a resilient and profitable portfolio.”

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