When everything seems like an unsafe bet nowadays, I would still turn to real estate as a hedge against inflation. It is what it is, no more, no less. If you want an investment above inflation, then you need to get into development projects which usually involve rezoning and a higher level of risk.
There are two basic risks involved in a construction or development project – construction and market risk.
Construction risk mainly involves cost of construction and pace which directly translate into profit margin. Or you can look at it as two basic criteria – On time and on budget. The construction itself depends on efficiency and good management.
To better understand market risk, we look at the time for a project from drawing of plans, city approval, land clearing, construction and sales which range from 3 to 5 years. A regular cycle is only about 7 years which means each project will take up almost a whole cycle. It is therefore very important to time your project such that you can catch the peak of the bull cycle.
Take for example, if you are working on a project in the midst of the current global economic crisis, then like so many projects have, you will be facing the dilemma of either completing the project even though sales will be difficult and pricing will be compromised, or halt the project construction but continue to pay loan interests. In either case, you will be in a slow and painful ride.
Welcome to the real world, greed is just a price to pay.
4 comments:
Here's my question...With the current global market weakness, could construction risk be reduced to the lowest (because you can get your hands on cheaper materials and labor). If so, and if the developer has deep pockets, then it might be a good thing to go through with the development. Is this logic flawed? This will, of course, be entirely invalid if market is overly saturated and demand of whatever it is being developed evaporates. However, I do believe that no matter what sort of market you are in, if you are able to churn out good quality products that are needed and market them well, there will be business for you.
I think I am trying to convey that there are many risks involved in a development project.
As such, I think construction risk will always be high. Think about the time it takes to complete one project. Even if the cost is low, you are hoping the demand will remain as expected or elevate. All these assumptions are risks that you cannot control.
You have to pick your battles. If your pocket is deep, you do not need to take these unnecessary risks for a profit. There are many other safer ways to make money especially if you look at what we have been exposed to all along.
Good point. In a bull market, development projects have a higher chance of churning out huge returns even with higher construction costs, but in this market, there is no reason to take that risk since huge returns are not likely after considering the time factor. Yea, I think you are right.
by the way, what have we been exposed to all along? in reference to safer way to make money...
We have been exposed to conservatism that is risk evaluation coming before any potential profit. Risk management as in the probability of a loss has been minimized because it will take you twice as long to make back the money you have lost and then to make a profit. It is far more stable to consistently make profits, no matter how small as compared.
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