The real estate industry has long been a niche that is constantly thriving. In it lies vast opportunities for the shrewd, forward-thinking investors and developers abound. Investments in the real estate sector can take many different forms such as: Investment properties including land, residential, commercial, retail, industrial, and mixed-use developments, publicly-traded Real estate investment trusts (REITs), real estate related company stocks and mutual funds. In our Secrets to real estate investing blog, we focused on ways an investor can identify the existing investment opportunities in the various real estate themes. In this article, we discuss reasons why real estate is a great investment and key measures to consider before going into real estate.
Overview of the Real Estate Sector
The real estate sector has continued to grow locally. The sector recorded a 1.2% points rise in growth from 4.1% in 2018 to 5.3% in 2019 according to the Economic Survey 2020 report by Kenya National Bureau of Statistics (KNBS). The sector’s growth has been supported by; i) Rapid population growth, which according to the KNBS Census Report 2019, came in at 2.2%, 1.0% points higher than the global average of 1.2%. This continued to create demand for more properties, ii) Infrastructural improvements thus opening up previously remote areas for development, iii) improving client preferences and tastes, iv) an expanding middle class, and, v) the continued entrance of multinational firms who act either as clients or competitors, hence shaping the industry standards. For those armed with the best insight and advice, their future investment strategy can be very rewarding. With this in mind, we will now discuss some of the measures investors can consider before going into real estate so as to mitigate risks and maximize profits.
Key Factors to Consider Before Going into Real Estate
- Be Specific on Your Objectives and Theme You Intend to Venture Into – It is important for one to plan their resources accordingly and avoid unexpected shocks by deciding what risk, return and duration of investment to invest in. With the real estate industry being a broad industry, an investor needs to be specific about the theme he/she intends to invest in,
- Carry out Market Research and Be Open to Continuous Learning – An investor should endeavour to find out how the current performance, future prospects and who the key players are in the specific theme they intend to invest in. This can be obtained from visiting the actual sites, through reading research reports from real estate practitioners or by attending real estate expos. While research does not guarantee success of a project, it reduces the inherent risk by informing the investor of potential hurdles,
- Conduct Financial Analysis and Consider Your Cash Flows – A real estate investment is an illiquid asset class that takes time to obtain back one’s initial outlay. As such, an investor should also consider his cash inflows and conduct financial analysis to gauge the venture’s capital requirements and expected returns. Through financial analysis, projections on expenses to be incurred, expected returns and growth of the funds invested can be determined and forecasted. This thus facilitates decision making on the most favourable venture and also acts as guide to be used by the investor in fundraising,
- Conduct Due Diligence on the Prospective Investment Venture – Due to the unstructured nature of real estate in Kenya and information asymmetry, the investor should conduct proper due diligence on all aspects of the venture including the sellers, the parties he or she is to work with as well as legal restrictions and or guidelines on developing on the particular land parcel or investing in the real estate entity. This ensures the investment is not only available and profitable but also legal and hence the returns are guaranteed. For due diligence an investor should seek the services of a registered lawyer to ensure effectiveness,
- Build a Team of Experts – The labor-intensive nature of real estate makes it hard for a single investor to invest and run end to end. You will thus need to get professionals either as developers, contractors or consultants. An investor should ensure they select a real estate practitioner with vast experience backed by a track record and duly registered by the relevant body. This will reduce the investment risk and increase professionalism ensuring the development is conducted smoothly and the investor gets their target return, and,
- Exit strategy – who is the target market and how have you positioned the product to the market. Typical exit strategies in real estate are; i) a buy-and-hold strategy which involves holding rental property for a period of time, during which the property pays for itself through rental income, producing cash to pay all expenses while also producing an annual profit for the owners, ii) lease option where the owner of the investment property leases it to a tenant who has a contractual option to purchase the property, iii) wholesale, the real estate wholesalers find and buy deeply discounted investment properties that they resell to other investors for a small profit, iv) rehabbing, this involves purchasing a house, renovating it and selling it for more than the original investment costs, v) seller financing, with this strategy, the buyer gets financing for the house from the bank and the seller receives the total sale in one lump sum. The buyer then provides a down payment directly to the seller, who is the bank in this case and makes monthly mortgage payments for the life of the loan.
Benefits of Investing in Real Estate
Conducting proper research and using an analytical approach logically based on the financial factors, will help you in purchasing the best property. Some of the benefits of a rewarding real estate investment include;
- High Returns –The sector has consistently outperformed other asset classes over the last five years with sectors such as serviced offices offering average rental yields of up to 12.3% per annum. As of Q1’2020, average rental yields in the residential and commercial office sectors improved marginally to 5.2% and 7.8%, respectively, from 5.0% and 7.5% in Q4’2019,
- Security of Returns - Unlike traditional investments whose returns fluctuate with market performance, real estate returns have minimal variance and as the value increases over time, they provide a source of stable and consistent returns,
- Inflation hedge - Inflation erodes the wealth of investors over time. One of the primary objectives of investors is to protect their wealth against the negative effects of inflation, especially for long term institutional investors such as pension funds. Real estate provides a hedge against inflation as the value of the assets grow in tandem or higher than the inflation rate. Rents can be adjusted over time in response to movements in inflation rates, and,
- Leverage to Build Equity and Wealth – Real estate can be used as leverage to acquire various financial instruments/ borrowed capital thus enables one to buy more properties and increase cash flow and wealth.
Investing in real estate requires a good amount of financial resources which makes it critical to take extra measures to ensure profit on your investment or at least save yourself from huge losses. The diverse nature and unique challenges of real estate, if well planned for, could lead to great returns to any prospective investor either through net operating income, equity build-up or capital appreciation.