Like any investment, real estate projects are also subject to the possibility of losses. Vacancies, unforeseen expenses and market fluctuations can turn a promising investment into a financial burden. So what are some simple points to bear in mind here?
The location and the expected income are key factors for the profitability of a property. An important warning signal for possible risks are, for example, ‘’overrent’ or ‘underrent’. Overrent refers to the portion of the rent that is above the market average rent rates. Overrent is agreed, for instance, to compensate for structural facilities utilised by the tenant that were built by the landlord. However, if there is no obvious reason, possible causes should be investigated. After all, rental income that suddenly promises a 50 percent increase in income cannot be expected in the long-term. They are neither sustainable for ongoing operations nor do they provide valid data for the valuation of the property.
The recent insolvency of the real estate company Signa-Holding and possibly inadequate risk and scenario analyses by investors is not the first case where the value of properties has presumably been inflated by increased rents. There was a similar case of damage to a private bank – with far lower rental income from a villa. In 2012, this project alone resulted in eight million euros damages to the company.
Why Portfolio Monitoring is Cool
So what can protect against unpleasant surprises? The alarm bells of a portfolio management system usually warn property owners, investors or managers. A comparison with standard market rents alone helps. The tools have a cash flow and forecast calculation that calculates the profitability of a property even in different scenarios, for example, a weakening economy or rising interest rates – whether the expected income will continue to cover the interest burden, known as the debt-service coverage ratio (DSCR). It is a classic KPI for the future viability of a business model.
Active Portfolio Monitoring (APM) helps to achieve greater independence: the APM module of ICRS, a property management tool, saves work by automatically monitoring changes and developments across all assets in a portfolio as an assistant. The system notifies users by e-mail in the event of anomalies. This could be a sudden increase in vacancies or a rise in rents above a certain percentage. Asset managers can also define rules for their own requirements and – if they wish – utilise a comprehensive set of predefined rules that can be easily activated.
A scenario analysis takes into account various macroeconomic developments, such as inflation and cost scenarios. This allows assumptions to be made as to how purchase prices and rental prices will develop. In terms of location criteria, for example, purchase prices in suburban or rural locations are currently falling more sharply. Property prices in central locations, on the other hand, are relatively stable. These are important factors for portfolio management, which ideally should be broadly diversified. A distribution of ‘prime’ and less expensive locations, a distribution across different cities and countries, but perhaps also different types of property use depending on a core strategy are often recommended. The bottom line is that investments should not be concentrated in a single type of property in just one region. However, the larger and more diverse portfolios become, the more important it is to use management and analysis tools to avoid clustering – similar to an equity portfolio.