Risk of capital loss in real estate remains high

Real estate investors unwilling to take further potential hits to their portfolios have been told to look carefully at investing in the asset class amid warnings the short-term risk of losing investment capital remains high.

Despite property valuation declines of up to 50 percent in the US and perceptions 2010 will be the buying opportunity of a generation, real estate as an asset class should not be judged a risk-free investment given the market’s weak fundamentals.

If you can’t afford to suffer any loss, then put off investing in real estate – and definitely avoid high risk strategies targeting high yields and multiples. There is no such thing as a no-risk deal in today’s market environment.

A white paper from advisors David Hodes and Doug Weill said the desire to earn 20 percent-plus returns “year in, year out” ultimately proved unrealistic in the wake of the current real estate recession.

However, the duo said that even in today's market – where investors are hoping to generate returns of 15 percent to 20 percent, given the scale of the dislocation – caution is needed owing to downside risks.

Macro issues, such as unemployment and fiscal and monetary policy, “could have significant negative impact on valuations of, and demand for, commercial real estate”, the pair – who left Credit Suisse's Real Estate Private Fund Group last year to set up their own advisory firm, Hodes Weill & Associates – said.

“The real estate market … remains difficult to underwrite and time. If you can afford some degree of risk that you could lose capital, then perhaps the upside potential of investing in real estate over the next several years justifies the risk.”

However, it would be unrealistic to assume a near zero probability of a capital loss when targeting 20 percent-plus returns, the paper added. “If you can’t afford to suffer any loss, then put off investing in real estate – and definitely avoid high risk strategies targeting high yields and multiples. There is no such thing as a no-risk deal in today’s market environment.”

The paper also warned that the unrealised losses in private equity real estate funds were beginning to turn into realised losses, impacting fund performance. For vintage funds post-2005, Hodes Weill warned a 1.0x equity multiple could be “top-decile performance”.