Home Online Business Blog Real Estate Finance: Investment, Risk, and Financial Analysis

Real Estate Finance: Investment, Risk, and Financial Analysis

30 May
Finance in Real Estate

Real estate finance is an exciting and challenging path for a savvy entrepreneur. By performing in-depth risk analysis and making smart investments, you can turn real estate finance into a successful career or a passive income opportunity.

However, smart investing isn’t just a matter of buying property. There’s a lot of financial risk in property investments. That’s why it’s so important to start with a great education and understand the ins and outs of financial analysis. Knowing finance basics like how to read an income statement, balance sheet and cash flow statement is highly beneficial, as well as understanding how exactly real estate projects are funded and what are the determinants of success in real estate investing.

Below, this blog will explore the basics of real estate finance strategies, risks, and best practices for a burgeoning investor.

Real Estate Investment Strategies

Although real estate is frequently hailed as a sure-fire investment, it isn’t necessarily as simple as influencers and finance blogs make it sound. Real estate investing requires significant amounts of education, time, and strategy. That said, real estate is indeed a lucrative market. In fact, the global real estate market is expected to generate more than $4 billion by 2025.1

There are a few different ways investors can tap into this thriving market with different real estate financing options. These include:

  • Generating rental income: buying and holding residential properties to earn a passive income from renters
  • Fixing and flipping: buying, renovating, and reselling properties to earn a short-term profit
  • Commercial investments: investing in commercial properties and generating rental income from businesses
  • Real estate investment trusts (REITs) and funds: giving new investors and private money lenders the opportunity to invest in large-scale real estate projects without independently buying the property2

Each of these strategies has its own risks and pathways to success. Many successful investors use multiple strategies to diversify their portfolios and generate a combination net income both of short- and long-term income.

Risk Assessment in Real Estate

Risk analysis is a continuous and challenging practice in real estate. Unlike stock market investments, which have long-held standards for risk assessment, there’s no universally accepted metric for investment risk in real estate.3 That causes many undereducated investors to focus mainly on their potential returns while ignoring the risks.

Although it’s challenging, an accurate risk analysis is possible, and it’s crucial to an investor’s long-term success. We’ll break down a few common types of risks in the real estate market below.

Market Risk

Like any market, the real estate market undergoes ups and downs. Investors should have a thorough understanding of the current economic conditions, potential downturns, and market trends to make smart real estate investments.

Property-Specific Risk

It’s also important to account for property investment risks that are specific to your potential purchase. Given historical data and the current economic conditions and market trends, how risky is a prospective property? Are there any environmental factors, such as land erosion or rising sea levels, that could lower the long-term value of your investment? What is the potential ROI for any improvements you may make on the property?

Financing Risks

Only around one-third of homeowners commit to a cash offer, paying the whole price for their property upfront.4 If you’re financing your investment property through a home equity loan, it’s crucial to analyze the financial risks. Evaluate the financial data that you have thoroughly, as interest rates and loan terms come with fluctuating risks for each property investment.

Regulatory and Legal Risks

Finally, there are legal risks to consider. You must make sure your property is appropriately zoned and that any planned developments won’t incur any fines. This is particularly true for commercial property investments, as there are complex zoning laws for commercial properties that vary around the country.

Financial Analysis in Real Estate

After assessing the risks, investors should perform a financial analysis to determine the intrinsic value of their potential investment. Real estate investment analysis is not an exact science, but there are steps that well-educated investors and finance professionals can take to inform their decisions.

A few key elements of real estate financial analysis include:

  • Property cash flow and return: evaluating the prospective costs and ROI of a particular property, with risks taken into consideration
  • Net present value (NPV): a metric that lets investors determine the value of a potential property based on its current cash flow and returns5
  • Internal rate of return (IRR): tells an investor the projected profit they could earn over a certain period of time6

On top of that, investors can assess a combination of property valuation methods, such as comparative market analysis or income approach, to uncover more details about their potential investment as it pertains to their goals. For example, if you’re hoping to earn a passive income with your investment, you should consider an income-based analysis.

Tools and Techniques for Real Estate Financial Analysis

Modern tools and resources make analysis for real estate financing more accessible for newcomers. Some financial planning software, for example, can analyze real estate financial statements for you. You can use software programs to create models and store data as you conduct your risk and financial statement analysis.

Sensitivity analyses and scenario planning are examples of models you can run with the right software. A sensitivity analysis assesses your investment’s potential future performance under certain changes, while scenario planning allows you to create models for specific scenarios; for example, an economic downturn.7

Regardless of the tools you use, a risk assessment should always be integrated into your financial analysis. A real estate finance education teaches future investors how to harness the right planning tools and incorporate risk analysis to generate the best results.

How an Education in Real Estate Finance Can Help

Finance for real estate investing is a complicated, ever-changing, and exciting field. If you’re interested in property finance and investing, an online master’s degree in real estate finance might be right for you.

The online MS in Finance program at William & Mary teaches prospective investors how to make well-informed real estate investments. You’ll learn the details of the real estate market, how to analyze risks, and what tools you’ll need to conduct accurate financial analyses. The convenience of online classes allows students to earn their education while pursuing a career path in finance or real estate.

If you want to learn more about the Master’s in Finance program, connect with an admissions outreach advisor at William & Mary today.