When investing, it’s important to think in terms of Risk vs. Reward. The type of investment you’re making, whether it’s real estate, stocks, art, or other investments, is less important than evaluating whether the potential return from any of the options available to you is worth the risk you’ll take by investing. The temptation is to invest in things you’re comfortable with; you may be familiar with real estate and so you might focus your investment solely in that area, but you should only do so when the risk and reward are properly balanced.

For real estate, abide by this guiding principle: The riskier the property is to invest in, the higher the potential reward must be. If you purchase a newly constructed property which is already performing well, the risk is low. Your upfront cost of purchase will be higher, and the return will be commensurately lower. Conversely if you are looking at a property that is older and need of some repair work, and potentially has some problem tenants that need to be evicted, your risk is much higher. To be worth considering the potential return needs to be that much greater, and the upfront cost of purchase needs to be much lower.

A more extreme example is construction of new commercial property, the riskiest real estate investment you can undertake. Factors which compound the risk are numerous, including lengthy construction times, financing risks, and the effects of market fluctuations. Due to the high level of risk involved, your upfront costs should be as low as possible.

To provide numbers as a point of reference, consider three hypothetical investment opportunities on Long Island:

  • A fully performing Class-A apartment building. If this is the building you’re going to purchase, you want to do so between a 4 and 5 cap
  • If you’re looking at purchasing a “value-add” type of property, you’ll do so at approximately an 8 to 8.5 cap.
  • Finally, for ground-up construction, the riskiest investment, you’ll want to between a 12 and 15 cap.

To reiterate, consider any potential investment, in real estate or otherwise, in terms of Risk vs. Reward. Know your capacity for risk before entering into any investment, and perform a thorough analysis to be sure that the potential rewards will be worthwhile.

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