There is no doubt that many of us will have come across so-called “certain investments” which promise the world for minimal risk. These are very eye-catching, many people are attracted by these offers although the fact remains that if there is no risk with an investment then there is no return. The risk reward ratio in the real estate market will differ from country to country, property to property and area to area. But how do you play the risk reward ratio and should you really take too much notice of what it is telling you?
What is the risk reward ratio?
In simple terms the risk reward ratio is the degree of risk you are taking on for the potential rewards which is calculated as a ratio. The higher the risk the greater the reward required to take account of this risk and the lower the risk the lower the expected reward. Each and every real estate investor is different, we all look for different risk/reward ratios and investment returns. So the reality is there is no one strategy fits all for real estate investors, or any other type of investor, but it is really something you should take close notice of.
It is also worth noting that the risk reward ratio of any investment will change over time, it may well have started out as a relatively low risk investment although as the property increases in value the potential risk/reward ratio moves towards a greater risk for a perceived lesser return. This is perhaps the time you should look to sell your property.
Quote from PropertyForum.com: “When looking to acquire real estate there are a number of factors which you need to take into consideration, some of which are obvious and others perhaps not so obvious.”
How do you calculate the risk reward ratio?
The calculation of risk/reward is not an exact science as it will take into account differing views on the economy, local area, property values and the future. It is also worth noting that your duration of investment will also impact the potential risk/reward ratio as this would even out the peaks and troughs which we see in any investment market.
If for example you are buying a property in an area which has seen significant growth in the short to medium term then the likelihood is that squeezing more return in the future could mean you taking on a relatively higher degree of risk. This is perhaps the situation when you would look to sell a property if you had acquired an investment lower down the risk/reward ratio scale when the area was out of favour or only just recovering.
Using your gut feeling
Over the years you will come across an array of different markets, different properties and different areas in which investments are available. These will all bring together an array of different factors to help you calculate the risk/reward ratio and slowly but surely you will begin to build up a gut feeling/sixth sense about an investment. Your mind will assess future investments by taking into account historic deals you have either participated in or researched only to decide they were not for you.
The way these individual investment opportunities worked out in the past will to a certain degree influence your future thoughts but again no two investments are the same and you must look at each one in isolation. If you can buy property with a relatively low risk and potentially large reward this would be the perfect scenario and if you acquire a property which moves ahead and the risks become greater compared to the potential rewards, this is the time to sell.
Sometimes it is advisable to ignore human emotion when looking at real estate investments, however hard this may be, and look at them in terms of cold hard facts and figures. You will no doubt in time create your own calculations, your own formula and your own way of assessing the risk/reward ratio and indeed this approach may well change in time. Forget the emotion, ignore the media headlines and concentrate on the cold hard facts staring you in the face. Then decide……