Risky vs. Non Risky Investments
Blog post description.
8/25/20263 min read
April 30, 2025
There are many tolerances for investment decisions. Some investors like the tried-and-true low risk choices such as High Yield Savings Accounts, Money Market Accounts, CD’s, Treasury Yields and Government Bonds. Other investors may try their hand at the stock market and some prefer to invest in real estate. I prefer the latter - real estate.
The above low-risk investments also offer low returns typically between 3% to 4.5% annual return. I am not a financial planner or an expert in these types of investments. The decisions I make toward investing are more geared to the bottom line.
Comparatively speaking, assume a real estate investor buys a multifamily property that is fully occupied and the total rent received per year is $90,000. The investor needs to pay a total of $20,000 towards various maintenance costs and property taxes. It leaves the net income from the property investment at $70,000. Assume that during the first year, the property value remains steady at the original buy price of $1 million.
The capitalization rate will be computed as (Net Operating Income/Property Value) = $70,000/$1 million = 7%.
This return of 7% generated from the property investment fares better than the standard return of 3% available from risk-free Treasury bonds. The extra 4% represents the return for the risk taken by the investor by investing in the property market as opposed to investing in the safest Treasury bonds which come with zero risk. Obviously, the numbers are relative to value, rents and expenses of each individual property. Personally, I like real estate as an investment more than the other choices. That said, diversifying your portfolio is always a good idea. Don’t put all your eggs in one basket.
In this Newsletter I will discuss my recommendations for the best ROI in real estate investing and how to avoid the pitfalls of lower producing properties. Surplus returns, which are theoretically available to property investors over and above Treasury bond investments, can be attributed to the associated risks that lead to the above-mentioned scenario. The risk factors include:
Age, location, and status of the property
Property type: multifamily, office, industrial, retail, or recreational
Tenants’ solvency and regular receipts of rentals
Term and structure of tenant lease(s)
Term and structure of CRE financing
The overall market rate of the property and the factors affecting its valuation
Macroeconomic fundamentals of the region as well as factors impacting tenants’ businesses
Let’s look at CAP rates for a moment: Is a higher or lower capitalization rate better?
Generally, the capitalization rate can be viewed as a measure of risk. So, determining whether a higher or lower capitalization rate is better will depend on the investor and their risk tolerance. A higher cap rate means that the investment holds more risk whereas a lower cap rate means an investment holds less risk.
Capitalization Rate on Property
Property investment is risky, and there can be several scenarios where the return, as represented by the cap rate, can vary widely.
For instance, a few of the tenants may move out and the rental income from the property may diminish to $40,000. With $20,000 in maintenance costs and property taxes, and a property value of $1 million, the capitalization rate is 2% ($20,000 / $1 million). This value is less than the return available from risk-free bonds.
In another scenario, assume that the rental income stays at the original $90,000, but the maintenance cost and/or the property taxes increase significantly, to say $50,000. The capitalization rate will then be ($40,000/$1 million) = 4%.
Yes, there are lots of variables to consider when investing in commercial real estate. In order to make better investment decisions, I have some recommendations to share.
This due diligence will go a long way when choosing to invest in CRE properties:
· Lean more towards purchasing properties with a long track record of successful cash flow. These properties have weathered the cyclical changes in the real estate market.
· Look for longevity of ownership. Chances are if one owner has been on the deed and is now selling, it’s most likely because he/she is cashing out and retiring. Not because the property is failing.
· Location is important, but keep in mind, a high traffic area also comes with higher expenses. It may be prudent to look at a property close to high traffic areas and not smack dab in the middle of them.
· Do your property inspection! No matter how nice the CRE property looks or seems to be a good deal – know everything about the roof, the plumbing, the electrical, presence of mold or dry rot, etc.
· Make sure you have reserves. Even the best laid out plans – which include a good Operating Statement-could come up short. Acts of God such as hurricanes or even fires could derail your rental income for a long time.
· Most importantly, be a good landlord. That means perhaps offering incentives such as one-month free rent if your tenant brings you another tenant from his/her recommendation
As always, reach out to me with any questions or comments. I can be reached at: