Expert's tips on reducing risks in property investment

Failure to learn the key rules of real estate investment has caused many individuals or developers to invest in the sector based on hearsay or advice from non-experts.

This, in return, has led to investors’ regrets after losing the investment, time and energy they put into the venture.

Last year, construction project manager Nashon Okowa launched a book titled; The 7 Rules of Real Estate Investment that seeks to guide investors’s investmentsHere are some of the rules one should consider before investing in real estate according to Okowa.

Never ignore feasibility study

Feasibility study refers to the procedures and actions taken to determine the viability of a business, project, problem or improvement opportunity. It will provide you with an overall picture of a project’s costs, the potential roadblocks, the effort required, and the potential success.

According to Okowa, a former chairman of the Association of Construction Managers of Kenya and owner of Bean Africa, a construction and real estate consultancy firm, the feasibility study is the transcendent Swiss Army’s knife of real estate investment.

“It is Mother Nature’s best effort yet to ensure you don’t burn your fingers. It must be done, and thoroughly for that matter,” says Okowa. Unlike before when real estate was a buyers’ market, people would just decide to invest without caring to do a feasibility study.

However, today, the sector demands that one does a feasibility study since the sector is saturated with bad projects, justifying Henry Ford’s quote: “A market is never saturated with a good product, but is very quickly saturated with a bad one.”

An investor who avoids doing a feasibility study, Okowa says risks falling into the bin of commoditisation, where properties are sold to the buyer who wants the cheapest price- no differentiation or uniqueness.

“It gives you the opportunity to get it right before committing time, money and business resources to an idea that may not work in the way you originally planned, causing you to invest more to correct the flaws, remove limitations and then simply try again,” says Okowa.

A feasibility study will help you to know if the project is bankable or can attract funding from financial institutions or not.

“It would include, inter alia, financial summary and project; to whom the property product will be sold, why and how; how the property will be acquired or produced and delivered to the market; and risks involved and mitigation measures put in place,” he said.

There are five kinds of feasibility studies including market assessment (Comparative Market Analysis or CMA), technical, legal, operational and scheduling feasibility. A well-done CMA must include ongoing, upcoming and completed projects.

Set your expected return on investment (RoI)

The purpose of investment, anywhere, anytime is to make good returns and real estate is no exception.

Unlike before, when there were good returns in real estate investment, today the sector is competitive and you cannot make abnormal profits in this boom era.

ROI is a measure of how much money, or profit, you have earned, should earn on investment as a percentage of its total cost. It helps investors evaluate whether they should buy, build or rent an investment property.

The ROI of an investment is equal to the gain divided by the cost multiplied by 100.

“Note, that it’s imperative to calculate your ROI after the tax income. Some spurious people will inevitably attempt to do it before tax just to make it look more attractive and invite you to proceed with investment. My advice is; to always do it after the 30 per cent income tax deduction. That will give you a true picture of your take-home return,’’ says Okowa.

One question that lingers in many investors’ minds is about what good ROI should be. He says it depends on one’s investment strategy. What do you want to get back as a return when you put your money into such an investment?

Against what other alternative investments would you consider it?

“Ultimately, there has to be some minimum acceptable mark below which a real estate’s rate of return wouldn’t make sense- below which a real estate’s rate of return wouldn’t make sense- below which a project would be considered not viable, below which you should consider outing your money in another investment area,” he says.

Regardless, of your investment strategy, he says there is a minimum ROI mark.

When developing for sale, he says a good real estate investment needs to give you a minimum annualised rate of return of 15 per cent and when the rate of return is also too good, something could be wrong, especially with numbers.

Also, it’s key to note the centrality of time in achieving your annualised ROI.

“Real estate development investment should be allergic to delays if you are to bullet-proof your rate of return,” he said.

Apart from sale yield, there is rental yield, which is developing for rent and has two types; gross rental and net rental yield. According to Okowa, any ideal piece of real estate one buys should earn at least an annual gross rent of 10 per cent of its cost or value.

Be ruthless with due diligence

He says it’s vital for investors to be careful when they see  Caveat Emptor- a Latin word for “Let the buyer beware”.

Due diligence is an integral part of any investment, not just in real estate. It has been revealed that most Kenyans are gullible when it comes to investment, leading to many burning fingers after some properties are demolished for instance after investing in riparian areas.

Some have invested in properties with title encumbrances by financial institutions or disputes of various kinds.

“Most times, due diligence helps you to negotiate better. It can provide you with valuable insights that give you an edge or leverage over the seller during negotiations,” says Okowa.

There are two types of due diligence- pre-offer and post-offer. Pre-offer due diligence is done before you make or accept the offer. 

Post-offer due diligence is conducted after your offer has been accepted. “There is no universal rule on the length of the period but most documents have it as seven to 14 days,” he says

Real estate investment due diligence will broadly cover six main areas including market, legal, technical, financial, environment and tax.