1 Safe as Houses? Business Risk in Real Estate Investment

The financial and systematic risks of investing in real estate are well-covered in applications of modern portfolio theory. However, real estate assets and their associated markets have a number of idiosyncratic characteristics that give them unique risks that are not amenable to elimination through diversification. These are business risks arising out of real estate markets, and commercial and financial aspects of real estate ownership. They arise from multiple inefficiencies in the market, and share a common thread of inadequate knowledge that requires real estate investors to expend considerable effort on investment strategy, market assessment, property evaluation, and other due diligence processes. This paper examines the sources and consequences of business risks in real estate investment, and points to strategies for their management. Intuitively one would not expect much risk to be associated with a market that is literally “as safe as houses”. This paper challenges that intuition by examining the sources and nature of business risks in real estate investments, and proceeds as follows: section I sets out definitions and introduces relevant literature; section II identifies business risks in real estate; and then section III discusses their implications and management