In any commercial real estate (CRE) transaction, balancing the risk and return is key. Balancing risks and returns means taking on more challenging investments without sacrificing higher potential returns.
Especially in the current market, risk tolerance is a major driver for each investor’s investment strategy. While some investors are not shaken by periods of volatility, others are frightened by the possibility of a loss. Thus, when comparing the performance or returns of investments in your portfolio, it’s important to consider not only the potential gains of the investments but also the amount of risk that must be taken to earn the returns.
Investors seek to build a portfolio that coincides with their risk tolerance and overall investment strategy. Risk-adjusted returns allow them to compare investments with different risk levels to determine the best options for their desired risk and excess returns. A portfolio management software improves visibility by collecting property and portfolio data and making it more accessible and actionable. With software, you can identify risks and opportunities in your portfolio and monitor performance to make better decisions about risk-adjusted returns.
Read ahead to learn about different types of risks, how to use these risks to maximize returns, and different ways you can leverage portfolio management software.
What Is a Risk-Adjusted Return?
A risk-adjusted return is a calculation of the profit or potential profit from an investment that considers the degree of risk that must be accepted in order to achieve a return. The goal of risk-adjusted returns is to improve the relationship between return and risk in a portfolio relative to a common benchmark.
Typically, if two investments perform similarly over a set period of time, the one with lower risk has a better risk-adjusted return. Essentially, the higher the risk, the higher the return, and the lower the risk, the lower (and more stable) the return.
What Risks Should Investors Consider?
Commercial real estate investors have several risks to consider when making an investment. Amongst the most common risks are:
- Market risk – The commercial real estate industry’s performance is closely correlated to economic factors like inflation and unemployment. Investors must consider how economic trends could impact their investments.
- Asset risk – Each commercial real estate asset class responds differently to economic shifts. Some asset classes, like senior housing, are recession-proof. Others, like retail, are more likely to be negatively impacted by certain market shifts.
- Liquidity – Liquidity, the ease with which an asset can be converted to cash, is directly correlated to market demand. Typically, demand for a property in a high growth market is likely to provide more liquidity than one in a low growth market.
Liquidity risk occurs when an investor cannot meet his or her short-term debt obligations. In this case, the investor is often unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market.
By adjusting returns on the basis of risk, you eliminate the uncertainty of loss in critical economic situations and market fluctuations for your investors.
How Can Portfolio Diversification and Technology Improve Risk-Adjusted Returns for Investors?
Measuring the risk-adjusted return of an investment provides valuable insights about investment opportunities and an understanding of how two investments compare relative to the levels of risk they must assume. These insights should inform portfolio decisions about how to diversify your portfolio and maximize returns.
A diversified portfolio is one way to increase risk-adjusted returns. A well-diversified portfolio contains multiple asset types that respond differently to economic and market shifts. Allocation across a diverse range of assets helps to reduce concentration risks and thus provides consistent risk adjusted returns.
Investors can afford more risks when they have built a portfolio with multiple uncorrelated or inversely correlated assets. In fact, investors who allocate 20% of their portfolios to diversifiers have the potential to not only lower the volatility of the overall portfolio, but also to increase the portfolio’s return over time.
Portfolio management software provides cost and time savings throughout your business operations while improving visibility into your properties’ performance. Portfolio management software enables you to set thresholds for specified metrics and receive real-time alerts and recommendations for next steps. Intuitive, configurable dashboards offer a single location to manage both operations and portfolio insights and help you align with and execute on your growth strategy.
With risk-adjusted returns, you can more clearly navigate economic uncertainties and market fluctuations. And by anchoring your firm’s decisions with risk-adjusted returns, you can strategically update, modify, and improve your portfolio.
Download the Six Actionable Steps to Propel Your Portfolio Growth whitepaper to learn strategies and initiatives you can use to gain a competitive edge.