When considering an investment, one of the most critical questions is, “what is my time horizon?” Basically, how and when will I get my money back and then some! How you answer to this question will determine whether an investment is suitable and should always be considered in portfolio allocations. Moreover, risk and time are closely linked. Investors with more distant time visions may have an appetite for high risk, high reward investment possibilities, and expand their portfolios accordingly. The converse is true for those nearing the Golden Years, particularly if they plan to retire soon.
What is Time Horizon?
An investment “time horizon” is when an investor is prepared to fund a deal before taking its first capital contribution (plus profit) back. Investors ordinarily refer to time horizons as either short, medium, or long-term in nature. Short-term time horizons can be as short as ten days (or less), i.e., an informal loan to a friend to a 10-year structured deal. Medium-terms are generally 10 to 20 years long. Long-terms are typically 20 years or more.
Time extents can vary based on a person’s age, income, and various other factors. For example, an investor may begin with a long-term strategy, with a portfolio that will be distributed as such. As that person ages, she may need to move some of those investments to adjust to a medium-term or even short-term horizon if those moves benefit her in achieving specific goals (e.g., like funding college or early retirement).
Time Horizon Determinants
Your personal operating expenses significant and small.
Expenses, aka “liquidity needs,” play a significant role in assessing the time horizon. Before determining your time limits, it’s worth doing a thorough index of your finances or personal P&L. Take a look at current debts, liabilities, and any major upcoming expenses. If you intend to buy a house in the next two to three years, you may need to invest in a way that maintains short-term liquidity. Be sure to measure the costs of all significant life acquisitions and obligations, such as paying for college (your own or a child’s), organizing a wedding, purchasing a new home or car, etcetera.
Aside from “liquidity needs”, there is also “liquidity wants”: for example, an investor who feels like we are at the top of the real estate market might want to keep her powder dry in the short-term to have that capital readily available to capitalize when the market softens, and while others are already over-levered.
Forecasting Income
Your current and projected income will profoundly shape your time horizon. A person who makes a substantial six-figure salary may be comfortable investing $50,000 into a real estate deal where she won’t be receiving her money back for seven years. This may be more of a reach for someone who earns less and anticipates needing that cash for daily living expenses.
Lifestyle habits
Meticulously analyze your lifestyle habits, particularly as it relates to spending and saving. There’s an interesting phenomenon in which traditionally careful savers find themselves consuming more funds as they make increasing sums money (a term dubbed “lifestyle creep”). Lifestyle creep can speedily corrode an investor’s savings, which can influence her investment time limit.
Risk tolerance
Risk tolerance is one of the deciding factors that impact the investment time scope. Someone prepared to accept more risk might be amenable to adjusting her time horizon to capitalize on a particular opportunity. A more risk-averse person might invest otherwise in “safer” real estate deals over a different period.
Real estate market trends
The nature of the real estate market can also affect a person’s outlook. For example, a Millennial with a long-term vision might not object to investing at the height of the market if she’s planning for the long-haul. Someone who believes she can endure multiple real estate cycles may be less risk-averse than someone who’s nearing retirement.
Short-term Horizons vs. Long-term Horizons
0-10 Year Time Window
Investors with a short runway, or approximately a zero- to a ten-year time range, habitually want to manage their liquidity. There’s a vast distinction between needing that liquidity in 0-5 years versus 5-10 years, so depending on an individual’s wants, even her short-term investing strategies may vary.
For example, someone needing to protect flexibility may only desire to invest in commercial real estate through a real estate investment trust (REIT), shares that can be bought and sold as swiftly as with securities. Those with a 5-10-year investment limit might be more concentrated in dealing with reliable cash flow now or during this period. Someone nearing the end of this short-term horizon will want to invest in “safer” markets that exhibit stable income and growth through appreciation.
10-20 Year Window
An individual with a mid-term timeframe, let’s say 10-20 years in duration, will likely seek a more expanded investment approach. It makes sense to invest in neighborhoods with strong local economies, healthy job markets, and continued expansion plans. These areas often have robust current cash flows with growth opportunities. Someone with a medium-term time range might be tempted into value-add real estate deals in which an investor intends to purchase, renovate, and fully stabilize the property before refinancing and empowering investors to cash out their original investments with their preferred returns.
Investments executed on a medium-term basis are sometimes made by leveraging other assets, such as pulling from credit lines to fund the deal. The span of the stake allows ample time for the investor to service the debt on this obligation while concurrently developing additional equity in their investment portfolio.
20+ Year Time Window
An investor with a longer-term time range, 20+ years, has considerable flexibility to invest in riskier real estate deals. The elongated runway presents the most time for an investor to overcome severe economic shocks, pandemics, or market corrections. Of course, this doesn’t suggest that investors should toss caution to the wind. They should still opt for a well-balanced portfolio, investing in some assets that carry insignificant risk, but perhaps also investing a larger share of their portfolio in less conservative opportunities that have boosted forecasted yields. This could incorporate value-add real estate deals as well as developments coming out of the dirt. It may also involve investing in secondary or tertiary markets that show signs of ROI but are not top of mind in institutional investors’ eyes. A person with an extended time purview might also look for deals that appreciate; conversely, a shorter-visioned individual may look to invest strictly for in-place cash flow.
Discovering your Investment Time Range
Here is an old rule of thumb: deduct your age from 100, and then what’s left is equal to the percentage of your investment portfolio that should be kept in stocks. If you’re 25 years old, that means 75% should be invested in stocks. If you’re 60, only 40% should be invested in stocks. Those with shorter-term time strategies might instead use a portion of their stock allocation to buy into in REITs or various real estate-related securities.
Age is only one facet that should be considered when determining your investment time limits and portfolio allocation. Beyond age, the other fundamental factor is risk. Each asset class has its level of risk and return. Investors should acknowledge their risk tolerance and investment objectives, as this plays into their strategy.
Before considering any deal, in commercial real estate or otherwise, an investor should reflect on how various circumstances will impact their time horizon. Knowing one’s investment intentions and aspirations will alter their time horizon. In general, your investment time horizon will help decide the types of assets you should invest in, including the risk profile of each.