How does risk relate to return in real estate investment?

In real estate investment, the relationship between risk and return is a fundamental principle guiding investor decisions. Higher levels of risk generally require the potential for higher returns as compensation for taking on that risk. Investors are typically not willing to accept uncertain or higher-risk investments unless there is the prospect of a proportionately higher return. This is because risk represents the uncertainty about the future performance of the investment. If an investment carries the potential for significant fluctuations in value or income, investors will look for a substantial return as motivation to proceed with that investment.

This principle is central to investment strategy across all asset classes, including real estate. Investors consider the risk associated with a property—such as market volatility, location, economic conditions, and tenant stability—and balance it against the expected financial returns. Hence, the potential for higher returns is a necessary inducement for taking on additional risk, aligning well with the correct choice in this scenario.