8 Types of Risk Every Real Estate Investor Should Know About

Walter Novicki
June 18, 2020

Everyone knows that there is always risk involved with any investment. For the most part, the level of risks involved is directly proportional to the gains or the losses incurred on the equity invested. While not always true, one could also say that means the higher the risk, the higher the possible returns.

Regardless of the investment type, there is always a need to assess the risks involved to determine whether it is the right strategy for you, and the appropriate amount of equity to invest.

The following are some risk factors that an investor should put into consideration while evaluating private real estate:

1.      Risks in the general market

Markets generally have their highs and lows that are connected to the economy. Interest rates, inflation rates, and other economic trends that can have a massive impact on the investment is one of the first types of risk that investors will look at.

2.     Risks based on Asset-Level

Some risks are common in every investment in an asset class. Residential apartments are considered to be of low-level risk,and they bring in lower gains. At the same time, sensitive consumer assets such as shopping malls and hotels involve a much higher level of risk. This is ever apparent as seen over the past few months amidst the impact of COVID-19.  

3.     Idiosyncratic Risks

Some risks are unique to a specific property.These risk factors are such as the location or the cash flow of the property.

4.     Liquidity risk

There is a need to consider the trends of a market and an exit plan before buying an asset. The locality of a property may present endless chances of an exit through possible bidders or none at all,making it hard to exit the investment.

5.     Credit risk

Income and stability always drive the value of a property. Many investors are more willing to pay for a property with a more stable stream of income since it is more predictable and thus safer.

6.     Replacement cost risk

Older buildings may have a justifiably higher rent as demand for space increases. However, what if a new building goes under construction and creates a more attractive facility? Then it may be difficult to hold on to those higher rates or even lose some tenancy. Therefore, the cost of replacement needs to be assessed to see how a property stacks up in its current market and a potential new competition.

7.     Structural risk

This is about the financial structure of the investment and the rights given to the individual participants. An investor should understand how much profit they are to gain from the deal.

8.     Leverage risk

A higher amount of debt on investment directly translates to more risks. Leverage in excess of 70% would be considered very risky. Understanding the full capital stack is crucial to understanding an investment.

 

Investors in real estate should find out more about these risks from their advisors, deal sponsors, or fund managers and obtain straight answers to make their investment decisions confidently.