For real estate investors, understanding and managing risk is the key to healthy investing.
Property investment is an exciting and lucrative business. For individuals with capital to invest in new and existing developments, the process of acquiring, renovating, and leasing a new property can be highly rewarding, financially. However, a project can cause more trouble than it’s worth if it’s not well-planned.
While real estate investors can face many risks, only a few of them are known. Understanding how sponsors and property managers have worked through them for years, is important. Assessing them accurately is more a matter of finding the right Sponsorship team than reinventing the wheel. Here are some of the most common risks real estate investors must manage.
Market Risk
Demand for real estate is notorious for its ups and downs. In a strong market, investors can expect their vacancy rates to be low and their income high. But in a down market, they may need to offer discounted rates to fill spaces.
The real estate market isn’t tied directly to the rest of the economy. In fact, a strong economy might lead to a development spike that oversaturates the market. The two are linked but must be assessed separately.
Economic Risk
Real estate investments face fluctuating market demands, but they are also vulnerable to macroeconomic changes. Uncertainty in the stock market can cause other investors to pull out of the markets, a change in interest rate could increase mortgage rates, or rising inflation can devalue other assets. Using multifamily real estate to protect your principal and create cash flow and wealth is a great upside.
Cash Flow Risk
A cash bottleneck can slow down an investment project any number of ways. If a sponsorship team is unable to meet necessary operating expenses, they must either assume more risk in the form of debt or else cut costs in some other area of the business.
Legal Risk
Property owners are responsible for the buildings they own. If a building does not meet specific codes, such as those for health and fire safety or handicap accessibility, they must either invest money into bringing it up to standard or face legal repercussions.
Property Management Risk
Most independent real estate investors have neither the time knowledge or interest in managing their property themselves. Instead, they look for a commercial real estate property manager to do it for them. It is the duty of an asset or property manager to care for the building, collect rent, manage leases, and asses incoming tenants.
This is a position that requires a high level of trust. A building that is left untended can quickly deteriorate, causing more expense down the road. And difficulties filling vacancies or collecting rent have a direct impact on cash flow. It is therefore imperative that investors find the right property and asset manager to reduce this kind of risk.
A sponsor that acts in best interest of the stakeholders and shareholders as an asset manager is critical to the success of the investment.
Leasing Risk
For many investors, filling space is the most obvious risk. Real estate isn’t as simple as “if you build it, they will come.” Instead, finding tenants requires an expenditure of marketing resources, as well as a full assessment of tenant applicants (see below).
Tenant Risk
Maintaining a healthy tenant roll is one thing but ensuring those who move into your space are well-qualified is quite another. Bad tenants who are late paying rent, damage the property or disrupt their neighbors can threaten your property investment.
A careful property manager knows how to look for red flags in a potential tenant. These might include prior evictions, insufficient bank funds, or an unstable business model.
Geographic Risk
In real estate, what you build is often less important than where you build it. In some cities, new properties fill as quickly as they can be constructed. In others, new developments might change through a series of hands as owner after owner struggles to fill vacancies. Some geographic areas also face environmental risks, such as flooding or earthquake. Investors coping with these risks will have to plan on higher insurance rates and steeper construction costs.
How can you mitigate risk?
Real estate will never be risk-free. However, careful investors who practice due diligence in assessing the risks involved bolster their chances of success.
A trustworthy sponsorship team is able to work with the investor to understand the risks involved in acquiring a new property. One way to assess property risk is to assign each risk factor a score, wherein a 0 means “no risk” and a 3 means “high risk.” By totaling the risk scores, an investor can weigh the various risks against each other and have a better sense of the overall risk. If the risk total is too high, the investor can choose to look elsewhere, or address the most significant risks to bring the score down to a reasonable level.
If you have an interest in owning multifamily real estate, reach out today and schedule a meeting to explore your options. You can email Mike Morawski at Mike@MyCoreIntientions.com