When it comes to real estate investing, there is always a certain amount of risk involved.
Here are six risk factors of real estate investing that every investor should be aware of.
1. Market Risks
Every market ebbs and flows depending on the current market trends. Interest rates, the economy, inflation, etc. all have a part in the ups and downs of the real estate market. While no investor can control the market, he can strategize based on market conditions and build a diversified portfolio.
2. Asset-Level Risk
As a general rule, the less risky an investment, the less return it delivers. In real estate, the same holds true. For example, there’s always a need for apartments regardless of the economy. This makes multi-family dwellings a low-risk venture and also a low-yielding one as well. On the other hand, hotels that rely on seasonal traffic and tourism are a much higher-risk investment.
3. Idiosyncratic Risks
Idiosyncratic risks are risks that are specific to a particular property. For example, construction of any kind (renovations, repairs, new constructions) add risk to a real estate investment because they usually halt rent payments during that time. Other idiosyncratic risks include things like not being able to acquire the proper permits, environmental risks such as soil contamination, and budget overruns.
Another idiosyncratic risk has to do with the location of a property. For example, in Chicago, owners of buildings behind Wrigley Field lost big when a new scoreboard was erected, blocking the view of the field and halting private rooftop parties during the games.
4. Liquidity Risks
Being able to get out from under an investment easily is something every investor should consider before buying any property. In markets such as Houston, dozens of investors may throw their hats into the ring hoping to buy your property, regardless of the market. In Indiana, however, fewer investors may be interested in taking that property off your hands. While this means less competition in buying property, it also makes it more difficult to get out of an investment, too.
5. Credit Risk
Having a credit-worthy renter doesn’t mean your investment is a sure-fire money maker. Even the biggest name renters can go bankrupt, leaving you in the lurch. Overall, the more stable a property’s income stream, the more investors are willing to pay for the security. Don’t let this fool you into thinking that you will always have a steady and reliable income, however.
6. Replacement Cost Risk
Demand is a powerful motivator. As lease rates climb in older properties due to an increase in demand for space, it stands to reason that someone will come along and build new buildings to accommodate that demand. If you can’t justify raising lease rates in your older property, you may lose tenants to the newer, better building and ultimately, lose your income stream.
