Sometimes real estate can be a hit or miss. The industry is either doing fantastic or, other times, it might be struggling, head barely above water. But one thing is for certain: real estate is essential, and it’s here to stay no matter what the industry currently reflects.
That being said, if you’re interested in investing in real estate, you must understand the ins and outs of the industry. We recommend starting off familiarizing yourself with the following real estate investment risks, whether you’re looking to invest in commercial property or even in a residence.
1. Asset-Level Risk
Often, the overall demand for different types of housing plays a big role in whether or not a specific real estate investment is going to be risky or not. For example, even in bad economies, the demand for housing in an apartment complex is generally good. As for other types of housing, this may not always hold true.
2. Credit Risk
How long and how solid of an income property has can definitely affect its value and, therefore, its overall price.
3. General Market Risk
The real estate market is always going to fluctuate depending on numerous factors including current interest rates, inflation, deflation, and other various trends that often occur in the market, some of which are difficult to control or are even inevitable.
4. Idiosyncratic Risk
This has to do with the risk factor of a particular property. As an example, if a property is currently under construction or poses the danger that must be restored, it will be difficult, or even impossible, to rent out the property as it’s not in a currently livable condition. In this case, this property would be considered a risk to invest in.
5. Leverage Risk
How much debt is on the property you’re looking to invest in? The more debt it has, the riskier it is. In the case of a high leverage risk, investors may find themselves in deep financial trouble if they take a leap of faith and invest if they don’t fully understand the risk and work extra hard to ensure return on investments are greater than the property’s interest payments.
6. Replacement Cost Risk
There’s only so much and so far a property’s value can be driven up by the market before the building eventually becomes old, worn, and rugged and requires reconstruction to keep up with its competitors. What goes up must come back down eventually.
7. Structural Risk
What investment financial structure (mix of debt and equity) does a property have? And what rights does it offer? Out of everyone, it’s the equity holders who typically experience the most risk.
8. Liquidity Risk
The number of market participants can greatly affect the investment risk of a property. Even with poorer market conditions, there are some cities (particularly, those that are more populated and/or more wealthy) that are actively willing to participate in the real estate market.
If you truly want to succeed when investing in real estate, you must understand what the risks are. The more you know about the upsides and downsides of real estate, the better likelihood you’ll adapt to its ever-changing market and, ultimately, succeed.