Types of Risks in Real Estate

by | Oct 18, 2022

With the trending world changes, many people are venturing into real estate investments faster than ever. This is with or without knowledge of various property investment risks they are bound to encounter; all investments involve profits and losses.

However, like other investments, commercial and residential property investment poses various risks. Some are unique to specific investments, while others are general risk sources that can impact any investment.

Nevertheless, whether you’re a real estate strategist expert or a complete beginner, it’s worth not assuming these risks; they might mark your success or failure.

Look closely at some of the types of real estate investment risks in this article.

1. Management Risk

Management is a crucial aspect of real estate properties, whether commercial or residential. A property may be very nice and located at the best location but remain unprofitable due to poor management.

The right management should be able to maintain properties, respond precisely to economic changes, and make preformed decisions on leases about concessions, operating budget, and lease rates.

Contrarily, poor management leads to high operation costs, high vacancy rates, and sometimes the holding of properties. In turn, the return on investment (ROI) and property income reduce significantly.

Thus, competent and knowledgeable property management is attributed highly to the profitability of your real estate investment.

2. Environment Risk

You are now worried about what the environment has to do with your investment in real estate. Environmental risk comes from environmental protection concerns and regulations on land utilization. Besides, it also comes from the environmental situation of your property.

Soil contamination, hazardous chemical, asbestos, lead-based paints, protected wildlife, and wetlands are among the environmental protection concerns. On the other hand, regulation on land utilization is hard to mitigate and anticipate since another body controls it.

However, noting the high expense associated with environmental mitigation, property owners should use due diligence about possible challenges and solutions.

3. Construction Risk

Whenever you’re undergoing a property construction project, there are usually lots of additional risks from the start to the end. It also applies when doing a renovation of an existing property.

For instance, a property you thought would take two months to be fully constructed may take longer. That will increase the investment cost, delay the anticipated rental income, and sometimes expose other defects in the property.

All these will reduce and delay the rental income expectation of the property owner.

4. Liquidity Risk

I know how it feels to have the best property to lease out or sell, but it takes time before you can turn it into cash. You’re worried that it will become outdated and brings you out of the market!

Nevertheless, this is always a risk associated with real estate properties. The properties are highly illiquid, and it’s rare to find their market immediately after construction completion. Besides, it may offer a price far below the market value if you find one.

However, liquidity depends highly on your location, market cycle, and property type.

5. Default/ Credit Risk

Default Risk happens when tenants don’t make their monthly payments on time. The late payments for your leased properties lead to cash flow challenges. Besides, the dishonesty levels of some tenants who can move out of your property without your consent worsen the situation.

The property owner is then forced to incur costs to find another tenant for occupying the space alongside a sudden income fall.

6. Location Risk

Having the best and most-nice looking property guarantees you not a market for your real estate property. It goes in handy with the right location that fits the target market’s wish.

This means that you can incur a high cost in property investment and cannot meet the client’s needs regarding location. Besides, note that a prime location today may not be the best after ten years. This is because of the rapid changes and growth in different areas.

7. Legislative Risk

It is one of the greatest risks that property owners cannot control. It involves regulations and law changes by the government, directly impacting tenants or property owners.

The risks may be direct or indirect at the national or local levels. The direct risks include zoning changes, utilities, access to public goods, and building codes. On the other hand, indirect legislative risks include federal & local tax rates, banking regulations, and mortgage deductibility needs, among others.

An indirect risk, like an increased tax rate, affects the property owner’s taxable income while reducing the tenant’s cash flow. It is highly risky because, to some extent, the tenants might decide to get out of your space.

8. Financial/ Debt Risk

For many investors, borrowing money is their first source of capital, i.e., from financial institutions or private individuals. They usually do this believing they will settle the debt with the expected income after asset investment.

However, it is crucial to note that the debt may lead to the foreclosure of your investment plan. This is a normal experience for many people, especially due to debt maturity and overleveraging risks.

Overleveraging is an instance where your investment property has a lower capacity of return on investment than the debt you financed it with. While financial institutions don’t lend money beyond what you can pay, this arises in cases where you aren’t able to get tenants.

Types of Risks in Real Estate – Bottom Line

Real Estate is a rapidly changing investment plan all over the world. When done with precise knowledge and passion, it is a source of employment, urbanizing an area, and developing an outlook, among other benefits.

However, as discussed above, it sometimes poses more risks that outweigh the potential benefits and returns. These risks include liquidity risks, credit risks, location risks, legislative risks, management risks, environmental risks, construction risks, debt risks, and market risks.