Ten Types of Risk in Commercial Real Estate

Real estate is one of the most popular and oldest types of investing. Property, land, buildings, etc., are all examples of real estate. For example, owning land is considered real estate, as is owning property plus a home constructed on it! Residential, commercial, industrial, and land are the four basic categories of real estate.

This blog will concentrate on commercial real estate and its risks!

What is Commercial Real Estate?

Today's commercial real estate industry is expanding rapidly. Commercial real estate is a non-residential property utilized for commercial reasons. It includes retail, commercial, and office spaces. Commercial real estate is a property bought to generate money.

What are Some Commercial Real Estate Risks?

An investment-be it of any type, involves a certain amount of risk. Certain general sources of risk influence all assets – things like geopolitical risk and global macroeconomic risk. What makes each property unique is the level of sensitivity that its rate of return has to those risks. In addition, specific types of properties have risks uniquely their own. 

Any investment has some level of risk, and commercial real estate risk is unavoidable. So, let's look at some of the hazards associated with commercial real estate investment. This article will look at eleven types of risk in commercial real estate investment.

Macroeconomic Risk

Macroeconomic risk influences broad, national economic activity on property cash flows and valuation. For example, during high GDP growth, most firms have plenty of cash on hand and minimal unemployment. Property owners might raise rental rates and expect low vacancy rates and collecting loss. These variables also increase property values. On the other hand, businesses mainly struggle to stay running during a recession, and unemployment rates may rise. Property owners may face a more difficult time collecting rent on time from renters, and in the worst-case scenario, tenants may go out of business completely. In this case, a property manager can give you the best solutions. Vacancy rates are rising, and finding new tenants is difficult. All of these things contribute to reduced property valuations.

Interest Rate Risk

The danger of rising interest rates in the form of interest rate risk that most people are concerned about. Rising interest rates have a detrimental impact on borrowers with a mortgage with a variable interest rate. This is because mortgage payments rise in tandem with interest rates. Higher rates may also harm people who take loans for their property.
Rising interest rates also affect the net present value of investment cash flows. As a result, the current value of future cash flows is reduced due to this adjustment. In some situations, this might result in the cash flows no longer producing an acceptable return for an investment.

Geographical or Location Risk

Ultimately, real estate investing depends on having the right property in the correct location. Cities, on the other hand, function as dynamic and changing entities. What is considered a good location for office and retail space today may be vacant in the next 20 years. The external environment and the neighborhood's contribution to a property's value are sources of location risk. Changes in city expansion, transportation patterns, or decreases in public goods and services can all negatively influence the attractiveness and value of a certain property.

Space Market Risk

Property owners buy real estate with a preconceived notion of market rental rates and space demand during the investment period. The possibility that those expectations are incorrect is referred to as space market risk. For example, consider the impact of a worldwide pandemic on long-term business behavior about remote working. If firms suddenly start allowing a big percentage of their employees to work remotely, the market demand for office space will fall dramatically. This unexpected shift in demand conditions is a space market risk that impacts real estate properties.

Construction Risk

When a property is under construction, the property owner has an additional source of risk. Construction risk exists whether there is new construction or a large one. The building project may take longer than planned, delaying projected rental revenue income, costing more than the budget estimate, or exposing previously uncovered flaws in the property that require more time and expenditure to repair. All of these circumstances reduce the property owner's projected cash flow.

Construction planning is a difficult process. Should the design be modern? Will it be around for long? Is the quote within the budget? Will the payment be late? Will the construction be completed on time? Will there be any mistakes during or after the building? The questions are limitless!

Environmental Risk

Land usage rules and environmental protection issues might threaten the ecosystem. However, it can also be caused by the property's ecological circumstances. The environmental risk is difficult to predict and control. A comprehensive assessment of the site and any historical data concerning the land's previous use must be used to mitigate the environmental risk. Environmental hazards vary by location, but they may include paints with harmful chemicals, hazardous substances, groundwater or soil contamination, wetlands, etc. Because environmental mitigation can be quite costly, property owners should take the time to research potential causes of concerns. Hiring a qualified Property Manager who has experience and knowledge will help you deal with environmental risk.

Management Risk

If not properly managed, even the most beautiful house in the finest location may be an unsuccessful investment. Property managers build connections with tenants and make choices on rental rates, concessions, and the operational budget. Poor management can lead to high vacancy rates, less rental revenue, and expensive maintenance costs. These factors affect the owner's property income and return on investment. As a result, skilled and professional property management is important for real estate investment success.

Risk of Price Inflation

Assume you're purchasing a car with an EMI that might last 24 months. You calculate the interest rate based on the inflation rate for those years. So the only risk here is your expectation of the second-year interest rate. Consider the same scenario, but with a house lease. You're now calculating lease rates for a far more costly residence over a longer period.

Risk of Administration

If you've found the ideal property in the perfect location, you'll need the right administrative staff and property managers to handle it. This guarantees that property decisions are made smoothly and intelligently, that interactions and relationships with renters are managed properly, and that all other processes are carried out correctly. However, even if all other conditions are excellent, poor management can pull the price of a property down.

Risk of Liquidity

The owner of any item would like to get a good price for it. However, turning a property into cash or cash equivalent is a risk that every property owner faces. For example, if someone had to sell their house quickly, the prices they received would almost always be lower than they expected.

Conclusion

Many risks must be evaluated alongside possible profits while investing in commercial real estate. One should thoroughly understand the risks involved in commercial real estate property management. This can be easily done through thorough research on the internet. If you do not have the time and the resources to do so, you can always hire a property management company. With their knowledge and expertise, they can guide you on how to minimize the risks involved in commercial real estate property management.