From volatile markets to rising sea levels, the risks (and rewards) are real
Whether you buy a condo in a prime downtown neighborhood, makeover a house in a growing suburb, or sink your money into a commercial office space or apartment complex, real estate can be an essential part of an investment strategy. There are, of course, risks, and any smart investor does his or her homework before signing on the dotted line. But after some initial financial outlay, real estate can be a great way to generate passive income plus remain connected to the larger community.
Below are just a few examples of risks that any new or seasoned CRE investor should keep in mind, whether it’s their first purchase or their thirtieth.
Unpredictable markets
All markets have their boom and bust cycles, and real estate is no exception. Inflation, interest rates, and the economy at large all have a significant impact on a property’s value and prospects. While no one is immune to these ups and downs, the savvy investor keeps tabs on the markets and adjusts accordingly.
Buy when demand is hot and you risk selling when things have cooled down, and a similar cycle applies to varying interest rates. Likewise, purchase during a bear economy may allow you to sell high when the bull returns, but also risks that property remaining on your books and generating little-to-no income if a downturn persists.
The wrong type of property
Not all CRE assets are created equal. Each type of property has its own strengths and weaknesses, complicated further by your local geography. A few tips to keep in mind:
- Apartments tend to have high demand, no matter the economic cycle, which makes them low-risk. But as a result, they can provide a lower return depending on how hot that specific market may be.
- Hotels rely heavily on tourists and business clients and therefore may claim higher rates but also more risk, given the cyclical nature of the hospitality industry.
- An office complex generally (though certainly not always) has less reliance on consumer demand and tends to rely more on keeping current tenants satisfied, but the ongoing cost of tenant improvements creates downward pressure on overall rates of return.
- Industrial buildings are in high demand by tenants and investors in most major markets around the country, and as a result, the yields for this sought-after product type is generally lower as the pricing is pushed higher by competition. Industrial properties generally require less maintenance, management, and improvements but careful consideration should be given to the location and specific attributes—clear height, power, cross-docking, access, distance to major interchanges, and the major drivers of occupancy in that specific market area.
Whatever corner of the CRE market you occupy, knowing the risks of your particular specialty will manage performance expectations.
Risky locations
The old saying is true—when it comes to real estate, the key to success is location, location, location. It’s first and foremost in your mind when investing in CRE, whether you’re riding the wave of a white-hot neighborhood or placing a pioneer’s stake down on an as-of-yet-undiscovered block.
Both scenarios carry risk. Join the popular crowd at the right time and you’ll see many tenants and high rents; join at the wrong time and it may be too expensive and saturated. An up-and-coming neighborhood has lower costs and more space but also the potential for higher crime rates and less foot traffic.
A location’s rosy prospects can change in a heartbeat. For example, businesses near Chicago’s historic Wrigley Field learned this the hard way in 2015, when the venue mounted a new scoreboard that cut off their once fantastic view of the historic ballpark.
Unreliable tenants
For all income-property owners, tenants are necessary, if complex, part of a CRE investment. The risks here are fairly clear—late or unpaid rent, property damage, and rude or obnoxious behavior that drives current and prospective tenants away. Owners always have eviction as an option, but it takes time and money that has a negative effect on overall yields. Comprehensive tenant screenings are an effective way to mitigate this risk, and far cheaper than having to force out a tenant. A competent property management firm will help you manage the risks.
Foreclosures
It happens to even the most experienced CRE investors—expenses grow beyond expectations and/or vacancies are higher than you could have predicted, all resulting in an inability to meet your commitments. Foreclosure is a real risk in this scenario and the consequences reach far beyond one property. It will certainly impair your ability to get financing down the road.
Due diligence such as a thorough real estate market analysis can prevent such a drastic turn of events. Once you’re up and running, work to pay down the mortgage as quickly as possible—within the framework of the interest rate you are paying—and have a reserve fund at the ready to cover the slow periods and also unexpected tenant or common-area improvements.
Bonus risk (South Florida edition): climate change
Many areas of the country—South Florida chief among them—have begun to factor climate change into their risk assessments for new and existing CRE properties. While this risk is real, local governments in Miami, Miami Beach, and elsewhere, have been working on these issues for some time and are taking active steps to reduce risk and encourage investment.
Morris Southeast Group is confident that Florida will remain a vibrant CRE market, but risks are always a part of commercial real estate investing’s reward. For a free consultation on our commercial real estate investment or property management services, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.
Tags: Bonus risk, CRE Investment Risks, Foreclosures, Risky locations, seasoned CRE investor, Unpredictable markets, Unreliable tenants, volatile markets
