Here are eight risks that investors need to consider when looking at any investment in real estate that is private:

1. General Risks in the Market. Every market has fluctuation and fluctuations that are linked to the economy or inflation, interest rates or other trends in the market. Market volatility isn’t a guarantee for investors; however they can protect themselves against the effects of booms and busts by having diversifying portfolios and strategies built on generally-prevailing market trends.

2. Asset-Level Risk. Certain risks are shared by all purchases in any asset category. In the Real Estate Industry there is always a demand for apartments both in economic conditions that are both good and bad so multi-family real property is considered to be low-risk and typically produces lower returns. Office buildings are more tolerant to the demands of consumers than shopping centers, while hotels, because of their short duration, seasonal stays, and dependence on travel for business and tourism have a higher risk than offices or apartments.

3. Idiosyncratic Risk. Idiosyncratic risk is ascribed to a specific property. The greater the risk, the greater the returns. For instance, construction could increase risk for an investment because it reduces the possibility of collecting rent during this period. When developing a property from scratch investors are exposed to greater risk than only the risk of construction. There’s also the risk of entitlement which is the possibility that government agencies that have jurisdiction over the project will not issue the necessary approvals for the project to go ahead; environmental risks which range from soil pollution to pollution, budget overruns and other risks including risk to the workforce and politics. The location is another unique risk aspect. Idiosyncratic risk is defined as the risks specific to the asset as well as the company’s plan for business.

4. Liquidity Risk. In addition to the size of the market as well as how to get out of the investment should be taken into consideration prior to buying. A buyer can expect many buyers to be at the bidding tables in a location similar to Nashville regardless of the market conditions. However, a home inside Evansville, Indiana will not have the same amount of market participants. This makes it easy to invest in the market and difficult to take out.

5. Credit risk. The duration and the stability of the property’s income stream is the main factor that determines its value. If a property is leased for Apple over a period of 30 years can be sold at a higher cost than a multi-tenant office structure that has similar rents. But, remember that even the best credit-worthy tenants could fall apart over time or become insolvent, as history has proven repeatedly. Consider Sears or J.C. Penney’s credit histories 10 years ago as opposed to the present. The massive market in triple net leases that are believed to be as secure as U.S. Treasury bonds and requires tenants to pay taxes, insurance, and improvements which can confuse investors in the property market. The more stable the income stream of a property, the more investors will be willing to pay since it operates much like a bond that has steady income streams. However, the triple net lease owner is taking on the risk that the tenant might remain in business throughout the term of the lease and there could be a buyer who is waiting. A new construction could be an attractive alternative to the 30-year-old structure that was built by a previous tenant.

6. Replacement cost risk. Since the demand for space on the market makes lease rates rise in older buildings It’s only the case that lease rates can justify new construction and increase the risk of supply. What happens if a brand new structure will render your investment property inaccessible because there’s a better building with similar rents? It’s not likely for investors to increase rents or even achieve satisfactory occupancy rates.

7. Structural Risk. It has nothing to do with the construction of a building, but refers to the finance structure as well as the benefits it grants to the individual investors. Senior secured loans give the lender a structural advantage in comparison to “mezzanine” or subordinated debt due to the fact that it is the first one to be paid, and has an upper position in the eventuality of liquidation. Equity is the final payment on the balance sheet, which means equity owners are at the greatest risk. Structural risk is also present with joint ventures. When dealing with these kinds of agreements investors must understand their rights in relation to their stake in the LLC that’s either the majority or minority holding.

8. Leverage Risk. The higher the amount of debt an investment is the higher risk it is and the greater investors must demand for the returns. The leverage effect is a force multiplier. It can help speed up a project’s progress and improve returns when things are going smoothly, however, if the project’s loans are in trouble — usually when the return on assets isn’t enough to pay for interest payments — investors can expect to lose fast and often.

In general it is recommended that leverage not exceed 75 percent of the total property value, which includes mezzanine and preferred equity, as both kinds of debt are over common equity in the payment orders. At Origin, our portfolios do not exceed 75% leverage. Returns should result mostly through the performance of real estate, not from the excessive leverage and it’s crucial that investors comprehend this. Most property investors don’t know how crucial it is to measure leverage, and they can end up with over leveraged investments. Investors need to inquire what leverage is utilized for capitalizing an asset and ensure that they are getting an amount that is proportional to the risk.

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