Managing risk in the real estate sector is significant. Both residential and commercial real estate have the same types of risks that any investor must know. The investors should put in place strategies to tackle the threats when they do occur. If you want to be ahead of other real estate players, here are the main types of risks you should know about:
Physical Property Risk
Both multibillion-dollar properties and small apartments are prone to risks. The main threat facing properties is physical damage. Roofs can begin to leak, the paint can get scratched, and cracks can appear on the wall. While total prevention of this situation is not possible, you can implement specific risk management strategies.
Most property owners transfer the risk to an insurer. As a building developer, you may not have enough money to cater to all the damages to your properties. The money you have can be spent on paying insurance premiums. If a mistake or damage occurs, the insurer will cater for repairs and other payments. In some cases, the insurer may pay for any damaged or stolen goods within the insured building.
While getting an insurance cover for your property is a smart move, you can also take other measures to reduce the risks. Many physical damages can be controlled if they are identified in the early stages. Consequently, you should conduct regular home inspections. You can ask professional home inspectors to look for any problems with the roof, the floor, or the walls. Also, you should conduct an audit of the goods within the house to prevent any losses. Then, you should get some photographic evidence for later use.
Regulatory Risk
The legal landscape is always changing. State and federal authorities are creating new laws to control the real estate market. Your current investments may be anchored on a specific type of legal framework. If the rules change, your business model may take a hit. For example, tax rules may be modified so that you now pay higher taxes. Simultaneously, the rules don’t allow you to transfer this extra cost to the tenants. As a result, you may end up losing money if you are not prepared.
The solution is to insure your property against legal changes. This means that the insurance company will offset any increase in your operational costs or any reduction in rental income from your property.
As indicated above, you can either avoid the risk, control the risk, or transfer it to another entity. Whichever method you choose, you must disclose it to your partners, investors, and customers. Moreover, that method must be consistent with state and federal laws. Consequently, your firm should seek the services of a qualified attorney when creating loan documents, leases, and contracts.
Even if you follow the rules, customers, investors, and tenants will always dispute whatever you say or do. Ultimately, the best thing is to transfer the risk to another party.
Environmental Risks
Several environmental factors such as wind, tornadoes, and hurricanes can wreak havoc on your real estate investments whether commercial or residential. A mitigation strategy is essential.
The easiest option is to stay away from places with extreme environmental changes. For example, the State of Florida and the Gulf Coast face frequent tornadoes and hurricanes. If you’re purchasing an investment property here, you may have to repair it every year.
However, the risk of environmental catastrophes has spread throughout the country due to environmental changes. Consequently, risk transfer remains the best method of avoiding the occurrence of such issues. If you have good property insurance, you don’t have to worry about hurricanes, storms, and floods.
Risks Within the Market
It is not possible to stay away from risks when you are a real estate player. While you can prevent some risks, others can’t be avoided entirely. The latter requires strategies that can reduce the effects of those risks on your profit.
Staying away from risky properties and risky investment decisions is the best way to deal with unnecessary risk. For instance, you can stay away from lawsuits by avoiding certain properties. Unfortunately, it is not possible to avoid every single risk. In this case, the best option is to come up with a risk control mechanism. For instance, you can conduct maintenance operations on your property to reduce the occurrence of extensive repairs later on.
If you can’t avoid the risk, maybe you should remove it from your portfolio. Some firms cater specifically to such risks. For example, you can get an insurance cover for your property so that the insurance company takes the hit when something goes wrong.
Final Take
Even with the advent of the internet, the real estate market remains extremely localized. Events in one market are unlikely to affect another market. Consequently, the best way of tackling risks is by diversifying your real estate investment portfolio. People who own property in different sectors, classes, and markets will not be affected when one sector goes under.
Any business has a lot of risks, but the real estate industry seems to have more. Learning how to manage these risks is something that you cannot avoid as a real estate investor. You can use our guide to get started.
This post has been contributed by Reciprocity.