Risks of Investing in Commercial Real Estate

Investment opportunities exist in any type of property. However, commercial real estate investing usually offers greater financial rewards and tax benefits, but it also carries higher risks than investing in residential properties, such as rental apartments or single-family homes.

Whenever you choose to undertake a new project as an investor or owner of commercial real estate, you will be faced with a number of risks. Commercial real estate investment and ownership can be profitable if you manage the different types of risks involved.

Commercial Real Estate Investing Risks

Real estate risks are not all the same. Owning a residential rental property has a very different level of risk from investing in commercial real estate.

While some of these risks can be managed by the owner, it is more valuable to know them ahead of time before purchasing so the forecast returns can be judged fairly in light of all risk factors.

Location

Location, location, location—this is the key to all real estate investing. If you are building a property or investing in one, you should make sure it is located in a suitable area for profitability. 

Considering the area in which the property is located, the demographics of the neighborhood, and how many people use the property regularly will help you make a good decision.

In order to maximize your profits as an owner, you should make sure that your property is located in a prime location.

Liquidity

Because commercial real estate investment usually costs more than residential, there will be fewer buyers at the exit.

In bull markets, buyers scrambling to gain a foothold will be more likely to overpay as they compete for market share. However, during downturns, liquidity can really dry up, so it can take three to six months for assets to sell at market value.

It is important to note that tenant and building quality are highly correlated with liquidity risk. Structures with strong demographics, such as office buildings or supermarket-anchored neighborhood centers, are going to be more liquid than, say, non-central business district offices or regional shopping malls.

Valuation Risk Via Market Rent and Cap Rate

Interestingly, market rent and cap rate are two of the most important drivers of value outside the control of the investor. Depending on the real estate market in the area and the growth of the tenant pool, the rent is determined by supply and demand.

Changing market conditions can affect stock if new buildings are developed or if existing buildings are taken off the market.

In any negotiation between tenants and landlords, market rent will always be the guiding principle. Every piece of real estate is different, but there is a commodity aspect to it in that tenants can find better value elsewhere if the asking price goes beyond the market.

On the other hand, an owner may set the rent below market if they want to fill the space quickly to meet cash flow shortfalls.

Value can also be affected by the cap rate. There is an expansion and compression of cap rates in commercial real estate over time. In general, assets tend to trade around their market cap rates, and transactions rarely deviate from the trend.

Leasing

With direct commercial real estate investment, vacancy risk refers to the possibility of prolonged vacancy after the current tenants have leased the premises.

In the investment period, long-term leases always provide better income security than short-term leases, which are always prone to vacancies. The redevelopment opportunity can be opened up, however, by using short-term leases on certain potential development sites.

Commercial Real Estate Risk Management with Saint Investment Group

There are a number of risks involved when investing in commercial real estate, as shown in the list above. From asset to asset, the importance of each point will vary, but they will ultimately impact every property.

When evaluating projects and investments for long-term capital appreciation, investors should be aware of these factors and consider them in the context of return expectations.

By doing ample research, keeping up with industry trends, and working with a reliable company, you can minimize risks and maximize returns. Long-term returns and appreciation can be obtained with commercial real estate investments if you do it right.

Interested in gaining multiple benefits from real estate investment? Our team is here to assist you and inspect each commercial property we select for investment thoroughly, providing greater security for you as an investor.

To learn how you can benefit from our commercial real estate expertise, contact us at 949-881-7128 at Saint Investment Group today!

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