Real Estate Investment Risks

2 Types of Real Estate Risks

Business Risk Impacts the Cash Flows from Operations a) Diversifiable b) Non-Diversifiable	Financial Risk a) Internal: Obtaining a Fixed Rate Mortgage in which investor knows that what he/she will pay. b) External: Getting a Variable Rate Mortgage that is amortized in 30 years but due in 5 years with a balloon payment

3 Approaches to Manage Risks

1. Risk Avoidance

Avoid Land Speculations

2. Risk Transfer

Shifts risks by Contractual Agreement

For instance:

Net Leases.

Fixed Interest Loan: Transferring Maturity Risk to the Landlord.

Avoid Balloon Payments: If investor gets a loan that includes a balloon payment, the investor take the risk.

3. Risk Reduction

Invest in Real Estate Investment Trust (REIT) which offers low volatility making them ideal for low risk investor. REIT pays out 90% of profits as unqualified dividends to Investors. As a result of the 2017 tax reform legislation, the highest effective marginal rates was lowered from 37% to 29.6%.

5 Measures of Remaining Real Estate Risk

1. Single Period Ratios

e.g., Debt Coverage Ratio (DCR); Comparison of ROE to ROI to K.

2. Trends in Single Period Ratios

e.g., Comparison IRR of Total Capital vs. IRR of Equity

3. Partitioning of NPV's.

4. Sensitivity Analysis.

Investor tests his/her assumptions.

5. Monte Carlo Analysis.

Including two types of variables: controlled and stated variables.

Controlled Variable: Square Footage

Stated Variable: Rents, Vacancies, Growth Rate. Each one has a probability distribution.

Minimize Risks:

Tax Rate

Selling Cost Fee

Net Capitalization

Evaluating expense growth rate.

Revenue - Gross Schedule Income (GSI) growth rate

Vacancy rate to generate an Internal Rate of Return (IRR)