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)


Sensitivity Analysis