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Navigating the Seas of Commercial Real Estate: 11 Types of Risks You Should Know About to Stay Safe

Navigating the Seas of Commercial Real Estate: 11 Types of Risks You Should Know About to Stay Safe

All investments contain a certain level of risk, and business-related real estate is no exception. These eleven types of risks are often associated with business real estate investment.

  1. Credit or Default Risk

A commercial real estate owner faces the risk that their tenants will not pay their monthly rent or lease on time. Owners count on those payments to meet their financial obligations, and this disruption can cause havoc with the owner's ability to pay their debtors. The situation can become even worse if a tenant goes out of business and leaves before being replaced.

  1. Inflation Risk

Inflation is an economic term that refers to periodic increases in prices. Since 2000, inflation in the United States has averaged approximately 2% per year.

Currently, when a business-related real estate owner rents out a property, inflation is built into the lease and results in a 2% increase each year. Counting on this figure is risky for a long-term lease because inflation forecasts can change and result in a significantly higher inflation rate. In that case, the tenant is happy, but the property owner may not keep up with the rising costs of doing business.

  1. Macroeconomic Risk

Macroeconomics is concerned with general economic factors, such as interest rates and level of unemployment. When the economy is growing, business property is in demand, and owners can increase the rent costs while anticipating a low vacancy rate. However, if a recession occurs, the property owner may have difficulty collecting rents on time and finding new tenants when current tenants leave. The lack of a steady income will have a financial impact, including a lower property value.

  1. Interest Rate Risk

Business property owners who choose a mortgage with a floating interest rate run the risk of increasing interest rates. A fixed income does not typically offset the mortgage payment surge and results in a negative financial situation for the borrower so be careful to steer clear of this as one of the types of risks you can avoid.

  1. Liquidity Risk

Business liquidity is represented by how fast a business can sell their assets for cash. Real estate is not a liquid asset and becomes a risk for an owner who needs money quickly.

  1. Legislative or Regulatory Risk

Changes in laws or regulations that affect business real estate owners or their tenants can present a risk for the owner. Examples are direct risks, such as zoning and building code changes, and indirect risks, such as tax rate increases. And, as previously noted, any law or regulation that impacts a tenant impacts the owner if the tenant is not able to pay the rent or goes out of business.

  1. Location Risk

When you purchased business real estate, it was likely in a perfect location for your needs. However, as years go by, cities change, and vacant buildings and empty lots may now surround this previously ideal setting. There is no way to foresee what a neighborhood will look like in 20 years. This scenario is location risk.

  1. Space Market Risk

When deciding on the price of business real estate, two determining factors are the market rental rates and the demand for rental space. Space market risk is the probability that those factors are accurate and will remain so for the long term. If a significant upheaval occurs locally or even globally, it might affect the tenant’s need for space or ability to pay for it.

  1. Construction Risk

Construction types of risks for a commercial real estate owner are similar to those that a homeowner faces. Will the project be completed on time and within budget? Will hidden defects be uncovered that require additional work and costs? Any of these possibilities will result in reduced income and additional financial output for the owner.

  1. Environmental Risk

Many issues could be considered environmental risks, ranging from environmental protection to asbestos in the floors and walls. Be sure to have a professional inspection of the property to identify problems that can be avoided or mitigated.

  1. Management Risk

Efficient and personable property management is the key to profitability in business real estate. The poorly managed property will not be successful regardless of an incredible location or booming economy. Establish a good rapport with the tenants and let them know that you will collaborate to ensure their success.

Consider these 11 types of risks when buying business-related real estate. Most, if not all, will never affect you, but it is good to be aware of the possibilities.

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