Role of risk management in commercial real estate (CRE) wealth creation

  • Tax advantages: Real estate investors get tax advantages in the form of tax breaks and deductions. This helps exclude valid costs of owning, running and controlling a property.
  • Capital appreciation: Investors usually make real estate investments for long-term needs, and a major benefit of investing in real estate for the long term is the appreciation of its value over time.
  • Cash flow: One of the key advantages of investing in real estate property is the steady cash flow that investors receive from rental income. Moreover, cash flow in real estate investment becomes net income after the payment of debt services and business expenses.
  • Low correlation with other investment assets: Correlation in the finance and investment industries is a statistic that measures the degree to which two investments move in relation to each other. Real estate is a non-correlated asset class, and performance is not typically linked to that of the stock or bond markets.
  • Secure investment: CRE has a stable real value (intrinsic value). Buying the appropriate type of commercial property in the right location will keep investors safe from loss of cash inflow even during an economic downturn.
  • Long-term leases: The duration of a lease in CRE properties is longer than that in residential properties. As a result, investors in CRE properties do not need to look for new tenants frequently.
  • Increase wealth by leveraging: As investment in CRE is safe, the loan to value (LTV) can increase to 95%, but in the case of residential properties, the LTV stands at 65–80%. Therefore, for CRE, investors can use additional leverage to generate more returns.
  • Liquidity risk: Liquidity refers to the ability of an assetor security to be converted into cash without affecting its current market price. CREs are substantially expensive, making it less liquid.
  • Credit risk: Credit risk or default risk is the possibility of loss from a borrower’s failure to repay the mortgage or meet contractual obligations. With leased or rented property, there is always a risk that tenants will not be able to make lease or rental payments on time.
  • Lending rate risk: Lending rate risk or Interest rate risk is the possibility of loss due to a change in interest rate. In case of an increase in rate, borrowers holding a floating rate loan are negatively impacted. In addition, an increase in interest rate will likely result in a higher internal rate of return, which will eventually reduce the net present value of the investment.
  • Regulatory risk: Regulatory risk refers to the risk from a change in laws and regulations.
  • Demand and supply analysis: Investors must analyse the demand and supply of their property. One of the main drawbacks of a CRE is that it is less liquid, due to higher acquisition costs. Therefore, before employing capital into the property, investors should analyse the demand and supply of the class of property at the location to generate maximum returns for capital invested.
  • Due diligence: Due diligence is a systematic way to analyse and mitigate risk from an investment decision, providing transparency and clarity for a deal. Investors must conduct a thorough research on the property that they are going to invest to prevent any monetary loss arising from the investment.
  • Know the real estate cycle: Real estate investors must pay close attention to the macroeconomic and microeconomic scales of the real estate cycle. The real estate cycle is a four-phase series that reports on the status of real estate markets (expansion, contraction, recession, and recovery). Understanding real estate cycles helps investors take better investment decisions.
  • Descriptive analytics: A type of analysis that uses historic data to understand the changes of the recent past. Descriptive analytics answers the most common real estate performance questions to enable investors to take proper investment decisions.
  • Diagnostic analytics: An analysis that studies historical and current datasets to explain the reason for a past trend. A CRE investor can use data drilling and data mining to analyse data using diagnostic analytics. This helps investors gain an insight into the data patterns that will help solve problems.

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Acuity Knowledge Partners

Acuity Knowledge Partners

We write about financial industry trends, the impact of regulatory changes and opinions on industry inflection points. https://www.acuitykp.com/