The X-Company
RiskS of investing
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Types of Risks
1. Market risk
Market risk may affect all investments in an asset class in a similar manner, such as in the event of a market-wide price crash. While certainly buying properties in different states might diversify market risk to a partial extent, if the wider property market crashes, diversification is unlikely to assuage the systematic risk successfully.
2. Liquidity risk
Liquidity risk is the risk that an individual will have inadequate cash flow and/or working capital to satisfy ongoing expenses, pay creditors and lenders, maintain capital to satisfy ongoing expenses, pay creditors and lenders, maintain capital facilities in proper working order. This can happen when owners become unable to maintain their properties because of lack of funds, resulting in an increase in vacancy rates. Moreover, this can also happen when the investment itself becomes difficult to sell quickly enough that investors will be holding to it for a longer period than expected or sell at a lower value just to attract buyers.
How to avoid liquidity?
By engaging in forecasting and market analysis you can gauge the direction you should be taking, helping to develop a systematic plan that will minimise risk.
Diversification of number of properties owned, types and location of the properties will ensure that the risk is spread out as much as possible so if, or when, a market crashes in a particular location, your whole portfolio isn’t hit, but rather individual properties. However, diversification can be quite challenging, teaming up with other investors or investing through property trusts will help to diversify your portfolio across different property types and geographic locations without having to outlay large amounts of capital or accumulate debt that comes from directly purchasing a property, hence minimizing your risk.
When disaster and unexpected costs hit, insurance will help protect you from being financially burdened in the process of recovering from these loses.
3. Tenancy risk
When renting out your investment property, there are various problems that may arise. If tenants do not treat the property well/if they are late on rent you could face a significant reduction in income/unexpected expenses.
4. Idiosyncratic risk
Idiosyncratic risk refers to the inherent factors that can negatively impact individual securities or a very specific group of assets. Construction, for example, will add risk to a project because it limits the capacity for collecting rents during this time. And when developing a parcel from the ground up, investors take on more types of risk than just the construction risk. There’s also entitlement risk, the chance that government agencies with jurisdiction over a project won’t issue the required approvals to allow the project to proceed; environmental risks, from soil contamination to pollution; budget overruns, political and workforce risks.
Location can also be an idiosyncratic risk. In the US, buildings behind Chicago’s Wrigley Field used for private rooftop parties lost significant capital when a new scoreboard blocked their views.
5. Replacement cost risk
As demand for space in the market drives lease rates higher in older properties, it’s only a matter of time before those lease rates justify new construction and increase supply risk. What if a new property makes your investment property obsolete because there’s a better facility with comparable rents?