Every investment entails some level of risk. Certain generalized sources of risk, such as geopolitical risk and global macroeconomic risk, have an impact on all assets. The sensitivity of any asset’s rate of return to certain risks is what distinguishes it. Furthermore, several asset classes have risks that are unique to them. Below we’ll look at three major categories of risk in commercial real estate investment..
Risk of Inflation
Inflation is defined as a gradual increase in prices and a decline in buying power. Since the year 2000, the inflation rate in the United States has been approximately 2% every year. In this market, preparing for 2% annual inflation would be an acceptable estimate. As a result, property owners can set lease rates that allow for this 2% annual increase in overall market values. The risk of inflation, on the other hand, is that this anticipation is incorrect. What if a renter signs a 10-year lease with the expectation of 2% yearly inflation, but inflation rises to 12% annually after the first year? The tenant got a good deal, but if inflation rates continue to rise at this rate, the property owner may be unable to keep up with the rising cost of operating expenses.
Macroeconomic risk refers to the effect of broad, national economic activity on the cash flows and valuation of a property. During a period of high GDP growth, for example, most businesses have plenty of cash on hand and minimal unemployment. Rental rates might be raised with the expectation of low vacancy rates and revenue loss. Property values rise as a result of these causes. During a recession, on the other hand, businesses may struggle to stay afloat, and unemployment rates may rise. Tenants may have a harder difficulty paying rent on time, and in the worst-case scenario, tenants may go out of business completely. In addition, vacancy rates rise, making it difficult to find a new tenant. All of these things contribute to reduced property values.
Risk of Interest Rates
The form of interest rate risk about which most individuals are concerned is the danger of rising interest rates. Rising interest rates have a detrimental impact on borrowers who have a floating-rate mortgage. Mortgage payments rise in lockstep with interest rates. When refinancing debt towards the end of a loan term, increased rates could be detrimental to borrowers.
Monroe Funding Corp has a wealth of experience and knowledge to help you reach your investing goals. To learn more about Florida Commercial Real Estate Loans, contact us online or by phone at +1 (954) 419-3539.