3.1 Classes of Risks

Real Estate Investment Risk Classes

• Professional real estate investors follow a five-step process when evaluating risks in a deal: identify, understand, evaluate impact, mitigate, and price the risk.
• Younger investors may lack experience, so investment committees of senior investors are often formed to analyze deals and identify potential risks.
• Risks in real estate investment are categorized into macroeconomic, interest rate, political, expertise, leverage, planning entitlement, and tenant risks.
• Macroeconomic risk refers to economy-wide changes, such as the global financial crisis, that can significantly impact investment returns.
• Interest rate risk involves the potential impact of changes in interest rates on real estate investment returns.
• Political risk encompasses the impact of government policies or actions on investment returns, including tax changes and regulations.
• Expertise risk relates to the level of knowledge and experience of the investor or the professionals managing the investment.
• Leverage risk pertains to the potential negative impact of high levels of debt or mortgages on investment returns, including the risk of default.
• Planning entitlement risk involves the high-risk stage of obtaining permits and entitlements for land development, offering high returns but also high risk.
• Tenant risk is the risk associated with the performance and stability of tenants in a real estate property, impacting rental income and property value.
• Real estate investors categorize risks to systematically evaluate and address potential risks in investment transactions.
• Understanding and mitigating these classes of risk is crucial for real estate investors to make informed investment decisions and protect their returns.