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Key Risks in Property Investing

Key Risks in Property Investing
May 12, 2020 Kenji Smith

All investments carry some level of risk. It is important to understand and consider these carefully when deciding whether to invest into the property market.

What are the potential risks?

Macro Risk:

The value of property can rise or fall in relation to economic cycles. These cycles may fluctuate due to political instability, economic recessions, tax changes, interest rates, and inflation. If these affect the market negatively, your investment return could decrease. In these respects, past performance is not an accurate guide to the future.

Development Risk

Due to unforeseen circumstances, developments can complete late. Various aspects are beyond the developer’s control, such as planning, and now social distancing. This potentially reduces profit due to cost over-runs, which reduces the return on investment to investors. The evaluation of a property’s developers is an important factor when considering an investment, to see their track record in respect to meeting their previous build schedules.

Liquidity Risk

Unlike some shares and bonds, property investments can’t be sold instantly. Instead, it is a long-term asset class which only becomes liquid when the project is completed, and the property sold. In some cases, investment terms can be extended where there are not ready buyers for the property. Property therefore needs to form part of a balanced overall investment strategy, taking into account that money invested into property may not be accessible quickly if it is needed.

Planning Risk

If planning has not been approved, this will increase the risk of the investment as it may not be granted. The consent from the planning authorities takes time. If difficulties arise with planning permissions, this can cause delays in the start of the project and its ultimate cost.

In addition, changes to local and national level planning laws can have positive or negative impacts on construction projects. For example, the government changing the building regulations for new environmental requirements.

Financing Risk

Most property developers will borrow in order to finance their investments. Typically, they will borrow money from banks or credit funds. In circumstances where projects fall behind, and developers require more cash, lenders will often demand higher rates of interest in order to supply further cash. This will impact the return of the investment.

Some lenders provide funds with a First Charge over the project. In a worst-case situation, where the developer is unable to repay his debts, First Charge lenders have the right to take possession of the property. In this situation, investors are likely to lose their capital. Therefore, understanding the structure of the deal, and where lenders and equity holders stand in relation to each other should the deal go wrong, is important when evaluating risk in the deal.

Summary

In conclusion, this summary highlights the key risks and consequences associated with property investment. These highlight the importance of an experienced team being able to evaluate such risks on behalf of investors.