The housing market is currently experiencing a surge, with low rates, a recovering economy, and people spending more time at home. This has made real estate investment an attractive option for many. However, it is important to understand the risks associated with investing in real estate. Business risk is one of the primary factors to consider when investing in real estate.
This risk is determined by the type of project, its management, and the market it is located in. For instance, a regional mall with long-term leases to tenants with good credit will have less business risk than an investment in undeveloped land that anticipates the construction of a motel. It is essential to do due diligence with sponsors to understand these key factors for success. Additionally, changes in the market can also affect a project's business risk.
This includes new competition, changes in local demographics, and slow regional growth. When investing in a real estate crowdfunding platform like CrowdStreet, it is best to look for sponsors with multiple transactions and a long history of operations. Financial risk is another factor to consider when investing in real estate. This reflects uncertainty about the return on capital when debt financing is used. Debt increases the variability of returns for owners; higher leverage can mean higher profits, but debt service must be paid before shareholders, which can lead to lower or even negative returns.
Financial risk also includes interest rate risk; higher than expected interest rate increases with a variable-rate or short-term loan will increase debt service and reduce returns for equity investors. Rising interest rates can also reduce the price buyers are willing to pay. Liquidity risk refers to whether and when an investment can be cashed out in the future; real estate is generally considered an illiquid asset. When investing in a deal with CrowdStreet, you're investing directly with the sponsor, so there's no risk for the CrowdStreet platform. To avoid negative cash flow risk, it's important to accurately calculate income and expenses before buying an investment property and ensure it's located in a prime location that generates positive cash flow for a high return on investment. To avoid vacancy risks, buy an investment property in high demand in a good location.
To avoid bad tenants, carefully select quality tenants. Smart and successful real estate investors carry out thorough market analysis and rental property analysis to avoid these risks. Investing in real estate can help increase and diversify your income as long as you make consistent profits each month.