Isaac Gutman Talks Key Risk Factors in Real Estate

Isaac Gutman is one of New York City's most distinguished and accomplished real estate developers and managers. Isaac Gutman has led Bronx based Ryer Realty Group to unprecedented growth while contributing to the economic development of hundreds of business and local neighborhoods.

The potential exists to make a lot of money investing in real estate. However, every significant investment isn’t without its potential risks. If you want to become a successful real estate investor, then you’ll need to make sure you create an organized plan that includes financing and risk management. Both risk management and funding are the most critical components to consider when investing in real estate. If you’re going to make a run in this industry, it’s usually best to find an experienced investor to take you under his or her wing. By working with a mentor when you first start in real estate, you’ll be able to understand much more about the current industry.

Understanding the critical risk factors in real estate will be one of the first essential lessons you’ll need to learn before you start investing in real estate. To help you better comprehend the vital risk factors in real estate, we’ll discuss the market risk, operational risk, and credit risks that come with investing below

#1 Understanding the Market Risk

There’s always a market risk involved when it comes to investing in real estate. Real estate is one of those industries that regularly experiences fluctuations in its market cycles. On occasion, we experience strong markets when there are stable occupancies and increasing rent growth. However, downturns give us the opposite effect, and we see fewer occupancies and discounted rental rates. Many different factors can create an imbalance in need for space, like a slow economy or a downturn in construction and development.

The real estate market’s ups and downs are usually linked to inflation, interest rates, and the economy. Since we’ll never be able to get rid of market shocks, the best we can do is examine the cycles of the real estate market and make predictions based on the current conditions. That means you’ll want to understand your business model and know your customers. Understanding how your customer relates to your product at present could help you better predict these market cycles.

You’ll need to learn how to identify specific market risk conditions as well as understanding the competition that is in your market. Remember, the value of a project’s vacant buildings are pennies compared to leased and occupied properties.

#2 Operational Risk

Operational risks are the daily risks the company incurs doing its daily business. In real estate, your operational risks will involve human resources, retaining talent, and the cost of replacing and updating your structures. When the economy is strong, it can be challenging to retain top-notch talent, simply because there are many jobs available. However, when the economy isn’t substantial, it will be easier to capture some top-of-the-line talent for your investments.

Since the demand for space in certain areas drives lease rates up when it comes to older properties, over time, those higher lease rates will force the property owner to complete some new construction, which increases the supply risk. So, with operational risks come to a replacement cost risk. Every time rent goes up on these older properties, some other companies will likely try to build a new building. If somebody makes a more beautiful building than yours and offers comparable rents, you’ll have an issue.

At that point, you’ll need to consider the property’s replacement cost and then assess if you can complete an economically feasible renovation project. If you are the first to create that new building, you will be able to attract many other tenants living in less attractive buildings and paying similar prices. But how do you figure out the building’s replacement cost?

You can assess a building’s replacement cost by knowing the property’s asset class, it’s sub-market, and your location. Looking at that will tell you if you can raise rent enough to push through that new construction process. If you can figure out a rate that justifies completing new construction, then you’ll be the investor that attracts the tenants to a beautiful, modern building. However, it might not be feasible to raise rents at this point, so you’ll need to assess the situation.

#3 Credit Risk

Not everybody is currently feeling the credit crunch on the consumer market. However, many small businesses are having issues getting banks to guarantee loans right now. Even when financing is obtained, you’ll need to make sure you understand the finance terms and the process. There are plenty of creative financing solutions available to companies that look promising. However, many of those options are not easy to find, and it can take a lot of hard work and effort to raise capital.

If a property is creating a long, stable income stream, that will drive the property value of the building higher. For example, if you lease a property to a company like Amazon for thirty years, you’ll be able to get a much higher price for it than if you used it as a multi-tenant office building. Still, the most successful tenants can experience an economic downturn and go bankrupt. So, you are always taking a risk that the tenant will remain in the building for the length of your lease.

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