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Possible investment risks in real estate transactions

On Behalf of | Aug 6, 2020 | Real Estate Transactions

Whether considering purchasing a home, new vehicle or investment property, every investment that involves a significant amount of money comes with a certain amount of risk. This does not mean that people should ignore risks since there is no way of avoiding them, nor should they refuse to make a decision until the perceived risk is close to zero. Instead, when considering whether to move forward with investment real estate transactions, investors should weigh the benefits and risks against one another. Consider these three areas of potential real estate risk.

The economic cycle consists of four components: growth, peak, recession and recovery. The market risk for a property refers to where it is in the economic cycle. One cannot simply evaluate the market risk for a property in Delaware based on the national economic cycle. It is not uncommon for different property types in localized areas to exist in different parts of the cycle.

Property type is not just important for considering market risk; it is itself a risk factor. For example, single-tenant net lease — STNL — properties generally have a secure certainty for cash flow. However, if a tenant defaults on a lease or vacates, then the property owner is suddenly faced with a completely vacant property without any cash flow. Multifamily properties tend to have a highover turnover rate and less certain cash flow due to market rental rate changes, but a vacating tenant will be unlikely to have as profound an effect on an owner’s finances.

Although it is sometimes overlooked, investment structure risk is another important risk factor. Purchasing a property with the appropriate legal entity will yield the best results, and an investor’s strategy or main objective should dictate his or her chosen entity. An investor interested in a lower liquidity risk might choose a publicly traded REIT — real estate investment trust. A Delaware Statutory Trust — DST — may allow an investor who already has meaningful real estate equity to defer capital gains and taxes, but operating activities can be somewhat limited.

Investing can be a successful path to creating passive income. However, considering the benefits without also taking the risks into account can lead to unintended outcomes. Since there is generally a lot at stake with investment real estate transactions, some find that speaking with an experienced attorney can help them weigh those risks more carefully.