Investing in industrial real estate offers the potential for substantial returns, but like any investment class, it comes with risks. Even when the commercial real estate market is thriving, there are still potential problems with making a career out of real estate investments. Not only do you need to ensure your property is protected, but you also have to worry about managing the property and its tenants while focusing on the market.
With so many moving parts, including purchasing, selling, and renting the property, the margin for error tends to be small. Whether you are a seasoned investor or new to the industry, risk management is vital for building a profitable commercial real estate portfolio. You may never fully eliminate the risks, but you might minimize their impacts while maximizing your returns.
Investing in industrial real estate is quite different from traditional investments such as stocks and bonds. In some ways, it can be a bit more complicated than the ways investors approach other markets. From the property’s location to considering property insurance, investors have many factors to consider. This makes it essential to have a plan for risk aversion. By understanding and effectively assessing these potential threats, investors may protect their capital and maximize potential returns.
There are three main types of risks involved with most real estate investments, including industrial properties. They are:
Financing Risks. Industrial real estate investments often involve financing by crowdfunding, whether that is through REITs or private equity funds. Difficulties in securing sufficient financing, fluctuating interest rates, and changes in the economy may all pose a financing risk.
Property-Specific Risks. Each property is unique and will come with its own specific set of potential setbacks. These might include physical deterioration, environmental issues, zoning restrictions, or legal complications.
Liquidity Risks. Real estate investments, especially industrial ones, are typically considered illiquid, meaning they cannot be easily converted to cash. The inability to sell a property quickly may lead to a liquidity risk, especially when it comes to your investment plan.
Most quality real estate risk management plans are based on three general strategies: avoiding risk, controlling risk, and transferring risk. Avoiding potential liabilities means choosing not to take part in potentially risky investments or actions. Controlling for risk means having a plan that works to minimize the impact of any potential problems. Finally, risk transfer means shifting some responsibility to a third party, which is where business or property insurance usually comes into play. With these in mind, investors may better protect their properties and portfolios by putting together a cohesive risk management plan.
Investing in industrial real estate can be just as challenging to predict and define as any other investment. Savvy investors may consider whether a property investment correlates positively with their return requirements and risk tolerance, primarily because investors cannot mitigate all risks with an insurance policy in the same way that property management companies may be able to.
Credit and Debt Risks: Investing in a property you plan to lease almost always comes with some form of credit liability. There is always the chance that a tenant will not be able to pay their rent. In addition to that, many investors take out loans to invest in a property, creating a potential liability with their debt. Most experts agree that the debt of a property should not be greater than 75% of its value, but it is up to the investor to decide what works best for them.
Market Risk: When it comes to industrial real estate investments, the market is subject to a variety of risk factors. This makes it vital for an investor to have a thorough understanding. Being able to identify these factors and their potential impact is key to successful investments.
By analyzing current market conditions and trends, investors may be able to discern potential risks. Factors such as supply and demand, interest rates, and economic indicators exert significant influence on property values and rental income.
Real estate investments are also susceptible to environmental risks. These may pose substantial threats to an investor’s portfolio, especially natural disasters, the effects of climate change, and environmental regulations. Property values and insurance costs might fluctuate depending on these and other factors.
Fluctuations in interest rates, property values, and overall economic conditions also expose investors to potential financial risks. Assessing these and implementing the appropriate strategies is crucial to ensure potential long-term success.
Physical Property Risks: For investors who also act as the owner and manager of their property, the number one issue to be aware of is the state and condition of the property. No matter the amount of properties in your portfolio, physical damage is a constant liability. This is especially true if you are planning on selling or renting the property, as environmental factors can wear down paint, landscaping, and the interior of the building.
Repairs should be performed regularly by licensed professionals, but adding extra coverage through commercial property insurance may also help. Insurance coverage may protect you from issues outside your control as the owner, including damage caused by fires or burst pipes. Weather, natural disasters, and other environmental issues should also be considered, especially as insurance companies change their premiums in response to climate change.
Even investors who are not actively involved in managing their properties may benefit from other insurance policies. Building a new property or renovating an existing structure all pose a certain potential liability that is best covered with insurance coverage such as builders’ risk policies.
Tenant Risks: Tenants are another significant risk to real estate, especially for investors who choose to act as property managers. Whether you are dealing with a handful of companies or a large industrial building that houses only one, the risks are still there. Tenants may sue if their equipment or employees are damaged by claiming it was due to the manager’s negligence. Legal battles are costly, and so investors benefit from avoiding these scenarios in the first place.
Investors may decrease the possibility of injuries through repairs, as mentioned previously, but implementing a screening process to reduce the chances of problematic tenants may also limit this risk. Consider hiring a legal team or a property management company to screen tenants, evaluate their ability to pay rent on time, and choose those that will best benefit the property.
Effective risk management is crucial for minimizing potential financial loss and safeguarding your investments. Strategies used include diversification, thorough due diligence, and comprehensive insurance coverage. Each strategy has its own way of protecting your investment from potential threats in and outside the market.
Diversification: One of the most effective strategies against potential risks in commercial real estate investment is diversifying your portfolio. By spreading your investments across different property types, locations, and market segments, you may reduce the impact of any single investment on your overall portfolio. Diversification also helps to mitigate the risk of potential losses in case of market fluctuations, regional economic downturns, or adverse events impacting specific industries and asset classes.
Invest in a mix of property types, such as industrial and commercial properties, to spread the risk and reduce exposure to market fluctuations affecting a specific sector. You may also consider seeking a balance between properties that generate immediate cash flow and those with long-term appreciation potential.
Cash-flow properties tend to provide stability and income, while properties with appreciation may potentially contribute to long-term wealth accumulation. Employing different investment strategies also offers some protection against potential setbacks. Buy-and-hold strategies or investing with a private equity firm may help you adapt to changing market conditions.
Due Diligence: Performing thorough due diligence is another vital aspect of risk management in industrial real estate. Before investing in a property, it is essential to conduct detailed research and analysis to understand the property’s market value, potential income streams, and underlying risks outside of the market, such as the environment. This process often includes reviewing financial statements, examining lease agreements, assessing the property’s physical condition and maintenance history, and evaluating the tenant mix. By conducting rigorous due diligence, you might identify and mitigate potential risks, such as high vacancy rates or hidden variable costs. Due diligence also enables you to make informed investment decisions to potentially avoid properties with hidden risks that lead to financial losses.
Risk Assessment and Insurance: Investors should not overlook the importance of risk assessments and obtaining the right insurance coverage. This involves identifying and evaluating potential risks specific to your properties and implementing measures to mitigate their effects. For example, if you choose to invest in a retail space, you may need to consider the risk of customer injuries and liability claims. In this case, consider obtaining general liability insurance to protect you financially in the event of accidents or lawsuits.
By addressing risks proactively and obtaining the right insurance policies, you might better mitigate the financial impact of unexpected events.
Monitoring and Adaptation: Risk management does not end after you have invested in an industrial property. It is a constant, ongoing process that requires monitoring and adaptation to changes in market conditions, tenant dynamics, regulatory changes, and more. As an investor, you would benefit from regularly reviewing and assessing your portfolio’s performance, identifying emerging risks, and taking the necessary actions to lessen their impact.
By continually monitoring and adapting your strategies, you may optimize your portfolio’s risk-return tradeoff and maximize your potential long-term returns.
Managing risks is a vital part of successful industrial real estate investment. By diversifying your portfolio, performing due diligence, conducting regular risk assessments, and adapting strategies, you may better protect and optimize your investments while enhancing your chances of achieving your financial goals. Risk management will never eliminate risks entirely, but it might help your portfolio weather any effects that come from these factors. By understanding them and implementing the right strategies, you may also be able to invest more confidently in commercial real estate while minimizing potential setbacks.
Avistone is a commercial real estate investment firm specializing in acquiring and managing multi-tenant industrial and warehouse properties. Since our founding, we have acquired and managed more than 4 million square feet of flex/industrial properties nationwide in California, Georgia, Ohio, Texas, and Florida. Our executive management team has over 160 years of combined experience in acquisitions, dispositions, operations, structured finance, appraisal, land use, and asset/portfolio management.
We have the unique ability to integrate extensive capital market knowledge with boots-on-the-ground real estate expertise to successfully acquire and operate properties that offer our investors attractive potential yields and a strong potential total return with relatively low risk. If you are interested in investing in industrial commercial real estate properties, contact one of our investment experts today!
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