Don’t Forget Political Risk

In my previous career I spent fifteen years as a financial planner and investment advisor. When helping clients select investments we usually discussed political risk, that is the risk associated with changes in the political environment. While it is usually associated with foreign investment, it applies to domestic securities as well. However, political risk is rarely mentioned by real estate investors. The question is – why not?

What exactly is political risk? Investopedia defines it as follows: The risk that an investment’s returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policy makers, or military control.

Large real estate developers certainly consider political risk. Changes in zoning laws are generally one of their biggest concerns. So why don’t smaller investors worry about it? Probably because they don’t realize they need to.

Budget Crisis

The current political environment in this country should certainly make any investor pause and take note. Significant tax cuts enacted during the Bush administration are set to expire – but will they? What about estate taxes? Much depends on the outcome of the November elections and despite what the pundits say, no one really knows for sure which way the voters will lean.

A bigger problem for the vast majority of real estate investors is the sorry state of affairs in a good number of state and local governments. Municipalities large and small have become bloated behemoths with an insatiable craving for your tax dollars. As fast as the sagging economy has caused tax revenue to decline, the need for more tax dollars to feed the various entitlement programs and burgeoning bureaucracy has increased. Many expenses have already been slashed to the bone so where does the money come from?

When a municipality can no longer cut expenses it must resort to layoffs and increases in taxes and fees. Locally I have already seen license fees double and permit fees increase while services have been pared to the limits of acceptability. Despite these measures the shortfall in the next round of budgeting is expected to be enormous. So I ask again – where does the money come from? Answer: look in the mirror.

Heed the Warning Signs

What is happening in your investment markets? When the government takes more from you it obviously comes right off the bottom line. Keep in mind that when they take from others it affects you as well. Money taken away from buyers, sellers, contractors, tenants, etc has an impact on what they have left to spend. On the flip side money handed out in entitlements and welfare, such as Section 8, may actually make it easier for someone to rent from you.

Politicians in this country have been on a trend of taking from the productive in order to give to the unproductive and to sustain the power of the bureaucracy they have created. Social programs are being used to curry favor and buy votes. If the polls are to be believed, a massive backlash may be on the way. The ramifications of this on real estate investors need to be factored into your investment decisions. Ignore political risk at your own peril.

I don’t make jokes. I just watch the government and report the facts. – Will Rogers

Photo Credit: pagedooley

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.