In today’s uncertain economic climate, people tend to throw out any form of risk management and opt for “safe” investments, not realizing that all investments are exposed to some sort of risk. Elements of uncertainty and risk are associated with all asset classes, including Real Estate, and can be managed and optimized by looking at how all your investments interact in a portfolio context.
UNCERTAINTY IMPLIES AN UNKNOWN # OF OUTCOMES
Events such as the 911 terrorist attack and its economic effects could not be forecasted and reflect uncertainty. By definition, uncertainty is unmeasurable. Uncertain events can not be quantified and estimated with any degree of certainty.
RISK IMPLIES A RANGE OF PROBABLE OUTCOMES
Elements of risk can be analyzed through research and various techniques. Ranges of possible outcomes can be predicted. Formal risk analysis incorporating sampling techniques, statistical inference, and probability measures can be used to great effect. Nobody can accurately predict the future, but we can estimate possible outcomes with differing degrees of confidence. Investors who purchase property are simply purchasing an anticipated stream of benefits.
The three primary forms of risk for Real Estate investments are Financial, Insurable, and Business risks. Other forms of risk to consider include Market, Capital Market, Inflation, Liquidity, Environmental, Legislative, and Management risks. Certain market areas such as Boston, NY, and some West coast cities are highly sensitive to changes in local ordinances which affect the amount of new construction, the supply/demand curve, and trends in migration patterns.
UTILIZE ALL FORMS OF RISK MANAGEMENT
Risk can be controlled through diversification, extensive market research, extremely competent property managers, and hedging. Landlords can often shift risk to tenants using tax stops, rent escalator clauses, net leases, and rental rates pegged to certain price indices.
Purchase properties that differ by type, are affected by different market forces, and cater towards tenants of differing socio-economic classes. Certain investments and property may be more sensitive to some elements of risk than others. This is why it is important to make sure that you hold investments that are uncorrelated with Real Estate as a whole, in order to further diversify your portfolio. Thinking through all your financial decisions from a broad, portfolio context, instead of each individual investment, will minimize your exposure towards risk.
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