• Increase in time from initial investment to cash flows equals increase in risk.
  • Risk mitigation planning involves market research and forward thinking.

An equity investor’s risk in a real estate deal increases with exposure to changes that may negatively affect the outcome of an investment project.

In many ways, risk and exposure are the same thing.

The impact of time on risk

Time has a dramatic effect on this concept of exposure and risk: The more time added to a project, the greater the exposure and the greater the risk.

Risk factors that can wreak havoc on real estate development projects include:

  • Business risk (fluctuations in economic activity over time)
  • Liquidity risk (non-cash flow assets tend to be non-liquid)
  • Legislative risk (such as unexpected zoning changes)
  • Interest rate risk (dramatic rise in rates during development)

These risk factors are exacerbated by prolonging the time it takes for equity investors to earn cash flows and see a return on investment (ROI).

Essentially, the longer the time between initial equity investments and incoming cash flows, the greater the chance of negative impacts on investments due to unknown risk factors.

Raw land developments involve a great deal of time — months or years — before assets can be stabilized and cash flows become consistent.

Are the risks worth it?

Whether these increased risks are offset by adequate returns is highly dependent upon the equity investor, the development itself and the current risk environment.

While Realtors hate when I answer their questions about returns with, “It depends,” the fact remains that ROI is dependent upon a great many things:

  • Does the equity investor have an aggressive outlook?
  • Is the equity investor willing to take on moderate risk for moderate return?
  • Does the development itself have a value proposition superior to that of its competition?
  • Is the current risk environment acceptable to the investor?
  • Is the potential gain worth the moderate risk?

Depending on your answers, the return may justify the increased risk.

Thinking like an investor

I always try to put myself in the investor’s shoes by thinking about what he or she would be most concerned about. I determine which risk factors are controllable and which are uncontrollable, and I gather valuable information for risk mitigation planning.

A thorough market study, a clear comprehension of the local legislative environment and a complete understanding of the economy — including interest rates, inflation and environmental shifts — can help decrease exposure felt by the investor.

How to decrease risk

We know that an increase in time between the investment of equity and the return of cash flows will increase risk for the investor.

As a development partner, you should seek to reduce that time and risk as much as possible by doing the following:

  • Forecasting the local market’s impact on your project
  • Predicting the moves of your competition
  • Leverage relationships with legislative decision makers or those in the know
  • Providing loan guaranties
  • Taking responsibility for construction cost overruns
  • Making effective product choices and placements
  • Implementing thorough, smart marketing campaigns
  • Participating in aggressive pre-leasing or pre-sales

While these tips are sure to work, keep in mind that effective project management can organically push a development project ahead of schedule, which is another great way to reduce risk.

Nick Schlekeway is the founder of Amherst Madison, a Boise, Idaho-based real estate brokerage. Connect with him on LinkedIn.

Show Comments Hide Comments
Sign up for Inman’s Morning Headlines
What you need to know to start your day with all the latest industry developments
By submitting your email address, you agree to receive marketing emails from Inman.
Success!
Thank you for subscribing to Morning Headlines.
Back to top
×
Log in
If you created your account with Google or Facebook
Don't have an account?
Forgot your password?
No Problem

Simply enter the email address you used to create your account and click "Reset Password". You will receive additional instructions via email.

Forgot your username? If so please contact customer support at (510) 658-9252

Password Reset Confirmation

Password Reset Instructions have been sent to

Subscribe to The Weekender
Get the week's leading headlines delivered straight to your inbox.
Top headlines from around the real estate industry. Breaking news as it happens.
15 stories covering tech, special reports, video and opinion.
Unique features from hacker profiles to portal watch and video interviews.
Unique features from hacker profiles to portal watch and video interviews.
It looks like you’re already a Select Member!
To subscribe to exclusive newsletters, visit your email preferences in the account settings.
Up-to-the-minute news and interviews in your inbox, ticket discounts for Inman events and more
1-Step CheckoutPay with a credit card
By continuing, you agree to Inman’s Terms of Use and Privacy Policy.

You will be charged . Your subscription will automatically renew for on . For more details on our payment terms and how to cancel, click here.

Interested in a group subscription?
Finish setting up your subscription
×