Risk Management for Investors

Managing Risk when Buying or Leasing Real Estate

Due Diligence for buyers and investors to manage risk is essential.  The steps you take to analyze risks will determine whether you have a good value asset or liability.

What are risks to be managed when buying or leasing real estate?

From buying standpoint, the primary business risk is affordability. Does this purchase fit into your business plan?  What is your exit strategy with this location?  If you are not paying cash, what are your financing options?  If you are in retail it’s all about location.

Legal risks for investors would include obtaining clear title to the property, environmental issues, access and permitted use of that location.  Does the zoning use match up with what you are trying to do?

When it comes to leasing, an important risk issue to consider is the length of the lease (long-term versus short-term).  If you find a good space, the investor might look into possible longer-term lease and can get better business terms.  The long-term would also lock you in for some time, so you should try to get flexibility into the lease as much as possible. 

Investors/lessees look into expansion rights and rights of refusal.  They miht need more space to accommodate growth and also possibly to negotiate a termination and subleasing rights. 

Why is flexibility important for the investor?

If you are leasing and moving into a large space with potential for growth, you would want potential to expand operations or offices than to have to find a new space and negotiate with a different landlord. 

On the other hand, the investor/lessee might want to negotiate a termination right, or a right to sublease in case things don’t go well for the business.  Although early termination rights usually come with penalty, that would help the investor quantify possible downside.

Landlords will offer better pricing if an investor signs a long-term lease, because they get stream of cash flow and help the landlord manage its risk.  Given this longer-term commitment, the investor/lessee should work these possible outs into the lease.

How should investors deal with risk in today’s real estate market?

If you’re looking at purchasing a property, explore your potential financing sources early in the process.  Financing takes longer to get approved than in prior years.  Exploring financing sources early in the process will allow the investor to know whether buying or leasing will be an option at the start.

The investor should be aware that the financing is coming due on many commercial spaces.  Banks have been shrinking their commercial real estate portfolios and sometimes not willing to renew on a long-term basis.  

What about foreclosure?  The investor/lessee would want to protect itself and your lease in the event the landlord is foreclosed upon and the lender becomes your new landlord.

A good tactic is negotiating subordination and non-disturbance agreements in connection with your lease to protect yourself if and when the landlord’s financing goes bad.

The investors should hire experienced lawyers and do business planning, possibly to create and use a single-purpose entity like a holding company to own the real estate and try to shelter the operating business from potential liability. 

The investor should also get advice from either tax counsel or your certified public accountant to determine whether leasing or owning real estate would be better for you. 

Investors should be proactive throughout the buying and leasing real estate process.  Stay in front of potential issues before you purchase or lease that space.  Ask lots of questions.  Make sure you do your buyer due diligence. 

Determine your financing capabilities.  Is financing available?  Can you afford the purchase or lease?  Hire and use an experienced Realtor and real estate broker who knows the market.

Investors can use various ways to manage risk, and especially valuable would be combination of using an experienced real estate lawyer and being proactive.

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Harrison K. Long – Business Solutions and Advisory – GRI, REALTOR® and broker associate, Coldwell Banker Residential Brokerage – 949-854-7747 (phone)  –  CA DRE 01410855 – ExploreProperties@gmail.com (email)

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