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What are the Risk factors when investing in Commercial Property?

When we consider the risk factors when investing in commercial property, the first & foremost risk will be with respect to location of the property. The market value of the building is decided by the site of construction. The value of the building will change according to changing times. A building may have a higher price tag at one stage. But, when another building is constructed nearby, with all the most-modern facilities & state-of-the-art amenities, the value of the existing building goes down. This is a potential risk factor.

Next risk factor is related to physical characteristics of the building. The type & use of the building also will be risk factors, in some cases. Type of the building refers to the utility the building offers to the owner. It is not easily measurable because it varies from person to person. Utility of a building is impacted by two potential factors - the location & the quality. The quality of the building is determined by the materials used, to complete the structure, the internal layout proposed by the architect & also the specification blueprint which goes into making the building. The risk factor is caused by depreciation value. Wear & tear is a common problem faced by all buildings. Due to advances in building technology & tenants' requirement, buildings lose a little in market value. For instance, specifications for modern constructions have undergone changes due to under-floor cablings.

Tenants:

The rental value to a building is also responsible for the risk factor. The rental income can decide the value of the building. If a building can bring more rent to it's' owner, that itself contributes a lot to the sale value of the building. If the credit quality of the tenant goes down during the period of ownership, then the sale value is also reduced.

Lease Length:

Another valuable factor is the lease period. If the property is let out for a longer period, then a good rental income is assured.

Market Risk:

Market risks affect important areas of the property market. Commercial property is subjected to cycles of growth - growth to oversupply & market weakness to stabilization to absorption & again reaching a stage of growth. From now on shortage of supply and so on & so forth.

Sector Risk:

Every property is part of a specific business sector - maybe a shop or an office or a go down or a storeroom. A building assumes importance according to its utility factor. So, variations in usage create a sector risk.

Rental Growth:

In property, the rental income matters a lot. Changes in utility will generate more rental income. The value of the property will indicate its rental growth. If the investment does not bring expected rental income, the value of the property will fall down. Rental growth can be influenced by many factors - the national economy, local trading conditions, the fluctuations in the financial stability, non-availability of alternative space & many more related features.

Stamp Duty Land Tax:

In buying & selling a property, stamp duty is levied. This is construed as a risk factor. It is levied on property transactions. Historical purchase of properties in stamp duty savings schemes may involve some sort of residual risk.

Product Risk:

A good number for investors will employ a vehicle or a product such as Unit Trust or limited partnership. The risk of investing is minimized to some extent. The negative corollary is additional risk.

Liquidity:

Liquidity depends on two factors - duration of transactions & market price conditions. In normal situations, commercial property takes more time for transactions and hence illiquid. In a dull market, possibility of the deal is practically nil.