Location may be an old saw in real estate, but the saying will always make sense, especially when it comes to geographical risk.
In some instances, the type of assets you hold in your real estate portfolio may not be as important as where they are located. In many primary markets, real property enjoys strong occupancy regardless of national economic trends. In some secondary or tertiary markets, however, real estate investors may find it difficult to fully lease their properties despite a high-powered national economy.
Geographical risk also can include environmental factors such as wildfires in California, tornadoes in the Midwest, or flooding in the Gulf Coast when tropical depressions or hurricanes strike. These geographical factors all can increase investment risk. Geographical risk also can include unfavorable tax regulations and other regulatory or legal factors that could adversely impact an investment and increase investor risk.
In this article we’ll take a closer look at geographical risk in real estate and discuss potential ways investors can manage locational risk factors.
Defining Geographical Risk in Real Estate
Real estate investing is a forward-looking business – investors must make certain assumptions about their current and potential investment assets. It’s not like baseball, where a bad pitch is simply called a ball and the pitcher is able to reset on the mound for another throw. A misstep in real estate could cost investors hundreds of thousands or even millions of dollars.
Real property investors also are constantly bombarded with a slew of risk factors that could adversely affect property values and bring red ink to their ledgers. These include potential changes in real estate regulations, changing business models, natural disasters, and a lack of comprehensive knowledge about market fundamentals and asset classes. Investors performing due diligence on investment opportunities will likely find that some geographical risk factors are manageable, while other factors are uncontrollable.
Generally speaking, thriving markets offer potentially less risk than troubled markets, but each potential investment asset should be viewed through a macro- and micro-level geographic lens that takes into account factors like job and population growth, population demographics such as the number of students, working families, and seniors, and any other relevant information that can be gleaned in order to come to a better-informed decision about an investment’s potential to be profitable.
Geographical risk has no boundaries, either. Asset-level risk can and will change across various submarkets in one city, as well as by varying geographical regions – the factors that make a multi-family property an attractive investment in thriving primary West Coast markets aren’t the same for apartment complexes located in emerging or declining markets.
How to Manage Geographical Risk
Information is the key to managing most types of investment risk. Investors can’t predict when the next hurricane will devastate coastal Texas or Louisiana, but they can be assured that another one eventually will strike in the future. To that end, investors can implement one of the following strategies to help manage geographical risk:
- Risk transfer–Move your investments into regions where you can better or more clearly identify potential risk factors and make more informed investment decisions.
- Risk avoidance–Pass on investing in assets in geographical areas that are outside of your core knowledge and strengths.
- Risk control–Identify potential risk factors that could impact your investments and implement a diversified investment strategy in an attempt to manage those risks.
The Bottom Line
Establishing geographical risk parameters is crucial to managing investment risk in real estate investing. Part of a successful real property investment strategy involves identifying and analyzing market and asset trends across different geographical areas. Real estate risk also can be highly localized, so owning real property assets across different geographical regions and in varying types of markets can potentially reduce your exposure to risk.
