Risks Associated with General Business Conditions

Business and Financial Risk Business risk relates to the variance between projected income and expenses. It is the chance that the actual operating costs will be higher than expected (e.g., a sudden roof repair) or that the rental income will be lower than anticipated (e.g., higher vacancy rates). Financial risk, often called default risk, is directly tied to leverage. It is the danger that the property’s income will not be sufficient to cover the mortgage payments and operating expenses, potentially leading to foreclosure and the total loss of the investment.Purchasing-power risk is the threat of inflation. If an investor is locked into a long-term lease with fixed rent payments, but the cost of goods and services rises significantly, the "real" value of that rental income drops. Interest-rate risk affects the property in two ways: rising interest rates make borrowing more expensive, reducing the pool of potential buyers and lowering property values, and they also increase the cost of variable-rate loans the investor might be holding.