Topic 17.5: Assessment of Risk

Learning Objective

After successfully completing this topic, you will be able to distinguish among the various types of risk.

Overview

Investors strive to make the best analyses to reduce the chance of loss. Dynamicis the risk from uncertain events that may or may not occur.

Risks associated with general business conditions

Business risk is the risk that the business may not be successful.

• Business risk is the risk that actual income or expenses will not be in line with the budget. It reflects the chance that the business will not be able to continue operations.
• Financial risk exposes the investor to the danger that the revenues of the property will not be enough to pay expenses and the mortgage.
• Purchasing-power risk means that the property value and operating income will not increase proportionately with inflation.
• Interest-rate risk is that associated with a rise in interest rate. Remember IRV? If rates increase, value decreases.

Risks that affect return

• Liquidity risk is the likelihood that the investment cannot be sold within a reasonable time, and that the property may be sold at a loss.
• Safety risk has two parts: market risk and risk of default.
• Market risk comes about from rapidly increasing interest rates. A 7% rate of return may be acceptable when a property is purchased, but if interest rates rise above 7%, investors may choose the other property and the value of the investment will fall.
• Risk of default is the risk that the income of the property will be less than the amount required to pay the debt service.