What's your strategy for managing commercial real estate financing risks?

1 Interest Rate Risk

One of the most obvious financing risks in CRE is the interest rate risk, which is the possibility that the interest rate on your loan will change over time and affect your debt service and profitability. Interest rate risk can be influenced by macroeconomic factors, such as inflation, monetary policy, and market demand, as well as by the terms and conditions of your loan agreement. To reduce interest rate risk, you can choose a fixed-rate loan over a variable-rate loan, or negotiate a cap or a floor on the interest rate. You can also hedge against interest rate risk by using derivatives, such as swaps, caps, or collars, which allow you to exchange or limit your exposure to interest rate fluctuations.

2 Credit Risk

Another financing risk in CRE is the credit risk, which is the possibility that you or your lender will default on the loan obligations or experience financial distress. Credit risk can be affected by your credit history, financial performance, and debt-to-income ratio, as well as by the lender's solvency, liquidity, and reputation. To minimize credit risk, you need to maintain a good credit score, a strong cash flow, and a reasonable leverage ratio. You also need to conduct due diligence on your lender and choose a reputable and reliable one that can offer you favorable terms and conditions. You can also diversify your sources of financing and avoid relying on a single lender or a single type of loan.

3 Prepayment Risk

A third financing risk in CRE is the prepayment risk, which is the possibility that you will have to pay off your loan before its maturity date and incur a penalty or a loss. Prepayment risk can arise from various reasons, such as refinancing, selling, or restructuring your property, or from contractual clauses, such as prepayment fees, yield maintenance, or defeasance. To mitigate prepayment risk, you need to understand the prepayment provisions and penalties in your loan agreement and weigh the costs and benefits of prepaying your loan. You can also negotiate for more flexible prepayment options or look for alternative ways to exit your loan, such as assuming, subordinating, or transferring your loan.

4 Liquidity Risk

A fourth financing risk in CRE is the liquidity risk, which is the possibility that you will not be able to access sufficient funds to meet your loan obligations or to take advantage of new opportunities. Liquidity risk can result from market conditions, such as low demand, high volatility, or tight credit supply, or from operational issues, such as delayed rent collection, unexpected expenses, or low occupancy. To manage liquidity risk, you need to have a realistic cash flow projection, a prudent budget, and a sufficient cash reserve. You also need to diversify your income streams, optimize your capital structure, and maintain good relationships with your lenders and investors.

5 Currency Risk

A fifth financing risk in CRE is the currency risk, which is the possibility that the exchange rate between the currency of your loan and the currency of your income will change unfavorably and affect your debt service and profitability. Currency risk can be relevant for cross-border investors who borrow or lend in foreign currencies or for domestic investors who have tenants or customers who pay in foreign currencies. To hedge against currency risk, you can use derivatives, such as forwards, futures, or options, which allow you to lock in or adjust the exchange rate. You can also match the currency of your loan and your income, or diversify your currency exposure across different markets and regions.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?