Market Risk vs Property-Specific Risk: How to Underwrite Both
Quick Answer
Market risk is systematic — it affects all properties in a geography equally (interest rate changes, economic downturns, population loss). Property-specific risk is idiosyncratic — it affects a single property (flood zone, structural issues, title problems, problem tenants). You cannot diversify away property-specific risk with a single asset. Underwrite both types separately.
Confusing market risk with property-specific risk is one of the most dangerous errors in real estate underwriting. They require different mitigation strategies.
Market risk indicators to monitor: interest rate trajectory (affects buyer affordability and cap rate compression), local employment data (demand driver), housing supply pipeline (competition), and price-to-income ratios (affordability ceiling).
Property-specific risk categories: structural condition (foundation, roof, damp), legal title (boundary disputes, rights of way, restrictive covenants), environmental (flood, contamination, subsidence), tenancy (rent arrears, anti-social behaviour, illegal subletting), and planning (unlawful extensions, enforcement notices).
The stress test methodology: for market risk, model ARV at 10% and 20% below current assessment. If the deal still clears your return threshold at 20% below ARV, you have meaningful downside protection. For property-specific risk, itemise each identified risk with a probability and financial impact estimate.
Crucially: property-specific risks can be quantified and priced into your offer. Market risks are uncertain and must be absorbed through margin of safety — which is why the 70% MAO rule exists.
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