There are numerous risks of property investing. In fact, every investment you make has some sort of inherent risk associated with that investment decision. Property investing also has significant entry and exit costs which means an investor really needs to understand what they are doing before pulling the trigger. Although there are numerous risks of investing, for every significant risk, there can be a subsequent protocol that can be used to mitigate that risk. By applying numerous risk mitigation strategies an investor can develop a “bulletproof” investment plan.
The risks in property investing range in their severity and likelihood. Though, regardless of their impact, it is important an investor can identify each of these risks and know how to avoid them. Regardless of the risks, if not dealt with accordingly, they can become extremely costly in time and money. Four common risks and their subsequent mitigation strategies faced by investors can be seen as follow:
A Decline in Price
One of the biggest risks of property investing is the decline in a property’s value over time. This risk is likely the biggest barrier stopping individuals from stepping into the market. However, there are ways to minimise the likelihood of price decline and this stems from education.
- Before purchasing, an investor should build their knowledge of the economy. The economy impacts the property market through consumer sentiment and government intervention. Knowing what is happening in the economy can assist in understanding what will happen to the property market on a national level.
- Understanding the mechanisms behind price growth will enable the investor to purchase high potential growth assets. By understanding the concept of timing the market an investor can identify high-growth locations. Moreover, they can use this concept to narrow down the pool of potential areas to invest in.
- The biggest influence on property price is the demand for a property. So, if an investor can identify a property with high demand, they are likely to see good short-term growth. Focusing on demand will enable the investor to identify what type of property in what location has growth potential.
Developing your education is one of the biggest risk-mitigating strategies that can be employed. An investor’s ability to understand a market will dictate if they are a successful or mediocre investor. Focusing on education can mitigate the likelihood of purchasing assets that flatline or decline over time.
Note, that a capital loss is only recorded when a property is sold. Therefore, if price decline does occur in the short term the investor has not lost money until they sell. Therefore, holding a property through a downturn may delay price growth but doesn’t necessarily result in a capital loss.
A significant risk to property investing is a property’s vacancy. The vacancy rate of a property simply relates to the proportion of time a property is unoccupied by a tenant. If a property is unoccupied, it means the landlord (investor) isn’t receiving a rental income from the property. This means a diminished return on investment and fewer funds to pay for ongoing expenses. However, there are a few steps an investor can take to minimise the vacancy rate of their property.
Before purchasing a property, an investor should research an area’s vacancy rate. Every suburb has a vacancy rate which is the average period of time over a year that rented properties are unoccupied. Some suburbs have high vacancy rates as they have an over-supply of rentable properties. An astute investor will recognise this before purchase and identify areas with greater rentability. A standard rule of thumb is to look at suburbs with a vacancy rate below 2%, however, the lower the better.
An investor should consider how their property presents. If a property is run-down and undesirable to the eye it is likely to have little interest. That doesn’t mean an investor should buy a shiny new off-the-plan property for a premium. Instead, presenting a property in its best light will increase desirability to potential tenants. This can also demand a premium in rent for property increasing your return on investment.
Rising Interest Rates
The last two decades have seen record low-interest rates as the government seeks to stimulate the economy in the current environment. Thus, a risk of property investing would be the rise of interest rates and their impact on an investor’s ability to hold onto their property in a high-interest rate environment. An extremely valid concern as the majority of a property’s expenses has derived from the repayments of a property’s loan.
Taking out a fixed interest rate will assist in managing rising interest rates. To ensure consistency in a short-term cash flow analysis an investor could consider fixing their loans. For a set period of time, a fixed loan will offer the security of a consistent interest rate usually lower than a variable loan. This allows an investor to minimise their expenses and better understand the holding costs of a property.
When running a cash-flow analysis use a higher interest rate during your calculations. Providing yourself with an interest rate buffer allows you to ensure the property can behold for the life of the loan. This also ensures an investor doesn’t over-leverage themselves and leave themselves exposed down the track. Interest rates are likely to deviate back to the historical average so an investor can better prepare for this by employing an interest rate buffer.
The potential damages to a property are a common risk of investing. Given property is physical in nature damages from wear and tear, natural disasters or tenant-related issues are all possibilities. The likelihood and severity changes with each potential damage but all of which can take a toll. Though, there are numerous ways to avoid damages and to protect yourself from this liability.
Before purchasing a property (or during settlement) an investor should purchase a building and pest (B&P) report. Nearly all properties are purchased with a B&P report, but the importance of these reports can sometimes be overlooked. Using this report can help to inform the investor of any potential concerns with the structure or condition of a property. An investor can use this report to pull out of a deal or reduce the purchase price of a purchase. It also highlights what potential concerns could arise in the future. Using this report can help to prevent the buyer from purchasing a lemon which later leads to unexpected costs.
An insurance policy will help alleviate the maintenance costs associated with a property during your ownership. If damages do occur to your property, your insurance policy should cover any damages or costs of repair. Landlord and building insurance are a necessity to protect yourself and your liability. One of the biggest risk-mitigating strategies you can employ is taking out an insurance policy. If you are unsure what your policy covers, you can simply contact your insurance company for a detailed report on what cover is included and to what extent. This way, you can avoid any major costs resulting from damage and better manage expenses.
There are numerous risks of property investing. Each of these can cost an investor significant time or money. Understanding these common risks and strategies to avoid them is critical in managing a successful property or portfolio of properties.