With every financial decision, there is always an inherent risk and reward. When investing in any asset class the risk vs reward should be considered before making any financial commitment. Within property investment, the risks of property investing can arise over the course of an investor’s time within the market. A seasoned investor can identify and implement risk mitigation strategies in order to reduce the likelihood of risks occurring. Having a sound understanding of the risks in property investing can prevent the investor from experiencing these issues firsthand. Here is a list of risk which can be identified and subsequent protocols to reduce the probability of their occurrence:
Decline in price
A decline in value is always a concern for all investors and is one of the risks of property investing. However, an educated investor will know which market is primed for growth and what markets to avoid. Preventing exposure to a declining market is mitigated before the purchase by asset selection and locality of the purchase. Understanding where a certain market is within its own cycle will help alleviate the potential downturn of a property. Purchasing well in a high-demand area will buffer the investor from short-term decline.
Cash flow analysis
It is important to note, if the property price declines, an investor won’t lose their original capital unless they are forced to sell. Therefore, taking into account holding costs through a cash flow analysis should be considered. A cash flow analysis outlines the expenses of a property and what additional funds (if any) will be required to hold the property. It is important to research all the expenses of a property to ensure the accuracy of the analysis. Using a buffer for expenses may also provide the investor with room to move should sudden expenses arise.
Vacancy
A major concern by investors is not being able to rent out their investment property and having it sit vacantly. This is a valid concern as most investment properties require a rental income in order to hold onto a property. Understanding the vacancy rates of an area will help identify if there is a large supply or strong demand. Property type should also be taken into consideration as there could be a discrepancy in the demand for different types of property. When investigating an area, research the vacancy rates and identify what properties rent well in what location. Doing so, will minimise your exposure to a vacant property and demand a premium in the rental market.
Damages
Given property is a physical asset a risk associated with property investing is the deterioration of the property’s condition. Some properties can have structural issues or given their age may have simple wear and tear over time. If damages do occur to your property whether it be by the tenant or as a result of a natural disaster then your insurance policy should cover any damages or costs of repair. Landlord and building insurance is a necessity to protecting yourself and your liability. Taking out an insurance policy is one of the biggest risk-mitigating strategies which can be employed. 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.
When purchasing property, it is important to note how you can avoid unexpected maintenance costs. Before purchasing a property, it is critical to have a building and pest report done by a licensed inspector. This report consists of a detailed analysis of the physical condition of the property and highlights any major or minor concerns with a property. With this, any potential problems down the track can be brought to light early and this may be used as a negotiating tool to achieve a better price or give you the ability to walk away from the deal should any unexpected issues be identified.
Interest rates
The last decade (as of 2021) has seen record low interest rates as the government seeks to stimulate the economy in the current environment. Thus, a common concern 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. It is likely interest rates will rise in the future as they move closer back to their long-term average. Should increased interest rates occur there are a couple of things an investor can do. Taking out a fixed-rate loan with a lender can assist in calculating cash flow in the short term and lock in lower interest repayments. Moreover, when running a cash-flow analysis consider using a higher interest rate to ensure the property can be held if interest rates do rise.
Leverage
Leverage can be an extremely powerful wealth-building tool and can speed up the snowball effect of building wealth. Leverage is what separates property from many other investment classes. One of the key advantages of leverage is that it allows an investor to grow capital at a superior rate. However, leverage can also be detrimental if not understood correctly and if uneducated investment decisions are made. It is important to understand that leverage can work both ways. It can grow capital rapidly but can also deteriorate quickly if the right investment decisions are not made. If a property declines then the original capital is magnified in its potential loss. Moreover, over-leveraging with a portfolio of properties by borrowing too much can leave an investor desperate should they find themselves in financial difficulty. Understanding what level of leverage is comfortable and affordable for the investor is paramount before making an investment decision.
Liquidity
Property inherently has low levels of liquidity. This means it takes longer to exchange an asset between a buyer and seller unlike other assets such as stocks. This can be advantageous to property investors because it means that property is generally less volatile. Although, it also means it can be difficult to sell a property within a short time period unless the investor is willing to sell the property below market value. Understanding the financial commitment of purchasing a property is essential to avoiding the sudden sale of an asset. In addition, having greater financial clarity will determine if an investor can afford an investment property. Please note, property investing should be used as a wealth-building tool and shouldn’t be become a financial liability.
The verdict
Each property investment concern can be seen to intertwine with one another. Understanding these inherent risks prior to investing will hopefully help the investor avoid these risks from taking place. The backbone to building a successful property portfolio is understanding how to mitigate risks before they present themselves. Having a clear picture of the common risks of property investing will help to make better investment decisions. While if these risks identified and mitigated an investor can minimise their risk and maximise their return.
