The Risks of Property Investment
The number of property investors in Australia has been growing for the past two decades as more and more people choose to create a better financial future for themselves.
With this growth in property investment, there has also been an increase in the number of people providing property investment advice but unfortunately not all of this “advice” is qualified or wise.In this article, we’ll outline property investment basics including buying
In this article, we’ll outline property investment basics including buying investment property and what makes a good investment property as well as renovation tips and traps and and property investment risks.
Choosing an Investment Property
There are literally millions of houses and units in Australia, but not all real estate makes a good investment property.
There are many different strategies for investors about how to select the best property investment. For example, some people look for yields or cash flow, while others invest in properties for their capital growth potential over the long-term.
Speaking to qualified professionals will help you decide which is the best investment strategy for you.
However, it can also be informed by your own personal financial situation and your ability to manage any cash flow shortfalls between mortgage repayments and rents.
- The Right Stage of the Economic Cycle
- The Right State or Territory
- The Right Suburb
- The Right Location
- The Right Property
- The Right Price
Other factors to investors consider include:
- properties that will appeal to owner-occupiers, because history has proven that it is owner-occupiers that drive up real estate values;
- the ability to buy the property under its intrinsic value;
- purchase in an area that has strong capital growth and will continue to outperform the averages because of its demographics;
- consider properties that are unique or ones where investors can manufacture capital growth via renovations or redevelopment.
One of the keys to successful property investment is completing research and due diligence long before you sign on the dotted contract line. Some other considerations to keep in mind may include:
- Future developments in the area, such as new unit, which can have a significant impact on supply, demand and property prices.
- What the market finds appealing in that particular area. That is, you don’t want to purchase the lone unit in an area where there is mostly demand for houses.
- It’s important to consider the condition of the property (both aesthetically and internally), however it’s equally important to look past relatively minor issues that can actually be opportunities to create instant equity in the property through a cosmetic renovation.
- Look at areas or suburbs that are undergoing gentrification
- Strong public amenity, parks, good public transport options, ease of access to the city and good schools are also very strong points to consider
- And you can always look to neighbouring suburbs of long term favourites as these tend to perform just as well, if not better as the favourites jump out of people’s affordability but they can live right next door for a fraction of the price.
During the research phase of your investment property search it can be useful to chat to neighbours next door to the property you’re interested in to identify any other property investment risk factors.
This way you may find out whether the property actually has problems, such as bad tenants whom you’ll inherit if the property has a current lease and is information which is probably not going to be volunteered by the selling agent.
It’s important to research the suburb and location of the property so you have a good understanding of the demographics of the area. That is, if the majority of tenants are families, then it’s probably not the smartest idea to invest in a studio or one-bedroom apartment in that location.
During your due diligence, as well as considering macro indicators, of course, it’s equally important to consider the building or property itself.
It’s a no-brainer that you should have a professional building, pest and/or asbestos inspection carried out if you are seriously considering making an offer, or have made an offer, on the property to identify any property risks.
That way you are aware of any issues that can ultimately affect the price you pay for the property or provide useful insights that will result in you wisely walking away from a property investment lemon.
As was outlined above, one of the keys of property investment can be the creation of capital growth or equity.
In fact, property investment is one of the few asset classes where you can physically increase its value by undertaking improvements or repairs.
Property investors need to ensure they complete stringent research and budget calculations, however, if they’re considering undertaking this strategy to make sure they don’t overcapitalise and to reduce taking on unnecessary property risks.
Overcapitalisation is when you invest more money into an asset than it is actually worth. That is, if you were to sell that asset today you would make a loss on it.
The simplest way for this to happen is overpaying for a property in the first place!
This can be overcome by holding the property for the medium- to long-term when capital growth will likely make up the difference. However, if you need to sell in the short-term, the result might not be pretty.
Another trap for property investment is overcapitalising through renovations, which can be an issue for many beginner property investors.
To mitigate any potential overcapitalisation issues, investors need to understand the local market, including prices of similar properties in the area.
For example, if you paid $750,000 for your house and are considering spending $150,000 on renovating it, the local market must have properties of a similar style and standard that are selling for at least $900,000 to ensure you’ve made a healthy return on your endeavours.
A better spend may be $60,000 to $75,000 on the renovation to further mitigate the property investment risks.
Also, as a general rule of thumb, most renovators of midrange properties generally don’t spend more than 10 per cent of its value.
Major mistakes that renovators commonly make include:
- Underestimating the cost of the renovation.
- Underestimating the time it takes.
- Not completing a financial feasibility analysis.
- Not using professionals for the renovation.
- Confusing TV reno shows with reality. Did someone say The Block?
- Not renovating to market requirements.
- Not balancing your holding and interest costs whilst under renovation (remember – no rent during this period)
Ideally, investment properties will be tenanted all year round, but there can be periods of vacancy, especially if tenants shift out and new tenants need to be found.
While property investors always need to ensure their properties are rented at market value, sometimes it can be worthwhile to keep rent at the same amount for a period of time if the tenants are long-term and are looking after the property well.
Upping the weekly rent by $10 or $20 regularly might be OK by market standards of the time, but it can be detrimental to tenants and result in them choosing to shift out to a more affordable property instead.
Sometimes the risk is greater than the reward!
In such a scenario, the property investor who left their rent at the same figure for a while, which encouraged their tenants to stay at the property, may end up better off than the landlord who continually increased the rent but had regular periods of vacancy where there were no tenants in the property at all.
It’s also a good idea for investors to have a financial buffer so they have reserves to cover any periods of vacancy.
Change of circumstances
The best property investment strategy is to hold for the long-term. That way you can benefit from years of capital growth as well as increasing rents before selling in your retirement or leaving your portfolio to your beneficiaries.
However, life is rarely linear, so sometimes your financial circumstances change due to job loss or divorce, which may result in the need to sell one or more of your properties.
Of course, in times of financial change, it’s important to access the best advice from a qualified professional to ascertain your options, including whether it’s possible to retain your investment properties.
However, if you need to sell some or all your investment properties, it’s important to understand the property risk of them being illiquid assets, which means it can take time for them to be sold.
Even in a good market, it usually will take at least two months or more for the property to be sold and settled.
In more normal market conditions, this period of time can be three to six months, depending on contract conditions and settlement periods.
Other property risk factors that can contribute to the time in which an owner can sell their property may include:
- Demand within the market.
- The condition of the property.
- The desirability of the property.
- The marketing of the property.
- The asking price of the property.
So whilst investing in property has proven to be an excellent long term wealth creation strategy, every investor still needs to enter and make these decisions with their eyes wide open to ensure that they can manage and mitigate the risks.
And if you need help, well we are here to do just that…