It’s natural to fear the worst. That’s why there are only a handful of Australian investors who own more than two investment properties throughout their career.
Fear is the first factor that holds people back from moving ahead with investing in any asset class. This fear comes in a range of disguises according to Margaret Lomas of Destiny Financial.
Fear of losing your own home
If you have already achieved a comfortable debt level, and have considerable equity in your own home, you may worry that making the wrong choice will lead to financial ruin. The likelihood of this is very small and this fear must be put into perspective.
Imagine you own a home worth $300,000 and you owe $150,000. You buy a property for $200,000 using a debt of $210,000 secured across your own home and the new property. Your debt is now $360,000, and your equity has been reduced, for now, by $10,000 down to $140,000.
Home value: $300,000
Existing mortgage: $150,000
New investment property: $200,000
New debt: $210,000
Total equity: $500,000 ($300,000 +$200,000)
Total debt: $360,000 ($150,000 + $210,000)
Total equity: $140,000 ($500,000-$360,000)
For any number of reasons, it all goes horribly wrong and you are forced to sell the new property. To do this quickly you must reduce the price, and you only get $180,000 for it. Now you have a debt of $180,000 which is $30,000 more than you had when you started.
This is far less than ideal, but it also is unlikely that an extra $30,000 of debt (which would cost you a net of $34 a week) will force you to lose the home you already had.
To deal with this fear, work out the worst case scenario and ask yourself if you can afford that outcome. If not, then you should not buy, but it is more likely that the worst thing to come out of a failed property investment is an increased personal debt that you probably can manage. And remember, the actual likelihood of this result is very small anyway.
Fear that you will not be able to afford to repay the debt if the property is vacant
When people first begin to consider this possibility, they imagine that there will possibly be months in which no income is being achieved and they will be required to meet the mortgage repayments from their own pocket. If this is your fear, you must consider:
- Buying positive cash flow property will give you extra income which can assist to pay for periods of vacancy. A property with a $20 a week positive cash flow gives you a total of $1,040 a year, which, for a property renting at $200 a week, provides 5 weeks of allowable vacancy before you must even reach into your pocket.
- Tax deductions reduce your shortfall. So, technically, for every $200 a week that you do not receive, a tax payer in the 30% bracket will receive an additional $60 tax break, reducing your commitment to $140, or allowing more weeks of vacancy.
- In reality, if a property is vacant for a week or two, you can take action then by reducing the rent. Even if you reduced a $200 a week rent to $180, you would only be losing $20 a week ($14 after tax breaks) and you will have boosted your chances of attracting a tenant as you have become competitive.
- For vacancy caused by an inability to rent out a damaged property, you should be sure to have landlord’s insurance. At an after tax cost of around $7 a week, this is vital.
Fear of making the wrong choice
Buying a property involves making a large purchase. Even if you borrow all of the money and use little or none of your own, your commitment is a big one.
Many beginner investors mistakenly believe they can use a ‘gut feeling’ about property, or base their choices around what they would personally like to live in. Worse still, they follow the crowds, take advice from their unqualified friends, buy a property in their dream location near the beach and largely put faith in people who have a vested interest in their purchase – such as the person selling the property to them. It’s no wonder so many bad choices are made.
You can never remove all of the risk when you invest in property, but you can manage it and increase the chances that what you buy will work out well by doing your research. Get educated. Learn from the mistakes of others.
If your fear is that you will choose badly, then leave your emotions at home, learn how to invest well and arm yourself with solid research. Create a sound investment and purchase plan for your own situation and then, commit to only buying property which can satisfy them.
