If there is one thing that always rings true about investing in real estate, it’s this: regardless of where you invest, what type of property you buy, and what kind of market you’re buying in, property investing comes with inherent risks attached. Period! There is no way to eliminate these risks completely – just as there is no way to be 100% certain you won’t have a car accident when you drive your car.
That said, there are definitely things you can do to minimise the risk of something going wrong. When you slide into the driver’s seat of your car, you can pop a seatbelt on, drive at the speed limit, have a clear destination in mind and start your journey with plenty of time on your side, so you’re not feeling stressed or under pressure to meet an unrealistic deadline.
And when you invest in property, you can put a number of measures in place to ensure your investing journey is as smooth - and as profitable - as possible. So what are some of the imminent risks for investors in the current market, and how you can prepare for them?
Clear and present danger
The first step is to work out exactly what risks you could potentially face. In my view, three immediate risks spring to mind:
1. Relying on low interest rates
If you are making repayments on any type of home loan right now, then you should be as happy as a clam when paying your monthly interest bill. Why? Because currently, Australians are paying some of the absolute lowest mortgage rates we’ve paid in years, if not decades.
Variable rates presently hover at around 5%, while fixed rates can be locked in at sub-5% levels. The ability to take the advantage of these super-low interest rates is an opportunity that many investors are using to their advantage, in order to qualify for larger loans and be able to pay off their mortgage debts more quickly. However, one potential risk for investors in the current market is that they may be too reliant on these incredibly low interest rates, without taking into account the fact that they are historically low and will likely rise at some point.
The fact is, interest rates are at all-times low levels and eventually they will increase to the historically ‘average’ mortgage interest rate of around 7.5% to 8%. If you’re paying 5% now, that’s a huge jump of more than 50% on your current repayments. Therefore, if you rely on current interest rates staying in place for the long term, you could end up financially overextended.
My advice is to enjoy interest rates while they are low now, but also factor in rates of up to 8% or even 9% to ‘stress test’ your loans, to see how you’d cope with higher rates in place. This will help you ensure you can afford your investment property now and in the future. Also, having a buffer in place will help you ride out any financial turbulence if interest rates do start trneding upwards.
2. Investing without a clear strategy
In my view, buying property without a clear investment strategy in place is one of the biggest risks an investor can take, and, unfortunately, this is what many Australians do on a daily basis.
Investing in real estate should be a positive and financially rewarding experience that ultimately lines your pockets and makes your lifestyle more comfortable. There are dozens of ways you can make money out of real estate – and therein lies the problem.
With so many potential ways to make a buck, it can be tempting for would-be investors to haphazardly employ several strategies at once. Worse still, they could have so many ‘stars in their eyes’ about the potential profits coming their way that they fail to put in place any solid strategy at all.
I’ve seen it happen dozens of times. An investor gets excited about the potential that property has to transform their wealth, so they jump onto the next opportunity that presents itself, without taking into account the fact that every opportunity comes with certain risks and potential issues to be aware of. For instance, an investor might come across an incredible development opportunity. It’s a subdivision and duplex project that, once complete, would generate several hundred thousands of dollars in instant equity.
The investor sees the dollar signs and tries to move heaven and hell to make the deal work – even though they can’t afford to finance that type of deal; even though they have to remortgage their own home in order to fund the deposit; even though the project puts immense stress on their finances, their relationships and their ability to sleep peacefully at night, because they’re so stressed about money… It may have been a good investment opportunity. It may have even been a great opportunity. But that doesn’t necessarily mean it was a great opportunity for you and your personal situation.
This is why it’s so important for investors to devise and implement their own personalised property investment strategy, one that matches both their immediate and long-term goals, and their present lifestyle needs. There’s no point in living from pay cheque to pay cheque and sacrificing your current lifestyle in order to financially manage your property portfolio while you create wealth for your future. There is a better way to invest, and it starts with you creating an honest picture of where you stand financially right now, and where you hope to be in five, 10, 15 and 20 years.
Without this kind of investment strategy and financial road map in place, you’re effectively gambling, as it’s impossible for you to make clear, smart investment decisions that take you towards your goal. After all, how can you reach your goals if you don’t even know what they are?
3. Buying in an overheated market
I’ve noticed a mentality that develops among some investors, which virtually scares them into thinking that they must secure their next investment immediately, lest they risk missing out on a rare and especially profitable real estate gold mine.
I’ve seen this happen frequently in recent months, particularly in certain suburbs around major capital cities that are becoming majorly overheated.
One of the immediate risks for investors is that people are increasingly paying too much for property, because they feel this urgency to buy – and, as a result, some people are simply buying ‘anything’ for the sake of getting into the market. I’ve had lengthy discussions with clients and investors in an effort to cool them off and encourage them to look at the bigger picture. I’ve even had some clients who were just so keen to get into the market in a particular area that they temporarily lost sight of what they were trying to achieve.
For instance, their investment strategy may be calling for a positively geared, two-bedroom apartment, but they’re so focused on getting into the ‘suburb of the moment’ that the supply and demand imbalance has skewed their view.They’ve gone from seeking out a two-bedroom apartment that suits their strategy, to looking at buying anything they can get their hands on and at almost any price, because properties are routinely selling within 24 hours of hitting the market.
It’s crucial at times like this that investors remain steadfast in sticking to their buying rules, by staying focused on what they are looking for. If you swing from a two-bedroom unit to a three-bedroom house, then back to a one-bedroom unit before viewing a two-bedroom townhouse, well, it’s fair to say your investment strategy is all over the place and it’s time to get laser focused on what you really want to achieve. If an area is overheated, look somewhere else. There are thousands of suburbs and towns around Australia, so shift your focus, because there will always be more opportunities for you to make money from real estate.
How do you ensure you don’t face these risks in the fi rst place?
Research, research and more research. Regardless of the market, but especially right now, the best way to protect yourself from the risks associated with property investing is to arm yourself with as much information as possible, so that you can make the smartest, most informed decisions you can.
Doing proper due diligence is all about ensuring you are 100% comfortable with every aspect of the deal. For me, this comes down to doing thorough and extensive research into a potential property’s past, present and future. Interpreting the data plays a big role here. Many investors don’t realise just how much data is available, nor do they realise how they can effectively use it to their advantage.
When I’m reviewing a potential property investment, I always obtain a free suburb snapshot report from RP Data; it provides a range of information on the area, and can give up to 10 years of capital growth history. For around $40, I can then obtain a more detailed overview of the particular property or suburb.
From there, I head over to Residex where, for another small fee, I can purchase a predictions report for that area. This report gives a capital growth prediction for the next five to eight years, The end result? I’ve got 10 years of data explaining how the property has performed in the past, along with up to eight years of data projecting how the property is expected to perform in the future. This is in addition to all the other research I’ve done on vacancy rates, rental demand, overall supply and demand and local demographics.
I now have a comprehensive parcel of data to inform my investing decision, which is a major factor in mitigating my risk and ensuring I don’t invest in a low-performing property. It’s a quick and easy way to create an effective process and harness the power of the masses of data that is available.
I honestly wouldn’t look at buying anything without having a look at these numbers, because in the grand scheme of things, when you’re going to spend upwards of half a million dollars on a property purchase, what’s the harm in spending $40 here or there on a report?
If you’re at risk, what can you do now to lessen the damage?
Let’s say you own an investment property and you’re at risk of things turning pear-shaped. Perhaps you overextended yourself financially, or you've run into trouble with dodgy tenants. Whatever the problem, there is always a potential solution. For instance, you could:
1. Reinforce your finances
If you are facing financial difficulties for a particular reason, such as a prolonged tenant vacancy, then you need some funds to help you manage the situation at hand. My advice would be to immediately focus on creating a buffer account.
If you don’t already have a cash buffer account at your disposal to help you deal with unexpected financial emergencies, I suggest you focus on creating one immediately. Savings from your salary, tax returns, redrawing equity in your home loans - do whatever it takes to create a cash buffer account, ideally offset against your PPOR mortgage, so that you are in a position to make clear decisions without being ‘forced’ to sell any of your properties from a place of desperation. At the same time, make a serious and concerted effort to pay down any ‘bad debts’ such as credit cards, as they chew through your disposable income and divert precious funds and resources away from your investing pursuits. Ultimately, if you do not have a tenant, you want to do what you can to get a tenant in place to ensure you have some rent coming in so that you are not having to fund the full mortgage repayment each month.
2. Get your head out of the sand
Often when a situation is turning negative, we may avoid facing up to it – and this can be a very costly mistake to make. I’ve seen many investors who have needlessly gone to the wall financially, often because they didn't face their financial woes early enough. The sooner you take a proactive approach, the sooner you can put the right steps in place to turn your situation around.
3. If necessary, seek help
A trusted property mentor, a friend in the industry, a colleague who knows property inside out – turn to those people you know and trust for advice, as they will be able to help you review your situation from a clear, unbiased and objective place. Importantly, they can then help you strategise how to move forward in a positive way. Remember, there will always be new opportunities to create wealth through real estate, and by having a clear strategy and a flexible, hoenst approach, you place yourself in the best possible position for property success.
Helen Collier-Kogtevs is an active investor with a multimillion-dollar property portfolio and is the managing director of Real Wealth Australia
This article was published in the July 2014 edition of Your Investment Property magazine. You can subscribe to the magazine here.
