You’ve read some books and spent hours combing through real estate websites. Your research shows that many people have become millionaires by buying multiple properties and it all seems pretty easy, right?
While investing in property is relatively simple, it’s not always easy. Therefore, you need to start with a strong foundation before you even start looking for properties. This means getting your house in order before you apply for finance and before you choose a property.
Understanding the risks of investing in property
Like other asset classes, property carries some risks. Before you commit, you need to be aware of what could go wrong when investing in property.
1. It takes a long time to transact properties
Unlike shares where you can cash out anytime you like, property takes longer to sell. If you need cash in a hurry, you could be forced to sell at a much lower price than you’re hoping for.
2. It’s expensive to get in and out of property
Unlike shares and other asset classes, you need to spend tens of thousands of dollars to pay for the entry cost of buying a property and then several tens of thousands more when you exit.
3. Cash flow crunch if your property becomes vacant
If your tenant leaves and you don’t find immediate replacement, you could face a cash flow squeeze that could lead to default or forced sales.
4. Interest rate hike
When interest rates increase, your repayments also increase and this could put a strain on your cash flow.
5. You could buy the wrong property
If you didn’t do enough due diligence and bought the ‘wrong’ property in the wrong area at the wrong time, you could face years of slow or no growth or worse, no income due to high vacancy in the area.
6. You could lose your job and be unable to meet your mortgage repayments
If the economy falters and you lose your job, you could also end up losing your home or investment.
Why property is as safe as houses
Don’t let the risks scare you into abandoning property altogether. The risks do sound serious, but so too are the benefits. Take a look at the reasons why property is still a relatively sound and safe investment.
1. You have more leverage
Property offers more financial leverage, and the more leverage you have, the more quickly you can build wealth says Rocket Property Group founder, Ian Hosking Richards. “For example, if I purchase a property for $400,000 I can put down a 10% deposit and borrow 90% from the bank. If that property increases in value by 10% I have made $40,000, because I have only contributed 10% of the purchase price but I get 100% of the growth,” he explains.
“So if it goes up in value by 10% in the first year I have effectively received a 100% return on my initial deposit. And if the original deposit and other buying costs came from my existing equity, it means that I have borrowed the full cost and do not need to put any of my own cash in, but still get 100% of the growth. I would aim to purchase a property that has great potential for growth and pays for itself even on high borrowings, so for me it is hard to imagine any other investment that is more attractive.”
2. Investing in property is simpler than you think
The amount of paperwork you need to produce the information you have to assimilate can be daunting at first, but the investment process in itself is remarkably simple. There are no complicated steps you need to take. As long as you’ve got your finances sorted out, you can start doing your research to find the right property. If you apply thorough due diligence in terms of getting inspection and valuation, there’s little risk for you to overpay or buy a dud property.
3. You have “control” of your investment
Unlike other investments classes, property offers you many options in terms of growing the value and income on your property. You can also control where you buy, how you buy and when to sell.
4. You have stability
Real estate is less volatile than stocks or mutual funds, especially in uncertain economic times. The continuing demand for housing fuelled by strong population growth ensures property prices are supported in general.
It’s also worth noting that the price drops most people fear are NOT real losses until you actually sell the property. If the property was purchased correctly and generates a healthy cash flow, the investment can be sustained until the price gets back up again.
5. Property is an easy asset to understand
Unlike the share markets where there are complicated terminologies you need to get your head around, real estate is relatively simple. You know what a house, unit or a townhouse is and you don’t need a 60-page prospectus to tell you all about it.
6. The taxman helps you pay off your investments
You can claim a range of tax deductible expenses through your investment property, which will help reduce your tax bills and improve cash flow. A good accountant can help you cut your tax expenses by the tens of thousands of dollars, legally through your property.
7. Your tenants pay your mortgage
Another advantage to property investing is that tenants are paying down your mortgage while you sit and watch your investment grow in value.
8. Property offers predictability
Property is undoubtedly more predictable than other investment classes. With well-chosen property, you can look out 18 or 24 months into the future and know which direction the market pressures will be pushing, unlike the share markets where anything could change within seconds.
9. Property is recession-proof
Property with strong cash flow can ride uncertain times such as during a recession for the simple reason that it meets a basic need – housing. People will always need a place to live, even during difficult times. They would do everything just to have a roof over their heads. They are prepared to forgo other luxuries just to have enough money to pay for their rents or mortgage.
10. Property can make you rich
Real estate makes more billionaires than any other asset class. In the recent Forbes Billionaire’s List, it reported that a total of 135 property tycoons now make up the world’s wealthiest list with 14 property billionaires joining the ranks this year alone, boosted by surging property values around the world.
The psychology of investing
To become a successful property investor you need both dollars and sense. Director of Property 4 Profi t Nick Burke says the best thing a wouldbe property investor can do is gain an understanding of their own risk tolerance before they start out. “All too often fi rst-time investors make what is a very large decision, costing hundreds of thousands of dollars, without giving much thought to how they will cope with some of the inevitable risk factors inherent to any investment, including property,” he says.
Before setting out to look for your first property, sit down and think about how risk makes you feel, and try to gauge if you are ready to deal with the potential emotional ups and downs.
Understanding your risk tolerance and the inherent risks of investing in property will help you decide what strategy to adopt.
Understanding and overcoming your fears
If you’re still wary about starting your investment journey despite gaining an understanding of the risks and rewards, you’re not alone. It’s a big decision and it involves a lot of money. 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 classes. This fear comes in a range of guises 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 $200k using a debt of $210k 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.
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:
1. 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 five weeks of allowable vacancy before you must even reach into your pocket.
2. 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.
3. 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.
4. 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. From this you can see that there are many ways to deal with vacancy issues, and it is highly unlikely that your property will need to remain vacant for long enough to cause financial stress to you.
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 beginners 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, 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.
Procrastination
If you know that you have the capacity to buy property, and you also have a desire somewhere deep inside to do so, you must recognise if you are a procrastinator. The worst thing for procrastinators is that they usually experience very deep feelings of remorse when they miss the boat and realise at a later date that they had the capacity to get ahead, but missed it.
If you are a procrastinator, then you must develop the habit of writing down your goals, developing the steps required to achieve them and then putting these steps as a must do o your calendar. Devise penalties for yourself if you don’t meet the date set and rewards if you do. Take control of your life by scheduling the tasks which must be completed in this way, and soon you will own an investment property.
Lacking motivation and time
So, you go to a seminar, read a book or a magazine and you are buzzing with excitement about the portfolio you are about to build. You go home and the next day when you wake up, the kids are sick, the boss wants you to do overtime and your mother in law has come for a two-week visit. Suddenly it all becomes too hard and as each day passes, buying property slips way down on your list of priorities. Regardless of how much education or desire you have, life easily gets in the way, and before you know it, another year has passed.
Allowing life to get in the way is no excuse. You must find qualified people to help you, and associate with those who have the same goals as you so that the support you receive doesn’t stop. You will be amazed at how your capacity to achieve more increases when you do these things.
Get your psychological house in order from the outset, and the problems which arise along the way will be easily dealt with. Recognise what your own particular issues might be, and develop strategies for dealing with them before you start. And never stop working toward your financial future – the road is long and tough, but remaining positive and committed, and dealing with your fears, is the only way you will ever start the journey!
In part 2, we’ll look at the different investment strategies and financing options to consider.
This article was published in the June 2014 edition of Your Investment Property magazine. You can subscribe to the magazine here.
