Previously, I’ve illustrated the fundamental concepts of property investment. In this article, I’ll highlight the risks in property investment and provide several valuable tips that’ll help train you to become a savvy property investor.
The risks in property investment
It’s important to note that property investment doesn’t come without any risks. As pointed out in our previous article, the greater the growth potential of an investment, the greater the risks. Look at Bitcoin for example. We’ve seen its magnificent growth, and we’ve also seen its magnificent drop. As a property investor, being aware of risks in property investment is absolutely vital. Here’s a list of potential risks that are attached to property investment:
When I say property market, I’m talking about the buying and selling activity of properties. The property market operates in a cycle. The phases in the cycle generally consist of the following:
- upturn (when property prices are rising rapidly)
- correction (when property prices are starting to drop after an exuberant upturn)
- downturn (when property prices are dropping rapidly)
- stagnation (when property prices don’t move much)
- recovery (when property prices are starting to pick up after a period of downturn and stagnation)
The buying and selling activity of properties can be affected by a number of different factors. Therefore, unlike cash and term deposit investments, it’s important to understand that property prices go up and down. The performance of the overall market will affect the value of your investment property.
Liquidity refers to the ease of investment to convert into cash. Property is an illiquid investment. Why? Because you can’t turn it into cash overnight like shares or in days like managed funds. The buying and selling process of a property is complex. It involves a lot of steps and time. So, when you invest in property, you must acknowledge that it takes time to sell. It’ll take time to find a buyer. It’ll take time for the buyer to obtain the loan from the bank. In a weak or cold property market, you may find it harder to find buyers.
Interest rate risk
Interest rates and property are often closely intertwined. This is because properties are often purchased via loans. When you borrow money from the bank, you’ll need to pay back the money with interest payments on top. Therefore, the movement of interest rates is one of the factors that affect the property market. When interest rates go up, loan repayments will go up, and people may find it less enticing to buy investment properties.
Not all properties are equal. Some can prove to be good investments, while others can prove to be bad investments. If you’ve selected the wrong property for investment, you can lose money no matter how well the property market is performing in general.
Income risk refers to the possibility of not being able to generate an income during the ownership of the property. This can occur when there’s no tenant in the investment property or when the tenant is unable to make rental payments. It can also occur when you’re out of work or unable to work. Remember, property investment incurs ongoing costs.
Political risk refers to changes in government policies and regulations. Government policies and regulations can either be favourable or unfavourable to the property market. For example, not too long ago, the Australian Labor Party discussed the possibility of changing negative gearing rules. If this was implemented, the property market could’ve been negatively impacted. Policies such as reducing lending restrictions, reducing stamp duty, and increasing first home owners’ grants are often seen as favourable to the property market.
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The overall performance of the country’s economy can affect the property market. A good economy means jobs and wages are growing, and businesses are thriving. In a good economy, people are more willing to spend. People will spend more on their lifestyle, holidays, cars and even properties. A bad economy will generally discourage spending.
Properties are built by builders, and different builders use different construction materials and methods to build properties. What you don’t want to see are constructions issues on your property. Constructions issues are often caused by poor building materials and building methods. Such issues will not only cause high repair costs but also discourage buyers and consequently affect your property’s value. An example of a recently constructed building in New South Wales with construction issues is the Opal Tower.
When you buy an investment property, your tenant is very important because they’ll be the one paying you a regular income. Not all tenants are the same, and it’s possible to encounter a bad tenant, which can cause headaches and problems to your investment down the track. Such problems can include not paying rent on time or even damaging your property.
Leverage refers to using borrowed money to make more money. The risk here often occurs when you’ve borrowed too much and the property value hasn’t gone up. Combined with interest rate rises and a property market downturn, leverage risk can be somewhat disastrous. It can cause cash flow strains (when you struggle to pay the high loan repayments) and negative equity (when your loan becomes higher than the value of your property).
Related Post: Property Investment Guide – Part 2 (The Tips)
In summary, it’s important to remember that property investment comes with risks. As illustrated above, these risks include market risk, liquidity risk, interest rate risk, property risk, income risk, political risk, economic risk, construction risk, tenant risk, and leverage risk. As a property investor, you must understand these risks and know how to manage them in order to do avoid catastrophe in your investment. In the next section, I’ll discuss risk management for property investment as well as valuable tips that’ll help you become a wiser property investor.