Managing risk

16 Nov 2019

All around us, property investing seems like the sure way to become financially independent. Creating a great passive income and the quick riches is all we seem to hear about in the media.

One of the biggest things that investors (including the experienced) don't have (and I'm talking about investors who haven't been investing for more than 30 years), is to comprehensively understand the risks of downturns. Downturns that no one foresees and we have little control over. I am talking about the risks related to widespread market downturns such as the Global Financial Crisis, the recession of 1992 and the Dot Com bust.

Today, I would like to explore the many risks involved with investment property and talk about the methods that sophisticated property investors use to mitigate them.

Leverage risk

Leverage is by far the main driver of why property investors can make the money they do from such passive, low return assets. However, property investors need to make sure they can manage current and future obligations of servicing and repaying debt. Many investors who overleveraged their portfolios have been burnt during the off-the-plan apartment debacle of 2018-19, as well as the during the Global Financial Crisis. To combat this type of risk, investors should:

  1. Understand their cash flows and have strong cash and equity buffers in place
  2. Limit their leverage
  3. Diversify their portfolio (interstate, multiple properties etc)
  4. Properties should be close to funding sufficiency (neutral / positively geared)

Legislation risk

This seems to be largely mitigated for property investors in the short to medium term. Legislation risk refers to changes in government regulation that may impact property investment. Governments can introduce new taxes and raise tax rates amongst other things. Given the results of the 2019 Australian Federal Election, we expect minimal changes to property investment in the short to medium term.

Market risk

Market risk refers to the supply and demand equation of property investment that dictates the rent you receive, as well as any capital appreciation.

The main mitigating factors are:

  1. Buying under market value can provide a safe cushion if capital prices fall
  2. Location can determine the future capital appreciation of your property as well as demand to rent that property
  3. Diversifying your portfolio
  4. Buying with a 'safe' amount of equity (e.g. not buying at 95% LVR, when market prices could fall by 5%)

Tenancy risk

This refers to the risk of vacant property but also how a tenant may treat our assets. On the worst end, this could mean malicious damage resulting in months of vacancy (speaking from experience!) but with the right insurance policy, this risk can be mitigated. Your property manager also has a significant role to play in terms of screening for the right tenant, making sure rent is paid on time and the property is looked after. Trust me, it pays to have a property manager that genuinely cares.

Liquidity risk

The illiquidity of a property is something that lots of investors love. It stops you from making quick emotional decisions and gives you the time to prepare. However, sometimes this illiquidity can present a risk as you may not be able to access your equity quick enough. The selling process can also take months. This is something that needs to be managed through your cash flow, offset accounts and redraw accounts by having a buffer in case you need access to quick cash (think medical emergency or losing employment).