It is easy to overlook important investment property risks in an environment where values have been steadily increasing
They may not be immediately apparent, but they do exist and should not be ignored:
Property Investment Risk - Poor Property Selection
Poor property selection is one of the fundamental property investment risks that need to be avoided.
Viewed purely through the lens of what has occurred over the past decade property investment would seem to be sure-fire way of making money.
However, not all properties are equal. The location and type of property require an understanding of the market and careful research:
- How appealing is it to tenants?
- What is its growth potential?
- Are there planning issues with the potential to affect values and rental demand?
- Will the property readily sell in the event of a downturn?
- Will the values hold up?
Property Investment Risks – High Gearing
High gearing can yield high returns, but it also poses a significant property investment risk.
If servicing your borrowings absorbs a significant proportion of your income, you potentially could be placing your total asset base at risk in the event of an economic downturn or unemployment.
The situation will be compounded further if you need to sell in a downturn and only have limited equity in the property.
Property Investment Risk – Interest Rates Increase
Sustained record low interest rates have been one factor driving increased property prices since 2008.
However, the potential for interest rates rises is a key property investment risk that needs to be considered.
Although the Reserve Bank is not forecasting an increase in the cash rate in the short term, we are seeing fixed term rates rising, as Lenders cost of funds increase.
This is partly due to inflation emerging in offshore markets and traditionally to temper inflation, regulators increase interest rates. Should this occur, it will put further pressure on rates in Australia. This will make it more difficult for highly geared borrowers to service their debt.
Loan Serviceability Risk
The minimum Serviceability Buffer that Lenders must use was recently increased by APRA
from 2.50% to 3%.
When assessing applications, Lenders must add 3% to the actual interest rate to ensure applicants will be able to repay their borrowings should interest rates rise in the future.
This may be a problem for borrowers coming to the end of their interest only period, as Lenders assess their ability to repay the borrowings over the remaining term, at current rates, plus a 3% margin.
Again, loan serviceability is a critical property investment risk that cannot be ignored.
Vacancy Risk
Tenant vacancy is another property investment risk that needs to be take into account.
While residential vacancies are currently at very low levels, this is not the case with commercial property.
It is always wise to have a buffer so you can service your borrowings should your investment property be vacant.
It is not worth placing your home, or asset base, at risk if you don’t have the capacity to cover rental vacancies.
Liquidity Risk
Unlike the share market or savings, if you find yourself in need of cash, an investment property can take time to sell.
Granted, in the current market, most residential properties will sell quickly and for a reasonable price.
However, as we saw in the early 1990’s, if there is an economic downturn, or a major offshore shock, this can quickly change.
In a downturn, values come under pressure and properties can take far longer to sell.
Structuring your affairs to provide you flexibility is important to mitigate this property investment risk.
Market Risk
In the context of the last two decades property has proven to be a sound investment.
However, due to escalating property prices, loan affordability is at extremely low levels. This, combined with low-income growth and COVID-19, has many borrowers in some markets experiencing mortgage stress.
Against this background and the prospect of increasing interest rates, the potential for a decrease in values, and its ramifications, cannot be ignored.
Summary
The purpose of this post is not to deter investors from property investment.
Many of our clients have prudently used property investment to create long-term wealth.
However, in a climate of sustained increases in values, it is easy to become overly optimistic and ignore the very real property investment risks, that can exist.
If you are seeking finance for property investment and would like to learn more, don’t hesitate to get in touch.
