What's The Risk of Leaving The Harbour?

I like to reflect on certain quotes at certain times. Depending on the situation they can help to clarify my position, make decisions, improve motivation or put things into perspective. One of my all time favourite quotes that inspires me regularly is spoken by the restaurant owner at the end of this commercial. However, just because you decide to leave the harbour, it doesn't mean you shouldn't consider the implications of doing so. When deciding whether to invest in property, or indeed once you have invested in property, there must be a logical and planned approach to many aspects of the investment.

The first thing to be aware of is that with any investment there is an element of risk. A common saying you may have heard is, 'There is no reward without risk'. Without delving too deep into the philosophy of adages, it is generally accepted that 'the greater the risk, the greater the reward' - otherwise known as the 'risk reward ratio'. Generally speaking, property as an investment class is relatively low risk which is why it is so popular amongst the general population in comparison to other asset classes. It is also why people often run into trouble after failing to consider the risks when perceiving property to be an 'easy investment'. Although forgiving, property investment definitely carries its own associated risks and being aware of these forms a part of your property investing success.

One aspect that many investors fail to consider is their personal attitude and tolerance to risk. Your risk profile will differ depending on your background, experience, skill level, education, and your personality. To fully understand your personal risk profile and how this might affect the decisions you make, you must understand the different types of risk and how to mitigate against these both before and during the investment phase.

Property investing has two main categories of risk: 'investment risk' (relating to investing in property in the first place) and 'specific risk' (relating to the property or property type itself). Below I have listed some of the most common types of risk, how they relate to residential property investment and some basic things you need to consider:

‍1. Market risk (investment) - this relates to market changes that could be outside of the investor's control but need to be considered. Changes in supply such as the oversupply of apartments in Melbourne in 2015 or changes in demand due to industry and/or jobs change such as previous falls in prices in some mining towns are examples of market risk;

‍2. Development risk (specific) - if you are purchasing off-the-plan or a house and land package, there is risk that the developer may not complete the project either to specifications, in the required time frame, or at all. Cases have highlighted this type of risk with respect to sunset clauses in purchase contracts;

‍3. Management risk (specific) - managing property yourself if not recommended as dealing with the plethora of practical and legislative issues on the property and tenancy itself can create pressure for both the tenant and landlord if not done correctly. Some insurance companies will not insure a self-managed property and employing a professional property manager can increase your returns and protect your investment;

‍4. Legislative risk (investment) - seemingly perpetual discussions surrounding threats to remove negative gearing is a good example of legislative risk. Legislation surrounding property is constantly evolving and any removal or introduction of legislation, such as the upcoming changes to Queensland land tax may affect the returns on the investment;

‍5. Liquidity risk (investment) - property by nature is unable to be sold quickly (unlike shares which can be sold at the click of a button) and depending on market conditions and how these relate to your personal circumstances, if you need to sell quickly there is a risk that this may not be possible;

‍6. Gearing risk (investment) - Lenders also see property as a relatively safe investment which is why they are prepared to lend a greater proportion of the property's value than for other investment classes. Depending on your goals, you may wish to 'gear up' and obtain a higher Loan Value Ratio (LVR) to push your capital further. This however carries greater risk if interest rates rise, there is vacancy on the property or you experience changes in personal financial circumstances;

‍7. Value risk (specific) - overpaying for a property (particularly your first) can have long lasting effects on your investment planning and wealth creation. Ensuring you mitigate risk from the outset by not paying too much for a property e.g. using a Buyer's Agent, or obtaining a valuation (not a Real Estate Agent's appraisal which is different) can help to mitigate this risk;

‍8. Event risk (specific) - one aspect of the buying process should be to check whether your purchase is within a flood or fire zone. Other event risks such as thunderstorms and cyclones can be more prominent in different areas of the country. Obtaining the correct insurance and conducting preventative maintenance (such as gutter cleaning) can help to mitigate these risks;

‍9. Tenant risk (specific) - although mitigated by employing an excellent property manager, the quality of your tenant can affect the returns on your property. This can vary depending not only on socio-economic factors, but also the type and number of tenants in a particular property that you are willing to accept;

‍10. Volatility risk (investment) - this relates to fluctuations in property values and price movements. Property prices do not always go up - they can and do move sideways and down, and investors must be prepared for this eventuality and how it could impact their investment plans or exit strategy.

This list is not exhaustive and as always, you should consider risk as a part of your overall investment plan and how it relates to the goals you set out to achieve. Whilst some element of risk is unavoidable in any investment strategy, there are ways to mitigate it throughout the process. To help you do this, ensure you only take advice from individuals or companies who are qualified to do so as they will always ensure that your risk profile has been considered when making their recommendations. You would never set sail on a great sea voyage without planning for things that might go wrong... why would you do it with your investing?