Like other asset classes, investing in property carries some risks. During an economic downturn, they can be significantly magnified. Therefore, it’s important to put a strategy in place that deals with risks when they occur.
Here are a few tips on what to do when confronted by the following investment challenges.
1. Your property loses value
If you find yourself in a position where the value of your property is falling, you need to determine whether you would be better off cutting your losses and selling now, or holding the property on the basis that prices will increase in the future.
Despite the increased investor activity in the market, rents are still rising in many parts of Australia.
That means that as time goes on, your property is costing you less, in terms of cash flow, to maintain. Add the lower interest rates and all of a sudden, many property investors are finding themselves holding positive cash flow investment properties.
Even if you have negative equity, if the property is costing you nothing to hold, it’s likely you’re better off holding on to it, rather than selling in a depressed market.
It’s costly to buy and sell rapidly, as stamp duty, loan costs and agents fees quickly eat into your profits.
The other thing to consider is that you haven’t really lost anything until you actually sell.
2. You lose your job
Losing your job will have an immediate impact upon your ability to borrow and begin – or continue – to build your property portfolio.
Curiously, this is not usually because you can no longer afford your investment loans – if you have owned a property for some time, it’s likely that the rents have increased, and the property is most likely looking after itself and paying its own costs.
Rather, it’s because you may no longer be able to afford your own loans and personal expenses, and if your property was to become vacant, the risk that you are unable to remain financially solvent becomes greater.
If you lose your job, you need to notify your lender immediately. A good place to start is to find out if you can take a repayment holiday from your current loans; if you’ve been making any additional repayments, it is likely that your loan is in advance and a few months off may be allowed.
If you have investment or interest-only loans, find out if you can capitalise the interest for a few months, too – that way the cash flow from your property can assist you to manage your daily personal expenses.
At times like these, a line of credit loan can also be useful. You can create a ‘buffer’ of extra funds that are not needed for the property purchase, but which you can draw-back for expenses or capital purchases, or to use during those times when cash flow is tight.
If you become unemployed, you won’t be able to switch to a loan like this, so you must put it in place beforehand, and then use it wisely in the meantime.
Don’t be tempted to use the additional funds for holidays or buying a new car. Instead, try to make extra repayments and save the buffer that you have for that rainy day – like losing your job.
Losing your job will likely put a stop to investing in the short term, so take this time to be patient, sit on what you have already accrued, and wait until you are once again employed before trying to add to your portfolio.
3. The news is consistently gloomy
Persistent negative sentiment in the marketplace is actually to your advantage.
Warren Buffet the billionaire once said that, “most people get interested in investing when everyone else is buying – but the time to get interested is when no one else is”.
The past 10 years have provided such a period of good fortune for most Australians that pretty much anything you bought as an investment did well.
This made some investors forget about the basics, especially where property is concerned – the basics being that the importance is not about market timing, but about time in market.
The doom and gloom at the moment is suggesting that property prices are about to experience a spectacular fall.
However, bread and butter property in lower priced areas will in many ways survive the storm and retain, and even grow, their values.
It all comes down to your investment strategy – if you’re in it for short-term gains, you will likely be nervous at the moment. But if you’re in it for the long term you will be looking for opportunities in the market, and won’t be dissuaded by the current negative sentiment.
4. You can’t get finance
When you borrow money, you must satisfy two types of eligibility criteria; the first one is serviceability; and the second is equity.
Serviceability relates to your capacity to service the new loan. Often, a borrower will approach a bank for more money before they actually find a property. In this case your lender might not be taking into account the additional income that the property will produce in terms of rent, ‘since the amount has not been established yet’.
A lender will generally accept up to 80% of any rent received, as long as it can be proven that the rent will exist. So someone previously rejected for a loan may find that, once they find that new property, they now qualify.
If you haven’t yet found the right property, but you know the general suburb you wish to invest in, try approaching a real estate agent for a general indication of rents in the area.
If they can provide you with a letter estimating the average rental return in the area, you can pass this onto your lender, so they can take this additional income into consideration when processing your application.
But beware that each bank has different serviceability criteria – one lender may allow you to commit $1 to loan repayments for every $1 that you generate in rental income, while another may just take 80 cents for each $1.
For this reason, it’s crucial that you get an opinion from several lenders as to the amount they are prepared to advance to you.
Equity criteria relates to the value of the security or property that you are able to offer. To borrow without paying lenders mortgage insurance, you will need to have at least 20% deposit or equity in each security you have.
The difficulty arises here once the valuations are performed – you may believe you have the equity, but a valuer may disagree and place a valuation on your property that is lower than you expect.
You can question this and ask for another valuation, but only if you have evidence that an equivalent property near your property recently sold for more than the valuation you received.
If your valuation comes up short, you can borrow more than 80% of the value of the property as some lenders are offering up to 95% loan to value ratio. However, you need to be aware that this will significantly increase your risk due to higher repayments as well as the hefty upfront cost of lenders mortgage insurance.
5. You have tenant troubles
As Australia’s economy weakens further, the issue of financial uncertainty is now at the forefront of most people’s minds.
The good news is that with proper preparation, you can avoid just about any situation that could result in you losing your rental income.
Having the right insurance in place is the first level of protection against financial loss. Landlord insurance is specifically designed for property investors to protect themselves from loss of rent, which is usually caused by either:
- tenants who have caused you to lose income by damaging your property, leaving without paying rent, or worse, they stay on but stop paying rent
- some sort of act of nature or freak accident causes so much damage to your property that your tenants have to move out
If you have landlord insurance, it is important to be aware of what the policy protects you against, and the excess that would be applicable in the event of a claim. A good landlord insurance policy should protect you against:
Loss of rent (for default of rent by tenant) Up to 15 weeks
Content insurance (malicious and accidental damage) $50,000
Building (malicious and accidental damage) $50,000
Landlord’s legal liability $20,000,000
Standard building insurance offers the best protection against freak accidents and acts of nature, like severe storms or fire.
Nila Sweeney is the managing editor of Your Investment Property magazine, Australia’s favourite property investing magazine. For extra dose of inspiration and motivation, check out her personal blog at nilasweeney.blogspot.com
Whether you are looking to buy your first home, move home, refinance, or invest in property, a mortgage broker can help. Access loans from all the major lenders, get help with paperwork – plus there is no charge for this service. Get help from a local mortgage broker
Nila Sweeney is managing editor of Australia’s leading property investment magazine, Your Investment Property, Canada’s only property investment magazine, Canadian Real Estate Wealth and Your Mortgage magazine. An active property investor herself, Nila owns a number of properties in Australia and overseas. She has worked as a TV journalist for CNBC Asia and CNN International for more than 10 years and has been writing about the Australian property markets for more than eight years.
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