One of the cardinal rules of investing, regardless of asset class, is to ensure that an investor has a researched risk management plan.
Property is generally considered low risk, and many investors figure they have managed their risk by researching location, setting up trust structures, etc… But few look at developing a comprehensive and structured risk management strategy, and that is a formula for risky business.
So, here’s my list of the most powerful risk management tools and how they help in reducing risk.
Know your numbers!
Investing in property is primarily a numbers game. It is critical that investors understand the numbers involved in building a property portfolio, so that risk (and rewards!) can be measured. Once the numbers are understood, investors can assess risks in monetary terms and move to the next step, which is…
Have a Strategy
Planning a portfolio is a very important risk management tool. Acquiring properties without a strategy is like flying a plane without instruments - a big risk! The strategy needs to address aspects such as how many properties can be safely acquired, gearing (i.e. loan to value ratios), expected cash flow for each property including taxation, timing of purchases, how to cope with interest rate rises, and yearly review of the strategy.
When structuring a strategy and a financial plan, investors should always ensure that they have “buffers” in place.
For example, if releasing equity in a property to invest in a new one, it makes sense to keep a comfortable amount available as a redraw or a line of credit to cushion against unexpected expenses, interest rate rises, etc… It is also wise for an investor to have an additional buffer, usually in the form of savings in an offset account for personal expenses (medical emergency, holidays, etc..). There are many variables to look at when setting up the quantum of these buffers, how they operate and how to keep them under control, but they are important in any risk management plan.
This is a constant topic of discussion in most investment property magazines so I’ll just say that in terms of a risk management tool, an investor needs to find economically diverse locations that balance cash flow and capital growth.
Also, it is important to stay in the middle of the price range, keeping in mind that what will create wealth is capital growth.
This is common sense risk management technique based on the timeless axiom, “do not put all your eggs in the same basket”. Over the last few years some areas have suffered a great deal from the high Australian dollar (Cairns, Gold Coast, and Sunshine Coast for example) as tourism slowed down considerably. With the dollar now weakening these areas are tipped to pick up in capital growth, albeit from a reduced base. So understanding property cycles and hedging a portfolio is a must.
It is all about being comfortable with a particular location, and looking very closely at the various industries, population base and growth, infrastructure projects, and so on. It also includes making sure that a target property is in the most-wanted bracket, i.e. not too expensive or too cheap in a given suburb. When time comes to sell, an investor needs to have the largest possible population to sell to. One of the most forgotten parts of research is that an investor needs to look at what the market may be in say 15-20 years when he/she will want to sell, not what the market is today. For instance, in capital cities, there is a sharp increase in the apartment market demand as there is a generational change where people want to be closer to entertainment and shopping areas in smaller maintenance-free dwellings, rather than the quarter acre block in a distant suburb.
Insurance is a broad risk management tool, not only for property investors but also for families in general. Apart from the obvious household, content and landlord insurance, investors should look at life insurance and income protection insurance as an important risk management tool.
The above elements are only a few important considerations, but there are many more relating to financing, legal structures etc…In my mind the best risk management decision an investor can ever make is to seek professional help in this field.
There are a few excellent knowledgeable experts out there and any investor “trying it alone” is certain to make most of the classic and costly mistakes that can be easily avoided.
It is a bit like trying to learn a new job without getting any training.
Join Philippe for his next Free Property Evening in Sydney on 5th May, with special guest Craig James from CommSec.
Philippe Brach is CEO of Multifocus Properties and Finance
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.