One of the cardinal rules of investing, regardless of asset class, is to ensure you have a researched risk management plan in place. Property is generally considered a low risk yet strong investment medium and many investors research locations and types of properties available, but few look at a comprehensive and structured risk management strategy.
Here are a few of the most powerful risk management tools and how they help in reducing risk.
This is a broad ranging tool that any investor would be crazy to ignore. Types of insurance to bear in mind include:
• Building and contents insurance. This covers building replacement, damage to building and contents, fire, water damage, and the like.
• Landlord insurance. This deals with tenant issues including loss of rent due to default, damage caused by tenants and tenant claims.
• Life insurance. This depends on the investor’s personal circumstances. Life insurance for a single person may not be needed as there is no beneficiary. However, for a couple, with or without children, cover should be in place to ensure that the remaining family members will be financially secure.
• Income protection. Not enough people have this cover. If for any reason you become permanently disabled (in a car accident for example), this cover provides you with an income of about 75% of salary until age 65. Beware of policies that are much cheaper and cover you for only 2 years.
This subject can become complicated and using a good insurance broker is paramount.
When structuring a strategy and a financial plan an investor should always ensure that they have ‘buffers’ in place.
If releasing equity in a property to invest in a new one ensure that you do not use all the equity to purchase the property. Keep a comfortable amount available to cushion against unexpected expenses, interest rate rises, etc.. I also recommend that investors have an additional buffer, usually in the form of savings in an offset account, for personal expenses (medical emergency, car purchase, holidays, etc.). The quantum of these buffers will depend on many factors but, as a simplistic example, I would recommend at least a $50K ‘investment buffer’ when buying a $400K-$500K property.
This is a constant topic of discussion in most investment property magazines. I’ll just say that, as a risk management tool, an investor needs to find economically diverse locations that balance cash flow and capital growth. Stay in the median price range in any given suburb, keeping in mind that what will create wealth is capital growth. A safe view would be to invest in houses in outer suburbs of major capital cities that are commutable to the CBD. Prices are usually lower, yield is better, risk is lower and capital growth prospects are safer.
This is common sense risk management technique based on the timeless ‘do not put all your eggs in the same basket’ idiom. If you are building a portfolio consider investing in different states. It reduces the economic risk of investing in a single state and avoids (or reduces) land tax.
Cash Flow Management.
Investing in property is a numbers game. In order to make a decision on the acquisition of a property it is essential that you understand what impact this property will have on your cash flow. After all, you will have to cope with the property’s cash flow for 15 to 20 years! It would be reckless to invest in something that turns out to be cash flow negative by an amount you cannot afford. Cash flow projections should always be reviewed against actual figures to ensure that there is no slippage. Research in costs/revenue is important.
It sounds elementary, but many people do not know where to start and how to analyse these cash flow numbers.
The above are some of the important considerations, but there are many more relating to financing, legal structures and other matters. In my mind the best risk management decision an investor can make is to seek professional help in this field. They 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 with the right advice.
Philippe Brach is CEO of Multifocus Properties and Finance.
Philippe is an experienced property investment specialist, mortgage broker and author of ‘Creating Property Wealth in any Market’.
Contact Philippe and get a jump start on your portfolio with expert advice.
Ph. 1300 266 350 | www.multifocus.com.au | [email protected]
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property
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