menu

Property Investment Risks (that no one tells you about)

Investments  |  26/10/2017  |   7 min read

Want to get into the property market without compromising your inner city lifestyle? ‘Rentvesting’ may be the solution you’re looking for.

While it’s an awkward phrase, the concept is pretty simple. It means buying an investment property while continuing to rent elsewhere.

For many people it’s a way to hedge against ever rising property prices, in the hope that one day the sale of their investment property will provide a decent deposit for the home of their dreams. But it’s not without its risks. And here are some of the things you need to consider.

Concentration Risk

The property market is actually made up of many sub-markets, each with different risk and return characteristics. Should you buy an apartment, townhouse or house? Which suburbs show the most promise for capital appreciation? What about investing interstate or in a regional city instead?

Whatever your decision, property requires a large capital investment, and if prices fall or stagnate there’s a good chance you’ll be kissing those sweet capital gains goodbye. And yes, property prices can, and do fall, sometimes spectacularly.

In other words, you’re putting all your eggs in one basket, which leaves you more vulnerable to changes in the market, or external factors such as interest rates.

Liquidity Risk

One of the major risks with property investment is liquidity, or the ability to convert some or all of an investment back into cash at short notice at a fair market price.

No one is ever sure how long it’ll take them to sell a property, and by the time they do, the market sentiment could have shifted.

From the time you engage an estate agent to the first auction attempt you could be looking at two to three months. Settlement can then take a further two to three months.

Interest Rate Risk

Property is highly sensitive to the prevailing interest rate environment. Rising rates tend to dampen activity in the property sector (and thus prices), while falling interest rates encourage activity. 

Interest is a cost of funding an investment property purchase, so if rates rise faster than the rental yield (rent as a fraction of the cost of the property), you’ll have to hope that the value of your investment property keeps rising to provide a decent total return upon sale.

Legislative Risk

All investing involves dealing with future uncertainties, and one of those is how the laws affecting your investments might change during the time you hold them. 

Property investing is especially sensitive to legislative risk, potential changes in tax laws can affect the demand for property.

Abolishing negative gearing for example, as has recently been debated, would significantly alter the dynamics of the investment property market and might impact on existing property investors.

Tenancy Risk

Investment properties are usually rented out to other people in order to cover loan repayments and associated costs. Until you have a binding lease agreement with a suitable tenant, it’s all expenses and no income.

From then on, investors have both rights and responsibilities when it comes to their tenants, and working cooperatively with both an estate agent and the tenants will save all parties lots of heartache over the term of the lease.

Gearing Risk

Gearing involves the use of debt to buy an asset while only contributing to a portion of the purchase price. In property investing, it’s fairly common for investors to borrow 80% or more of the cost of the property.

If everything works to plan, gearing can magnify the gains from property investment. Many investors choose to gear aggressively to maximise the difference between interest paid and rental income received (i.e. the negative gearing effect).

For those using variable rate loans, a rising rate environment will result in the negative cash flow getting progressively larger, and at some point becoming unsustainable. The Global Financial Crisis of 2007 – 2009 was precipitated by exactly this scenario in the US. 

Summary

At the end of the day, there are a lot of risks associated with investing in property, and these are just a few of them.

Ultimately you have to decide if the lack of diversification and the other risks associated with buying and owning a rental property are worth it. What’s right for someone else may not be right for you, so do your own research and take your time.

 

Originally published by Clover. Learn more about your invstment options with Clover's automated investment advisor.

 

This information is provided for general information only. It does not take into account your personal objectives, financial situation or needs and should therefore not be taken as personal advice. You should consider whether it is appropriate for you before acting on it and, if necessary, you should seek professional financial advice. Before making a decision to invest in the Equipsuper Superannuation Fund, you should read the relevant Equip Product Disclosure Statement (PDS). Past performance is not an indication of future performance. Issued by Equipsuper Pty Ltd ABN 64 006 964 049 AFSL 246383.  MySuper Authorisation Numbers 33813823017672 and 33813823017518  (‘Equip’, ‘the Fund’ and ‘the Equip Rio Tinto Fund’).

Equipsuper Financial Planning Pty Ltd (“EFP”) (ABN 84 124 491 078, AFSL 455010) is licensed to provide financial planning services to retail and wholesale clients. EFP is owned by Equipsuper Financial Holdings Pty Ltd (ABN 11 604 515 791). You can obtain the EFP Financial Services Guide and/or Privacy Statement by contacting our Helpline 1800 682 626.

Check your retirement income with the Equip calculator