You will be able to find hundreds of articles about risks of different strategies and possible returns. People will convey their opinions on different types of ‘investments’ and all will have good intentions.
Somewhere along the line, you need to do some maths on what is most likely to occur. After you have done this you can vary aspects of your initial plan, change the elements in the maths and forecast more positive and more negative scenarios.
But there are a few things to remember:
- Historically property values double in Australia every 10 years or so,
- If you are able to service the debt, then this ‘forced savings plan’ is likely to help you accumulate ‘wealth’,
- Most people who own their own home for a number of years have been able to pay the loan repayments and the value of their home has increased. By doing this over a period of time they develop ‘wealth’ which can be referred to as ‘equity in their home’. After about 10 years they may have generated , for example, half a million dollars. Most of these people would immediately tell you that they would not have been able to save half a million dollars any other way over that same time period!
The potential risks include:
The price you pay is above market value or above the bank valuation
(this is more like a mistake than a risk: research will prevent this)
This should probably be called a ‘fear’ rather than a risk, but because it is often expressed as a risk, we shall treat it in our summary: In this instance you have paid a price that the bank feels they cannot justify as a security at the price you paid; this may mean that you need a bit more deposit to make up the shortfall. Be mindful that banks can be very conservative when valuing property for mortgage purposes.
You can offset this risk by researching the area and the values and knowing an advance what the bank valuation is likely to come up as. Of course just as you may suffer less favourable numbers, you could also get a more positive outcome: the better you select the more likely that your IP preforms above expectation.
The growth of the value of the property is less than you would like
This may effect your overall plan and even effect when you can get your next IP. You may have been hoping for faster growth. In fact the value may go down in the short term, especially if you bought in a crowded rental market.
You can offset this risk by researching and validating the maths and expectations for the area and the style of property that you are looking at. Of course just as you may suffer less favourable numbers, you could also get a more positive outcome: the better you select the more likely that your IP preforms above expectation.
The rent you earn may be lower than you hoped, or no rent may come in for a period
The rent you earn may be lower than you hoped, or no rent may come in for a period
If you get less rent, then this may effect your gearing and may effect what you need to contribute to the investment: you may have to pay the mortgage for a while instead of the rent doing that for you; naturally this improves your tax situation on personal income for this time, if you are employed.
You can offset this risk in several ways:
- You may be able to negotiate a rental guarantee period where you receive a guarantee that if the property is not rented, you will be paid an amount anyway;
- By researching the area and looking at the historic and current rental yields you can reasonably forecast what is happening in the area;
- By choosing an area according to a criteria, you improve the likelihood of getting this right;
- By working with a partner who also does the maths and helps to remove poor performing areas, whilst concentrating on better performing areas, you benefit from their expertise;
- Of course just as you may suffer less favourable numbers, you could also get a more positive outcome: the better you select the more likely that your IP preforms above expectation.
There may be damage to the inside or appliances may fail, you may suffer from a bad tenant who damages the property, or some form of pest infestation
There may be damage to the inside or appliances may fail, you may suffer from a bad tenant who damages the property, or some form of pest infestation
This could happen with a tenant in the property. Naturally if it does this may be an expense to your IP ‘business’ and thus a tax treatment. It is not the same as the same thing happening in your residential dwelling.
You can offset this risk with insurance which specifically addresses the risks and means that the selected cover pays out in the occurrence of the selected event. You are also depreciating the value, expecting to have to replace things at a certain time in the future, this is a tax treatment, which is scheduling the replacement of items as they ‘wear out’.
There may be structural issues with the house over time
There may be structural issues with the house over time
This is one of the reasons people fear strata, fear existing houses and fear units, because these costs can be unexpected and more than you had conceived. This is one of the reasons why a new house and land package is often a better alternative.
New houses come with structural warranties of a minimum of 7 years and are backed by government agencies: the insurance exists even if you cannot get satisfaction from the original builder.
Natural Disasters, risks, bushfires etc
Firstly, whilst this may be a concern you have, this is very easy to identify with research. In the case of bushfire ratings they are clearly identified in the development and will be re identified in the approval processes. Yes you may need specifically rated windows for example, but this will be a known and mathematically identifiable consequence.
In the case of potential flood and natural disasters, you can identify specific insurance cover that will address the potential issues. Costs of the insurance become a mathematical part of the forecasting and tax position. If an insured event occurs there will be insurance which pays out based on your cover.
Interest rates changing
This will happen. There are forecasts that you will be able to refer to that will give you some predictive capability. Even the most basic forecasts will enable you to ‘plug in’ a different interest rate and see the effect this will have, if nothing else changes. With an Investment Property, it is quite proper for market forces to affect the rent. It is normal and expected that rent will need to increase in economic times where interest rates are increasing. Yes there may be a lag, but typically any costs associated with interest rate changes are able to be recovered.
You May Loose Your Job
Yes, this is something that can happen. Yes, it may happen at an unexpected time in your journey. Aiming for a positively geared IP is a strategy that people often use with their first few investments, which means that the tenancy will typically pay the costs and there will be no burden on you when you do not have income: in fact this may be a good time to have investment strategies that are already in place. You can also choose to have insurances for these circumstances.
