Property investment is one of best wealth creation strategies out there.
In part because it has a long history of solid performance, so is therefore relatively low risk.
It’s important to understand, however, that it is not completely without risk.
That’s because every investment opportunity has an element of risk.
The trick is to manage those risks to maximise your results.
So let’s take a look at 3 risk management strategies for property investors, so you can learn how to do exactly that.
1. Interest rate risk
The Reserve Bank has been slowly lowering interest rates and is likely to do so again early in the new year.
And it doesn’t appear that rates will ramp it up any time soon, because the inflation rate and wages growth stubbornly remain below the Reserve’s target band of two to three per cent.
The thing is, investors and interest-only borrowers have had to wear higher interest rates over the past few years because of APRA’s lending restrictions.
There is always the risk of interest rates increasing during property ownership – it’s actually a sure bet.
You see…having a loan is not a risk – not being able repay the interest on it is clearly a risk.
So strategic property investment involves having a risk management strategy such as a cash buffer or a line of credit so you can access extra cash when interest rates increase.
Or you could consider locking in some or all of your loan to fixed interest rates to manage the risk
Of course, before the RBA raises interest rates, the economy will have to pick up, inflation will have to rise, house prices will have to increase further and the rent you receive will have increased over time, meaning when interest rates do rise, you will have more cash flow to meet repayments.
2. Market risk
When I say market risk, I mean the risk of the property market crashing.
You know… like all those property pessimists are predicting.
And while there are plenty of scaremongers out there who foretell such an event, the truth of the matter is that capital city property market crashes are unlikely.
Even Sydney, which has now taking a breather from its boom of the past few years, is not expected to “crash” anytime soon.
Sure its prices may soften a little but its strong population growth – driven by all the new jobs being created by the buoyant economy and driven in part by significant infrastructure spending – will create an ongoing demand for real estate which will prevent any major price correction.
We just need to remember how during the GFC Australian property prices held their own, even when unemployment was rising and the world was panicking.
A strategy to mitigate market risk is to only buy investment grade properties that have a long history of outperforming the averages and will continue to be in strong demand from affluent owner-occupiers, who drive up prices.
Building your equity by buying under intrinsic value as well as manufacturing equity in your properties via renovation can also reduce your exposure to market risk.
3. Liquidity risk
Liquidity risk refers to your ability to offload an asset when you need too.
This could be because of your changing financial circumstances or perhaps you recognise that it is an under-performing asset that needs to be sold.
A good example of liquidity risk at play is the oversupply of new unit stock in our major capital cities at present.
Many investors who want to offload this type of properties have found that demand has reduced so much that, not only will they take a significant loss if they sell, they often can’t find anyone at all who’s prepared to take over their property.
Of course, the risk management strategy for liquidity is not invest in these types of properties in the first place.
Instead only buy investment grade properties in locations where there is sufficient market depth – where there are a significant number of buyers and a sufficient number of properties turning over to ensure a liquid market.
Similar to liquidity risk is the risk of holding on to an under-performing property.
A question we often ask investors is, “If you knew then, what you know now, would you still have bought that property?”
If the answer is no, then perhaps it’s time to divest it so you can invest in a better performing property.
There is no shame in recognising that a property isn’t working financially as well as you had hoped it would.
It is much more of a shame missing out on the opportunity to use your equity more efficiently by owing a better performing asset.
The bottom line…
At the end of the day, property investment can be a low-risk strategy for wealth creation.
The secret is to buy investment grade properties in locations that will exhibit ongoing long0term capital growth because they are underpinned by multiple growth drivers.
And recognise that all good things – like financial freedom – generally takes time.