Monday, December 11, 2017

The 10 major risks faced by Australian property investors

We all understand that all types of investment including property investment comes with a risk.

So let’s discuss the 10 pre-eminent guises of investment risk, as they apply to Australian property investors.

1. Market risk (or systematic risk)

Market risk may affect all investments in an asset class in a similar manner, such as in the event of a market-wide price crash.Dice_800x600

As such, market risk that cannot easily be mitigated through diversification.

While buying properties in different states might diversify market risk to a partial extent, if the wider property market crashes, diversification is unlikely to assuage the systematic risk successfully.

Property investors should additionally invest in other asset classes that tend to move in a non-correlated manner to real estate.

Property investors can also focus upon a longer investment time horizon which allows correcting markets greater opportunity to recover.

2. Liquidity risk

Equates to the possibility that an investor may be unable to buy or sell an investment when desired (or in sufficient quantities) due to limited opportunities.

Illiquidity is a salient risk in real estate.

It is difficult to sell a property quickly should the need arise, which is not the case for large-cap stocks or government bonds.

Liquidity risk in Australian property is best mitigated through investing in landlocked capital city suburbs with eminent demand and constrained supply.

3. Specific risk (or unsystematic/business risk) 

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Equities investors and fund managers talk much of specific or business risk, being the measure of risk associated with a particular stock or security.

Also known as unsystematic risk, this typically refers to the risk associated with a specific issuer of a security.

Businesses in the same industry may have similar types of business risk, and issuers of stocks or bonds may become insolvent or lack ability to pay the interest and principal in the case of bonds.

Specific risk in property investment is somewhat different, and rather relates to the risk of acquiring a loss-making property or one which delivers sub-optimal returns giving rise to opportunity cost.

Specific risk can be mitigated through diversification, although this can represent a challenging proposition in property as dwellings tend to be expensive.

One frequently invoked strategy of property investors is to acquire different types of property in different states.

Careful, detailed due diligence and research of any property purchase also tends to reduce (if not eliminate) specific risk.

4. Interest rate risk 

Normally refers to the possibility that a fixed-rate debt instrument will decline in value as a result of a rise in interest rates.

Where an investor buys a security offering a fixed rate of return, he introduces an exposure to interest rate risk.

Examples thereof including bonds and preference shares (preferred stocks).

In Australian investment property, the interest rate risk instead lies in variable rate mortgages as the cost of debt capital can materially increase when the Reserve Bank ratchets up the cash rate.

The risk can be mitigated through the use of fixed-rate mortgages and prudent cashflow management.

5. Foreign exchange risk (or currency risk) risk

Arises from a movement in the price of one currency against another.

When the Australian dollar appreciates, the value of foreign investments declines.

Conversely, if the dollar weakens the value of foreign investments effectively increase.

Currency risk tends to be greater for shorter-term overseas investments, which have insufficient time to revert to a mean valuation in the same manner as longer-term equivalent ventures.

6. Sovereign risk (or social/political/legislative risk)

Sovereign risk is associated with the possibility of unfavourable government action or social upheaval resulting in investment losses.

Governments retain the power to amend laws affecting investments, and rulings which result in an adverse investment outcome are representative of legislative risk.

One frequently highlighted legislation risk in Australian property investment is the possible phasing out of the negative gearing tax rules.

Investing in developing or unstable countries variously offers opportunities for substantial returns but, reflecting the principles of the risk-return trade-off (of the CAPM model) may bring a heightened associated sovereign risk.

7. Credit risk

house mortgageCredit risk normally refers to the possibility that a bond issuer becomes unable to service expected interest rate payments or a principal repayment.

Typically, the higher the credit risk is, the higher the interest rate on the bond.

In property investment, credit risk often lies in the investor rather than the lender, although there is of course a possibility that lending institutions can become insolvent as was seen in the US as the subprime crisis played out.

Property investors should retain a liquid buffer in order to mitigate the risk of mortgage default.

8. Call risk

Also usually refers to bond issues and the possibility that a debt security will be ‘called’ prior to maturity.

In bonds, call risk prevails when interest rates fall, as companies redeem bond issues with higher coupons and replace them on the bond market with lower interest rate issues to save cash.

Can call risk impact Australian property investors?

Indeed, but conversely when interest rates run higher.

Investors with high exposure to adverse interest rate movements may be considered risky by mortgage providers cyclically.

Investors in Australian commercial property have periodically been subjected to the real estate equivalent of a margin call, being forced to reduce debt exposure through the redemption of assets.

9. Reinvestment risk

Usually refers to the risk that future coupons from a fixed-interest investment will not be reinvested at the interest rate prevailing when it was initially purchased, a risk that increases in likelihood when interest rates decline.

Zero coupon bonds are the only fixed-income instrument to eliminate reinvestment risk due to having no interim coupon payments.

The most straightforward strategy for property investors to avert reinvestment risk is simple: never sell.

10. Inflation riskaustralian-mortgage-finance

Also known as purchasing power risk, the possibility that the value of an asset or income stream will be eroded as inflation diminishes the value of a currency.

The risk is the potential for future inflation to cause the purchasing power of cash inflows from an investment to decline.

Inflation risk is best countered through investing in appreciating assets such as real estate, dividend-paying stocks or convertible bonds, each of which has a growth component allowing them to outperform inflation over the long term.

The uplifting news for property investors is that favourably located Australian real estate is well recognised as a tremendously effective inflation hedge over time.

The Proportion Of Interest-Only Lending Has Reduced To A Record Low

When does the property “inspection” start for you?

It may sound like a trick question, but when do you first start “inspecting” the property you are going to buy. house inspect

It may differ slightly if you are considering to buy a home or an investment property, but the fundamentals will remain the same.

When I am searching for property, I like to take a top down approach.

My “inspections” start at my desktop;

The Property Cycle

It is important to remember that there are cycles within cycles and even within local markets.

I first consider the big picture and how the Australian market is travelling in general.

Is our economy in good shape? 

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Is unemployment high?

How is wages growth travelling?

Are we headed for a recession or is there uncertainty on the horizon due to some of the questions above? 

Or alternatively is the economy in good shape? Is there jobs growth and unemployment low?

Living in Brisbane, Queensland, I then like to ask the same questions and understand where we are in the current cycle.

Metropole are lucky enough to be in a position where we also have local market experts in our major capital cities that can provide their perspective on local markets and cycles.

While “timing of the market” may be beneficial, it is rather “time in the market”  that is more important.

Once I can establish how the local market is looking and where we may be at in the current property cycle, I can move to the next stage.

Homeowners may be a little more restricted with this first step because they may not have the desire or flexibility to move accordingly.

Local Market Factors and Suburbs

To ensure that we are buying in the right location, we will then analyse more local market factors.  location map house suburb area find

Things like, demographics, owner occupier percentages, land to asset ratios, and suburbs with scarcity.

School catchments, public transport and infrastructure are also very high on our radar.

Almost always, it will be our capital cities that will have higher demand for housing as they are producing the most jobs.

In Brisbane, we are seeing rapid expansion of our CBD, along with a second runway at our Airport and major expansion of our hospitals.

I will target suburbs close to these major employment hubs, with good infrastructure, transport and schooling.

The Street

Whilst still on my desktop I will investigate things like flood reports, zoning and even contours of the land.

The physical part of the inspection then starts as I am driving to the property and understanding what is happening at street level.

You should be looking to get a feel for things like;

  • Noise – Are you too close to a busy road, train line noise corridor. Neighbours?
  • Neighbourhood – How are houses kept? Lawns mowed? Untidy gardens?
  • Apartment towers – Are they staring into the back yard or blocking sunlight?
  • Streetscape – Are there many new builds, renovated homes or derelict properties?

I always get excited when I pull into a street to see a few newly constructed homes, and a handful of renovated properties.suburb area map location street city road

It would also help to see a few works in progress, a concrete truck backing up and home owners undertaking further renovations and making improvements to their home.

Traditionally, owner occupiers are generally not afraid to overcapitalise once they are settled and happy in a certain location and it can be evident at street level.

Property price pressure will continue where old tired $600,000 houses are being improved or demolished and replaced with newly renovated or constructed homes that are now worth anywhere from $1mil upwards.

This is a sign of gentrification.

Alternatively, you never want to be the pioneer, so if the street or location you are considering does not have these attributes, you do not want to be the first to test the water.

External Inspection

Once I arrive at the property and park up, my external inspection commences.

Can I find a park easily?

Is there a lot of traffic?

Is access to the property by foot and car fairly straight forward?

I also like to consider street appeal.

Charm and character will first be established from street level and is always an important factor as it is the first impression.

If it does not tick this box, are there things we can change to make it look more appealing?  house property

The slope of the land here is almost just as important and cannot easy to judge from a picture on the internet.

A flat or slight slope on most homes would be ideal, but I would be avoiding large sloping blocks, especially if they slope from front to back.

This type of slope can lead to stormwater and run off being directed towards the garage or front door.

A quick stroll around the outside and underneath the property may also establish any major cracking or structural issues that may be costly in the long run.

Termite activity is also something that could be spotted at this time.

Things like weather damage, gutter and roof condition and boundary fences are not deal breakers buy should be noted and allowed for when considering the price.

As an investor, we would generally steer clear of pools as they add unnecessary risks and costs and eat away profits in most cases.

As you enter the property, a staircase or entryway may provide a further opportunity to assess the property.

Internal inspectionkitchen home property

This is the time to sort fact from fiction!

Do the agents inspection photos match the property’s appearance?

I have lost count of the times I have thought to myself “Is this the same house I was looking at online?

With the help of high resolution images, wide angle lenses and photoshop, an old run down shack can look a million dollars with just a few clicks of a mouse.

Question marks are always raised with large amounts of cracking, bowed ceilings or hollowed out walls and floor boards.

Internal condition and room sizes are also something I need to get a more accurate understanding of when reporting back to my client and making an assessment on price.

A super keen agent may list the property as a 3 bedroom, 2 bathroom property.Big Painting Job !

Upon inspection though, I establish that one of the bedrooms is too small for a bedroom and a downstairs bathroom may be dingy and unusable.

None of these may be deal breakers, but will need to be factored in.

In fact, many unpleasant or unappealing things internally can be easily changed or upgraded.

You are not able to change the location though, the distance to train, the school catchment, which is why we consider these items paramount before any inspection takes place.

In Queensland, we have the luxury of making contracts subject to a building and pest clause 99% of the time and it is a good insurance policy.

Quite often at an inspection we are unable to gain roof access or crawl under the property, both of which are important to understand any structural issues or termite activity.

Summary

When considering their next property purchase, most people start at the physical inspection and then work backwards.   door-1089638_1920

As someone who inspects hundreds of properties per year, this can be a time-consuming exercise.

It is easy to like the look and feel of a property, to look for a reason you should buy the property rather than for a reason you should walk away from the property.

By taking this top down approach and considering macro and micro factors before jumping on a property, it will stop you from making emotional decisions.

It will also lead to a much better performing asset and something that you can hold in your portfolio over the long term before potentially coming back to add value overtime.

Ready to Tell Your Boss To Shove It?

When I first walked out of my last actual job in the mid-90s, I have to tell you I was more than a bit scared.

After I shook off the shackles, I realised that there would be no more nice fat deposits into my bank account from my employer.

habit routine success business man pet hamster daily exercise work job life psychology

It gave me a jittery, butterflies in the stomach type of feeling.

The type of feeling you get when you’re a bit excited, but also, just before you’re about to throw up.

A bewildering mix.

All of a sudden, I knew within every cell in my body that I was fully responsible for myself and my family, and I realised there was no-one else I could fall back on.

At the time, I knew I had made the RIGHT decision…

But there was still a little nagging voice of doubt in my head that seemed to amplify just before I fell asleep at night.light bulb idea leader think smart clever failure motivate thought

The same little nagging voice that helps to protect us and keep us safe, so that we don’t make stupid decisions.

Even though I’d been earning profits as regular as clock-work from the share market, I still was a little concerned that my transition to being a full-time investor might just stuff things up.

I wish I had knew other investors at that stage who had also gone through a similar set of emotions, and I yearned for a support network that really understood me.

You’ll never need to go through a similar set of scary emotions, because you have our full support every step of the way – whether you’re starting out as an investor, or whether you’re already taking on the world already as an Investing Dynamo.

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As investors, we refuse to let other people call the shots and we know it’s up to us to look after ourselves, and to develop more than one source of income.

We know in our hearts that people who rely on their boss to plot their financial futures will be sadly disappointed.

Our future is a direct reflection of our past decisions.

By focusing on your own education, you’ve taken a step in the right direction.

You’ve set yourself apart from the lazy or ignorant masses who are happy to stay in their misguided comfort zones.

By your actions, you’ve shown that you don’t want to be one of the people who gets to the end of their lives and wonder “what if?”

7 reasons why P&I loans now make more sense

As the saying goes, if you’re standing still, you’re going backwards.

Up until 6 months ago, deciding on P&I or IO repayments was easy, as the interest rate was the same for either, and the repayment type didn’t impact your borrowing capacity.

Today, it’s a very different story.

Let me explain. Mortgage Paid

A couple of months back I wrote a blog which was quite popular with our readers as it outlined what happens when your loan reverts to P&I.

Of recent times, commenters have gone to town writing about this very topic, as it’s becoming more evident that a whole bunch of mortgage customers will be exposed to higher repayments in a few years’ time as their IO term comes to an end.

This group of mortgage customers will discover that their repayment amounts will increase considerably once the loan converts to P&I, particularly if P&I repayments are amortised over the remaining term of 25 years (as the IO term is usually over 5 years).

Refinancing is an option, however some may not qualify given the more stringent credit environment we currently find ourselves in.

Credit policy may lighten up in a couple of years’ time… only time will tell..!

Here are 7 reasons why you should now consider making P&I repayments from Day 1:

  1. Pay off your home loan and ultimately own your own home or investment property asset sooner:  
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  2. Lower your repayments by amortising your principal repayments over 30 years as opposed to a 25 year period (IO term is usually over 5 years);
  3. Pay less interest over the 30 year loan term, as principal reductions lower your loan balance from Day 1 and interest is reduced each month as repayments are made;
  4. Increase your borrowing capacity as IO loans adversely impacts your serviceability for borrowing purposes;
  5. Achieve approval faster and easier, as IO loans are no longer flavour of the month with lenders;
  6. Achieve a much sharper interest rate as IO interest rates are more expensive nowadays, which can be as much as up to 100 basis points (1%) with some lenders; and
  7. Build your wealth faster by increasing your equity position, as equity is built up in your property as you pay down the principal loan amount.

IO loans still have their place, if the strategy is right, even if means paying a higher interest rate.

However IO loans should be considered very carefully and only taken out in certain circumstances so that you don’t get caught out down the track, and you don’t pay more interest than you have to.

The lending world has changed considerably and deciding on P&I or IO is now an even more important consideration when taking out a home or investment loan. Tack Of Books With Loans

The regulator (APRA) has been calling the shots and has mandated banks/lenders to limit the level of IO borrowings made to Australian mortgage customers (refer blog explaining more).

Sometimes, you just have to roll with the punches and make changes as deemed necessary.

Ignore the changes at your peril.

Now more than ever, professional advice is key to ensure you make strategic financial decisions that are congruent with your bigger picture, and that are aligned with your financial goals.

Disclaimer: This information does not take into account your individual objectives, financial situation and needs. You should assess whether the information is appropriate for you and seek specialist advice from a qualified and licensed advisor.

Podcast Episode 19: How soon can I give up my day job as a property investor? | Why a growth mindset matters | What really drives capital growth

How soon can you give up your day job if you invest in property?

The answer may not be what you really want to hear.  productivity-work-busy-office-tech-job-employment

In today’s show I discuss this as well as explaining the three P’s of property price growth.

Plus I highlight some interesting findings (at least I think they are) from the Census.

And in my mindset moment, I am going to talk about the importance of a growth mindset.

The 3P’s of Property Price Growth People, Price and Place

  1. People: Demographics and how many people there are and how they want to live. In fact household formation is the biggest factor
  2. Price : Affordability of property which is related to wages, interest rates and property prices
  3. Place: – supply and demand property market
  4. Every five years the census helps us understand the changing demographics.
  5. As a property investor, you need to understand what properties will be in strong demand in the future – and the Census gives us clues.
  6. The latest census revealed that we add about 1,037 people to Australia every day.
  7. Australia has a sparse population density, and people congregate in the capital cities.
  8. Our median age is 38. We are slowly getting older.
  9. We are a diverse nation – Australians were born in over 200 countries.
  10. Almost half of the population were either born in another country or had a parent born in another country.
  11. Most of our immigrants come from China and India.
  12. The census gives details to where people’s wages have grown.
  13. We pinpoint our research to find areas that will have growth.

Mindset Message: Why a growth mindset matters.

  1. A fixed mindset believes you can’t change your capabilities
  2. A growth mindset means you can move towards improving yourself.
  3. It all starts with your inner self. With your thoughts and feelings leading to your actions and results.
  4. In what areas of your life do you need to move from a fixed mindset to a growth mindset and what are you going to do about it?

How soon can I give up my day job as a property investor?

  1. It’s not easy to do this. Real estate investment is a slow game that takes 10 to 15 years of growth.
  2. You first have to build your asset base – and can do this by investing smartly in high growth properties. older, old, man, work
  3. Then, slowly lower your loan-to-value ratios. But in the meantime you need to have a real job.
  4. Then use your asset base as a cash machine
  5. Residential real estate in Australia is a high growth, low yield investment.
  6. It doesn’t matter how many properties you own. The question is how big is your asset base and how hard is your money going to work for you?
  7. To retire you’ll need a 3 -4  million dollars in assets and your own home.
  8. Cash flow will keep you in the game, but it won’t get you out of the rat race.
  9. House flipping doesn’t work in Australia because of stamp duty and tax rules.
  10. It can take 30 years to build a substantial property portfolio, because most investors get it wrong in the first 10 years. Then it takes two or three property cycles to build their asset base.

Links and resources:

Our favourite quotes from the show:

“Believing change is possible is one of the biggest tenets of personal development.” Michael Yardney  Light Bulb With Drawing Graph 1232 2775 300x200

“A growth mindset makes change possible, but you still have to take action to achieve your goals and success.” Michael Yardney

“Your thoughts lead to your feelings. Your feelings lead to your actions. Your actions lead to your results.” Michael Yardney

Never miss an episode and keep up with all the good things going on at the Michael Yardney podcast by subscribing on iTunes.

You can also subscribe to MichaelYardneyPodcast.com to keep up with the latest information including bonus material that comes out between the podcasts.

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