Posted by When it comes to property investment, it’s really important to understand risk and the impact it can have on a potential deal, so you can mitigate it from the word go.
Investment of any kind is all about managing the risks. They’re everywhere. It’s important to look at things with a cool head, but you also have to be aware of the different types of risk that are out there.
Asset Risk
Asset risk concerns the general age and condition of a property or a building. If you don’t know what to look for in what you’re buying, you may end up out of pocket from needing to fix or rectify something wrong with your property that wasn’t immediately apparent.
It could be a structural defect, or it may have been built with materials that are dangerous, like asbestos. You need to watch out for other potential problems, for example, dry rot, which is very expensive to fix. If you find a structural defect in the property after you’ve paid for it, as the owner it’s down to you to rectify the problem.
Remember that climate change is forcing governments and local authorities around the world to introduce policies around energy efficiency. This means improving the insulation of your property, but it also means improving the efficiency of the heating systems, which can become quite expensive.
So how can you mitigate asset risk?
Carefully examine the property before you buy, whether that’s you walking around with a careful eye or whether that’s employing an engineer to come in and actually do a proper survey or inspection. Make sure that you’re not going to get into a situation where you are forced to make costly improvements you weren’t aware of at first.
Location Risk
When we’re talking about location risk, the most important thing is that you understand the area that you’re buying in.
Is it a well-to-do area? Is it working class? Does it have any crime? Does it have any social issues that could have an impact on the occupants if you’re renting the property out, or if you’re going to try and sell it in the future?
It might be a perfectly good property, but if there are any of the above issues, they might put a cap on its potential value over time.
There’s very little you can do about location risk once you’ve actually bought: you can’t change the character of an area! So it’s important that you know and understand what you’re getting into right from the outset. Explore the area extensively before you buy, talk to people who live there and try to get sense of how the land lies.
Take a look at what plans the local authority has for the area. This can often reveal something that is not obvious, like road widening or new transport links. All of this may be years away, but that can often be a big generator of increased interest, traffic and value.
Tenant Risk
If you’re renting out a property, poor tenant selection can really cause you problems.
It’s easy for a potential tenant to paint a very pretty picture about how great they are. Then they get into the property and completely change: people who seem very nice, but then suddenly stop paying the rent, or damage your property.
It’s very important to understand the financial resources of your tenant. You’re putting a lot of money into this asset, so you have to rent it out to somebody who pays you on time.
The worst thing you can do is put the wrong tenant in there and they start damaging the property and you end up having to move to get them out. This costs you a lot of money. Not only money out of your pocket, but also opportunity lost because you’re not able to do anything else with the asset while you’re dealing with that problem.
So, how do you mitigate against this kind of tenant risk? The best way to do it is having rigorous tenant selection protocols and being disciplined when it comes to checking their references. A good idea is to contact the landlord they had before their current landlord, you may find they are more forthcoming with info, whereas a current landlord could be highly motivated to get rid of a problem tenant.
Make sure you understand the legal rights of a tenant and of a landlord. Those are available on the internet so research your obligations as a landlord, the obligations of the tenant and the rights of the tenants. In the event that they stop paying rent, what are their rights? What are the obligations around increasing rents? Make sure you know all of this before you think about renting out your property.
Financial Risk
These are the risks that are inherent around your banking and any loans that you’ve taken out to buy your property. When you borrow money, you obviously have to sign a loan agreement, which has various terms and conditions.
Even though they may be boring to read, it’s vital to know what your obligations are and what kind of rights the bank has if you break those obligations. Make sure you know what rights the bank have over your property and over you.
The biggest risk with a financial risk is increasing interest rates. If you can, consider fixing your interest rate, to lock in set payment level, meaning you don’t have to worry about fluctuation. It can be costly, but it means you know where you’re going to be for the next couple of years in terms of payments.
Economic Risk
Economic risk is basically market risk – something that you have no direct control over but will still have an impact on your pocket.
Economic market risk can often influence property prices as well. Supply and demand imbalances force the prices up or down and affect affordability. If inflation is increasing and interest rates go up, accordingly, people will have less money to spend so won’t be able to pay as much for property, potentially pushing prices downwards.
You have no control over any of this, but if you’re aware of it, you can at least protect yourself. Just remember that global events are never flagged in advance.
Always assume there’s a possibility of some sort of event driving prices down and consider where you stand in that event. Do you have a risky portfolio? Are you heavily borrowed? Do you have a low cash flow? Bear all of this in mind and plan for a worst-case scenario.
Your risk mitigation mindset
It’s vital to have the right mindset around risk mitigation. As I mentioned that at the outset, investment of any kind is all about managing the risks, and you have to know what you can and cannot control.
Consider: can you get yourself out of the deal? Can you lock in a profit before you’ve even bought the property? Once you gain experience you’ll start to look at everything and be comfortable with (for example) a location risk because you’ve already considered and mitigated it.
You should always be looking out for ways to lower your risk: always try and de-risk a deal from the moment you start looking at it, right up to the day that you buy.
Just remember to keep your cool!