HOW TO MANAGE THE RISKS AND REAP THE REWARDS OF PROPERTY INVESTMENT
“The biggest risk is to take no risk at all.” Casey Neistat
Investing in property has long been considered one of the safest and most rewarding forms of investment. There are many rewards of property investment that add to its allure. However, as with any investment, investing in property comes with its own set of risks and challenges.
Still, I truly believe investing in property is one of the safest investments you can make. And I’ll tell you why:
Property is tangible
Unlike stocks or bonds, property is a physical asset that you can feel, touch, and see. This tangibility provides a sense of security that many investors find reassuring. In fact, it’s one of the key advantages of investing in property.
Property is a basic human need
Property investments also act as a solution to a fundamental human need – shelter. Everyone needs a roof over their head, which means an entry-level property will always be in demand. This consistent demand is a reliable foundation for investing in property.
Demand drives property prices up
From a fundamental economic perspective, property prices are influenced by the simple law of supply and demand. In South Africa, the population is steadily growing but from a supply side, land is limited, and they are not making any more of it! This means that property prices will continue to increase, making property an attractive investment option.
Read our article, The Key To Prosperity is in Property Investment.
UNDERSTANDING RISK IN PROPERTY INVESTMENT
This might sound contradictory, but the risk associated with property investment is another reason to invest. The basic measurement for risk in the investment world is standard deviation. It measures how much your return on investment deviates from the average return on investment.
Now, consider all the properties you or your relatives and friends have ever owned. Have you ever known one to plummet in value? It is a rare occasion. The standard deviation in property is extremely low because returns are very constant. Property prices also do not deviate drastically from one year to another and usually increase (whether slow or fast) from year to year.
The same is true for rental income and your net rental yield. Rentals increase very consistently from year to year and very seldom go lower. The standard deviation for rental income is also extremely low because rental returns are very consistent. Again, rental prices do not no deviate drastically from one year to another.
MANAGING RISK IN PROPERTY INVESTMENT
While property is generally a low-risk investment, risk comes in when you start using leverage (debt) and when you have a monthly shortfall to service your debt. For example, when your monthly rental income is less than the mortgage payment, levies, rates and taxes, rental commission, etc, you could be in trouble. This is where a low-risk investment can very quickly become a high-risk endeavour.
So, how do you hedge yourself against such risk? You do it by building your property portfolio in such a way that there are no shortfalls on your property. Or if there are shortfalls on your property, you must have a strong reserve fund to subsidise your monthly shortfalls. Ideally, you want your reserve fund to cover at least five years of shortfalls.
The best way to prepare a reserve fund is to refinance your properties to market value. Then, park the funds made available in the access bonds of the properties so you don’t pay interest on the money while you are not using the funds. These funds can then be used to subsidise your monthly shortfall, providing a safety net in case of unexpected circumstances.
A reserve fund is so important as subsidising shortfalls out of your pocket can become very dangerous. What if interest rates go up? What if you lose your job? Suddenly, you won’t have a monthly income to subsidise the shortfalls anymore!
Even though property is a low-risk investment, your reserve fund is critical, especially when you finance and refinance your properties. You need to have a certain percentage of the property value in cash in case something goes wrong.
For example, you can start with a reserve fund containing 10% of the property value and then increase it to 15% eventually. In other words, if you have a R1 million property, you want R100k in your access bond and move towards having R150k. But you do not have to save up for this. You can refinance your property and keep this amount separate in your bond (access/flexi ) after you’ve had the property for a year.
Read our article on how to Maximise your Property Investment with Access Bonds.
BALANCING THE RISKS AND REWARDS OF PROPERTY INVESTMENT
Property investment offers a compelling avenue for building wealth and financial freedom, especially when leveraged responsibly. And while it’s essential to understand the potential risks, don’t allow them to put you off property investment. Use the safe investment of property and add leverage to your portfolio to increase the asset base and the internal rate of return even more.
By adopting prudent financial practices, maintaining a reserve fund, and assessing risk intelligently, property investors can navigate the path to prosperity while minimising potential pitfalls. The key is to do it responsibly, so you don’t turn your property portfolio into a high-risk investment.
Read the entire article in the December/January Edition of Real Estate Investor Magazine.