Do You Have a Risk Minimisation Strategy?

December 11, 2016 Sam Saggers

Fear is a powerful thing…if you give it power.

You give it power when you don’t name it and when you ignore it.

To take away its power you hit it…head on…with a plan.

When you first decide to buy an investment property you’ll be hit with fears, no doubt about it.

You’ll wonder what if I don’t qualify for a mortgage? What if I do? How much can I afford and what happens if I lose my job? Will I lose everything?

These and many more questions are very likely running around your brain right now if you’re thinking about buying an investment property for the first time.

Even seasoned property investors have fears take hold of them from time to time. The only difference between them and you now, is time investing in the market and risk minimisation strategies that they’ve learned to put in place to manage their fears.

Can the worst happen?

Sure…but rather than sit, cowering in a corner somewhere, savvy investors put systems and safeguards into place that minimise any losses from their investment property endeavours.

Ask yourself, how bad can it get?

Begin by assessing your personality including how you handle risk.

Your capacity for risk will impact the types of strategies you’ll use, how quickly you’ll build up your investment property portfolio as well as your finance choices.

Figure out what keeps you up at night and then take action to minimise your risk exposure.

Use the following questions as a guideline when considering what makes you nervous about buying an investment property.:

  1. Can I accept a drop in value, realising that my investment property is a long term investment or will I want to sell the minute I see prices go down?
  2. Will I be comfortable letting a property manager handle my properties or will I have to manage them myself?
  3. Would it bother me to borrow the maximum amount possible?
  4. What am I willing to sacrifice to build up my portfolio?

5. Can I buy without emotion and only use financial returns as a guideline for buying?

For example, let’s say you’re afraid you’ll have to pay the shortfall on your investment property because you can’t find a tenant.

Here’s how to handle that fear.:

Let’s say your investment property has a positive cash flow return of $20 per week.

If you’ve had a tenant for one year you’ll have $1,040 in income on that property.

Let’s also assume that your tenant is paying $200 per week.

Divide that $1,040 by $200 and you’ve discovered that your property can be vacant for about five weeks before you have to pay anything on it.

Kind of puts things into perspective, doesn’t it?

Work out the numbers for your own investment property and you’ll have the knowledge you need to battle this particular fear.

This is before we’ve even considered tax deductions, which can reduce your costs even more.

Types of risk

Financial

Financial risk comes in a wide variety of forms; bankruptcy, divorce, death, job loss, debt…any number of things can impact your financial outlook.

As capital is vital to buying an investment property, it’s important to minimise any risk to your ability to obtain it through lenders and personally through employment or business ventures.

Use smart cash flow management combined with a well planned investing strategy to offset any potential risk to your financial situation.

Liquidity risk

Real estate is not a liquid asset. Should you need money quickly you can’t simply sell your investment property one day to obtain it.

To offset this type of risk buy in tightly held capital city suburbs where demand is high but supply is low.

Interest rate increases

It’s possible to mitigate the risk of a variable rate mortgage through smart money management, including the use of a buffer to offset any potential rate increases.

Another option would be to use fixed rate or partial fixed rate loans, preferably tied to an offset account with an adequate buffer in place.

Market risk

We all love it when markets rise, but they can fall as well.

To minimise potential market losses buy in locations such as capital cities in popular suburbs with a limited supply.

Also, maintain adequate buffers and insurance policies to offset a drop in yields and/or damages to your assets.

Strategies for risk minimisation

1. Buy different types of properties

Don’t buy only homes or only units. Buy both of them, depending upon what the area demographic is searching for.

2. Spread out your properties

Find unique properties in diverse locations. An increase in value in one market can offset stagnant growth in another market.

3. If possible, find populations with different incomes

Ideally, you’d have tenants who work in different industries to avoid problems like those seen in mining towns where companies make thousands of their employees redundant.

4. Buy different price ranges of property

Why?

Should you need to get your hands on some capital quickly, your odds of selling a less expensive property faster are better.

In addition, the number of potential buyers will be larger for less expensive properties than they will be for more expensive ones.

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