What Are The Biggest Property Investment Risks?
Property is one of the most popular investments out there. This is due to the fact that investing in property has potentially massive returns. If you are familiar with Maslow’s hierarchy of needs, then you know that it is human nature to seek out shelter. This results in real estate being in high demand. Add to this an ever-increasing population, and what we get is a limited amount of prime land with increasing value over time.
With the Chinese New Year season in full swing, it’s also the time when we see property development launches and promotions taking place across the country.
That being said, property investment can be incredibly risky. There are a number of factors that affect a property’s value, some of which are completely out of your hands. Understanding them is key to making the right investment. Here are some of the biggest risks to real estate investment:
Maintenance and repairs
This risk is basically the risk that a property will incur due to unplanned costs as a result of the property’s physical condition. This risk is especially prominent for older or poorly maintained properties. These properties may require costly repairs or improvements, which may negatively impact its value.
Investors can reduce physical asset risk by conducting due diligence before closing a deal. This means assessing the property’s structural stability, condition of the mechanical and electrical systems such as lights or air conditioning, determining if the building is up to code, etc.
A property’s location is a major factor in determining its value and selling price. Depending on the location, the population, demographics, and job growth potential within the property’s market will vary greatly. This in turn affects the pool of potential tenants and buyers and can also act as a buffer in the case of a market downturn, allowing you to maintain a higher price.
The market in which an investment property is located is also something to keep in mind. High occupancy rates and steadily growing rental prices are generally a good indicator of a relatively strong market.
As the name suggests, properties that will need to undergo significant development or redevelopment will have a number of development risks associated with them. One such risk relates to construction. This is the risk that the property would not be completed within the expected time frame, leading to potentially higher construction costs or potential defects after completion.
Another development risk would be entitlement risk. Such risk occurs when you are trying to acquire a property and develop it for a specific use, but gaining approval from the associated governing body takes longer than expected. For example, trying to obtain a lodging house license from your local town council to develop a bed-and-breakfast.
If you plan to lease out your property, you incur a leasing risk if you are not able to lease your property within a targeted time frame at a targeted rental rate. This leads to the property being vacant for an extended period of time. The only real solution to this is to ensure that you have a decent amount of time and money set aside to form a buffer in case vacancies are not filled.
Once you have actually managed to get a tenant into your property, the risks do not diminish. Part and parcel of investing into property is dealing with potentially problematic tenants. On the occasion that you do receive poor tenants, you run the risk of property damage, poor upkeep of your property, or defaults on rental payments.
Eviction is one way of dealing with bad tenants, but it is no easy feat as landlords have to pay out legal costs. Recovering overdue rentals or utility bills could be impractical and can also be a long and tedious process. This is why you need to clearly state your clauses in your tenancy agreements in order to keep unruly tenants in check.
Another way to mitigate tenant risk is to diversify your tenants, so that the departure of a single tenant does not make a huge impact on the profitability of your property. Alternatively, you could sign longer term leases.
Real estate does not come cheap. As such, taking on debt in order to finance real estate investment is far from uncommon. However, you must understand the associated risks that come with taking on such debt.
For one, you may suffer from potential foreclosure if you overleveraged. Overleveraging is when a property takes on more debt than it can pay back in a timely manner. This could result in your property being seized.
Just like the economy, the property market runs in cycles. This means there will be periods of boom, bust, and recovery. In order to minimise outlook risk, you have to pay close attention to the market. You have much more to lose if you purchase real estate before a bubble bursts.
Malaysia in particular was experiencing property overhang even before the pandemic. Overhang means that new properties remain unsold after nine months. As a result, there is a surplus of property, thus driving both prices and profitability down. It is only recently that the property overhang situation has begun to improve, but the numbers remain high.
Liquid assets are things that can be converted into cash rather quickly and easily. These include things such as gold, silver, and stocks. On the other hand, property is considered a non-liquid asset due to the fact that it can take an uncertain amount of time to secure a buyer or tenant. Even then, regular cash flow is not guaranteed. This means that once you have invested in a property, you are more or less committed to it; even if it takes years before you see a decent profit.
Understand the risks before investing
For those who wish to begin investing in real estate, it is prudent to understand all the risks involved. There is no way to completely eliminate all the risks, but when done correctly, the risks can be mitigated and some can be avoided altogether.