How to minimise your property investment risk
This month Ian Hosking Richards addresses those niggly feelings that many beginner investors have - how do I balance that fine line between risk and reward? Like any form of investing, it entails some form of risk. How you manage this for the best outcome comes down to a few key decisions - and playing the long game.
Many investors would understandably prefer investments that offer high yields, but given the correlation between yield and risk, a balanced approach is necessary, in order to ensure that the investor does not make any costly mistakes. So, how can investors stay within their risk profile yet still use property as the main vehicle to create their future wealth?
The larger the population, the lower the risk. It's that simple.
Large populations tend to have more employment and more diversity of employment. They will generate more infrastructure projects, which in turn drives employment. One feeds off the other. So it should come as no surprise that the two biggest population centres, Sydney and Melbourne, are the most expensive, and have also recorded the most robust growth in recent years.
Whilst we see comparatively lower risk in bigger populations, that does not necessarily mean that these cities will grow indefinitely in a linear fashion. Take Sydney for example. Between 2003 and 2009 the market was quite subdued, and capital growth was minimal. However, if an investor has exposure to, say, Sydney, Melbourne, Brisbane, as well as a major regional centre such as the Sunshine Coast or Townsville, they should not be too badly affected by volatility in any one individual market.
By buying diversely, you are spreading your risk across the property cycles. When one is down, another will be up. It will then flip again over the next 5 to 10 years. Geographical diversity on a buy-and-hold strategy minimises the risk in long-term investing.
Unfortunately, some of these ‘safe havens’ are already unaffordable with miserable returns. It doesn’t really matter how good the investment is if you can’t afford to buy and own it. In parts of Sydney you are lucky to get 2.5% gross yield, and Melbourne historically has also not been that flash. So, what to do?
The answer is to pay close attention to property cycles. When cities enter a robust growth phase, rental increases often lag. A particular property may be worth $600,000 and rent out for $500 per week. Over a couple of years, the capital value grows to $800,000, yet the rent has scarcely moved. To get the best return, investors need to be able to identify and buy at the beginning of a growth cycle, not at the peak. In Sydney, the time to buy was back in 2010, not in the last couple of years.
If you are thinking of getting exposure to the Sydney property market it will be necessary to bide your time for a while until you can spot some value again.
good yield/good growth
High yield AND high growth - is it achievable? Yes, I think that it can be.
One way to generate high returns in a low risk environment is to buy a dual income property. That is, two properties on one title, or one block of land. Generally, much higher than average yields can be achieved using this strategy, and providing that you know what you are doing and really do your research, this can contribute to improved cashflow and even cross-subsidize properties with much lower yields. Nevertheless, this may not be in everyone's affordability bracket. If you have a bigger budget, then the reward on dual income properties are great.
Another way to achieve this affordably is to focus on location and timing - get in before the peak. Take a look at some properties in South East Brisbane and you'll quickly see a price difference. South East Queensland currently hits the affordability mark as it's right there before the high upswing on the property cycle and is already on a high population and employment growth trajectory.
It is important to understand your risk profile and make investment choices that reflect this. Investing in geographically diverse locations can balance out the risk of holding individual properties when future performance is not entirely predictable, and dual income properties can make it easier to cashflow a growing portfolio.