Risk is what you make it when you invest in property
Once you have decided on your lifestyle goals, the return on investment you need to achieve them, and your risk profile, you’ll be in a much better place to decide how property investment can help you achieve your ambitions. This was the theme of my last article in this series helping you decide your investment goals. If you haven’t read that article yet, hop over to aligning your goals, ROI, and risk when you invest in property.
In this article, you’ll gain a deeper understanding of investment risk, with an introduction to how you can reduce risk when you invest in property.
What is investment risk?
Risk boils down to a single word: uncertainty. There is no certainty that any investment will perform as you anticipate. It may not rise in value as much as you forecast, or provide the income you expect.
Three key risk factors when you invest
There are three key risks when you invest in any asset:
1. Risk/return trade-off
Generally, the lower the risk the lower the return, and the higher the risk the higher the potential return.
For example, cash in a savings account is considered to be zero risks (it’s not, but that is a conversation for another day). For this risk-free vehicle, you get paid a paltry interest rate. Over a long period of time, your savings will lose value, because the return on them won’t match or beat inflation.
At the other end of the scale, if you had invested £100 in Bitcoin in late 2014, your investment would have been worth around £5,000 in January 2018. But if you had invested £5,000 in 2018, only four months later it would have been worth just £2,100.
The greater your risk tolerance, the greater your potential return… and the greater your potential loss.
2. Time/risk trade-off
Usually, the longer you remain invested, the more likely it is that your investment asset will perform as expected. This is because prices fluctuate daily, while value doesn’t.
This means that the longer your timeline of investment, the more risk you could take to achieve your investment goals. Something you may have heard of is lifestyle investment funds. These work on the premise that as you approach retirement, your capacity and tolerance to risk reduce because you are less able to afford to suffer short-term losses which could push your retirement plans back.
Think of stock market crashes (of which there have been plenty). Or the Global Financial Crisis, which caused property prices to fall. Some property investors I know we're looking down both barrels when house prices collapsed. Those that were able to ride out the downturn are now worth many times what they had been before property prices declined in 2008/9. Long term, those investments have paid handsomely.
3. Asset-specific risks
Lastly, there are asset-specific risks. For example, when you invest in shares, you take on board risks associated with the industry in which the company trades, the geography where it trades, the ability of its management, its costs of borrowing, etc.
Property-specific risks and how to mitigate them
The risks that are specific to a property are:
· Location risk
The risk that where you invest will fall out of favour, and that property prices and rents will therefore fall.
You reduce this risk by investing where the property fundamentals are strongest and most promising – in close proximity to shops, schools, transport links, major employers, and major investment. Avoid areas that are reliant on a single industry, and think also about the local economy and demographics, such as population growth and age.
· Liquidity risk
This is the risk that you won’t be able to sell your property quickly if you need to. You never can be sure of what curveballs life will throw at you. A crisis may occur which means you must sell your property to raise cash. You may have to accept a knockdown price to sell quickly.
Mitigation of this risk is not difficult. Simply keep an ample amount as a cash reserve as a cushion against the unexpected.
· Market risk
This is the most difficult risk to mitigate. Markets can reverse quickly. Of course, if you have done your research and bought in the best places to invest in property UK, this market risk will be reduced. Also, because of the nature of market falls (usually sharp and short-lived), the longer the timeframe of your investment the less likely you are to suffer a lasting negative effect.
· Property and tenant risk
Tenants and properties both pose risks.
Get a bad tenant, and you could suffer property damage, refusal to pay rent, and difficulty in evicting. Actually, this is less of a problem than newspaper headlines and sensationalist television programmes would have you believe. The trick is to ensure that you comprehensively vet applicants and maintain a good relationship with them.
Property risk is most acute with older properties. They need more maintenance, and structural issues are more likely. Buy newer, better-built properties and much of this risk falls away.
· Cash flow risk
Finally, there is cash flow risk. Even a property that is cash flow positive can turn negative if you don’t plan your cash flow effectively. Three things to do to ensure you don’t suffer cash flow problems are:
- Keep an eye on costs
- Maintain an adequate cash reserve
- Get close to a good mortgage broker to ensure you always have the best mortgage rate
In the first of this series, you learned how property differs from other investments because of the control you have over it. This control extends to mitigation of risk. With property, you can have your investment cake and eat it – but to do so you must plan ahead, and this includes employing strategies to reduce risk while maintaining profit potential.
In my next article in this series, I’ll examine more closely the question of whether your investment objectives are achievable. In the meantime, if you’d like to discuss your lifestyle goals and how property investment could help you achieve them, book a property investment strategy consultation by contacting Gladfish today on +44 207 923 6100.
Live with passion and fun,