While property is one of the safest assets you can invest in, it’s not without risks. Your job is to minimise it if you can’t eliminate it altogether. To help you avoid losing money and maximise your property profits, Property Market Insider spoke to creator of DSRdata.com.au Jeremy Sheppard for his time-tested and proven strategies.
The easiest ways to lose money investing in real estate
There are a number of ways to lose money when investing in property. Here are some of the ways you could get yourself in trouble very quickly.
- Choosing poor growth locations
- Selling too soon
- Failing to accurately forecast income vs. expenses
- Embarking on a bad project or completing it poorly
The typical scenario goes like this:
- An investor buys in a bad growth location
- There are more expenses than they anticipated
- They grow impatient accruing losses each year
- So they decide to sell before any growth happens
- But they renovate first spending $20,000 which adds only $15,000
- Sometimes it’s a good idea to sell and cut your losses, especially if you’re holding a heavy cash-flow killer or if you’ve picked a terrible growth location.
But other times, a little patience might make all the difference. You’re less likely to second-guess your decision if you get some good growth early on.
How to avoid losing money when you invest in property
There are plenty more mistakes to make. I’ve made heaps. But I pride myself on not making the same mistake more than about 3 or 4 times, 5 tops – OK call it half a dozen. Going forward I plan to only make new mistakes.
Here’s a list of some lessons I’ve learnt that might help you.
1. Try not to sell
As a general rule, buy and don’t sell. This reduces your capital gains tax liability and gives the most time for compound growth to do its thing.
However, keep your eye on markets you have bought in. If it is a regional market or a unit market, be prepared to sell if oversupply becomes a problem.
I bought three houses in one regional centre in QLD in 2004. They doubled in value in about three years. I refinanced to put the equity to good use elsewhere. But then there was a correction in the market, and I ended up with negative equity. I should’ve sold.
Regional and unit markets can offer great short-term flings but are not good long term options. City and house markets are generally better long term choices.
2. Research the tenant
If you buy a property from a landlord, don’t forget to research their current tenant. My first property came with a nightmare tenant. The owner was self-managing so they didn’t have access to a professional property manager’s blacklist database.
The tenant never paid a cent in rent, and it took more than 6 months to get them evicted. They were so disgruntled about being evicted for not paying rent, that they blocked all the drains and left the taps running causing over $10,000 worth of damage.
3. Show no mercy to late paying tenants
You may like to show some leniency to tenants who have fallen on hard times. Perhaps you’re a nice person. But your insurer is not. It may not be your choice to allow the tenant some more time, that decision may invalidate your insurance policy.
4. Don’t buy in markets you can’t get data for
If you can’t get sufficient data on a market, steer clear of it. Ignorance is a risk, you need to know, not guess.
I did some research on a town in New Zealand in 2006. It was hard getting all the right data, and I took an awful risk buying six houses in the one town. Luckily I was right, and prices doubled in a little over two and a half years.
But keeping an eye on that market was very difficult. I got lazy and assumed growth was simply trickling along. I asked my agent for a market appraisal years later and was alarmed to see how far prices had fallen back from their last high.
Access to good data on a regular basis would have made it easy to keep an eye on that market and make the right decisions at the right time. If I saw vacancies rising, I could ask the tenant to extend the lease well before expiry and for a much longer extension.
5. Leave sufficient cash reserves
Have about 2% of the value of the property available in reserve. This is to take care of unexpected costs. Some of these might be repairs and maintenance or rising interest rates.
I’ve had to ask the property manager to inform the tenant that a particular fix-up couldn’t be done just now. And it was simply because of a bad cash-flow moment I had. This coincided with the end of the tenant’s lease.
6. Don’t cross-collateralise
Cross collateralisation is where you offer multiple properties to the lender as security for the one loan. It’s a bad idea. If things go pear-shaped with finances or properties, you want choices of how to respond. Don’t give that choice to the bank.
Instead, to buy another property, get a “top-up” on the loan for the property that has the equity. Then get a second loan for the new property, possibly even get a second lender. Use the “top-up” from the first loan as the deposit for the second purchase. A good mortgage broker can go through all this with you.
7. Limit non-bank borrowing
The third tier, non-bank lenders may give you a better deal up front. But in times of trouble, like the GFC, you want a mainstream lender that will react predictably to the climate. Don’t wait for trouble to refinance. Once you’re in troubled times, refinancing is difficult.
During the GFC one of my non-bank lenders raised their interest rate to 11.5%. It was a 90% LVR. The property was owned in the name of a trust, and I was self-employed at the time. None of the mainstream banks wanted to touch it. I was almost forced to sell but toughed it out to better times.
8. Joint venture with a plan to exit
Don’t get into a joint venture without a clear written agreement between parties. And make sure the agreement has an exit, say within 5 years. Things change, people change – nothing lasts forever. Plan to exit. Only if things haven’t changed should there be an option to continue the arrangement, if both parties agree.
9. Avoid oversupply
The biggest killer to capital growth is supply. Every new property is a thorn in the side of capital growth. Developers are the enemy of investors. Avoid markets with oversupply or the potential for it.
Source: Nila Sweeney