Here’s some cold hard facts and risks about buying an investment property that no-one will tell you.
Your bank won’t tell you, because they want you to borrow regardless of the risks.
The real estate agent won’t tell you, because they want you to buy despite the risks.
Your mum or dad won’t tell you because…. well…. they might not know themselves.
And you won’t let yourself believe it, because buying a property is widely considered an Australian Citizen’s greatest achievement.
But today, I’m going to play devil’s advocate and explain to you the deadly risks of sinking your hard-earned cash into the property market.
So what’s the reason why you want to buy an investment property?
Do you want to buy an investment property as an investment to make money?
Do you want to buy an investment property to get into the property market and possibly have it as your own home one day?
Do you want to buy an investment property to ‘build equity’, so you can borrow and invest more in the future?
Whatever your reason, give me a couple of minutes to explain to you the 7 things to consider before taking the plunge
RISKS OF INVESTMENT PROPERTIES
1. You’re behind before you even begin
Alright, so how much do you want to spend on a property?
Shall we go with that figure for now?
So, to buy a $400,000 investment property, you will need to pay the following costs (figures are approximate):
- Building and Pest Inspection – $400
- Legal Costs/Conveyancing – $1,500
- Bank Loan Establishment – $500
- Stamp Duty
- NSW: $14,000
- ACT: $10,000
- NT: $17,000
- QLD: $13,000
- SA: $19,000
- TAS: $14,000
- VIC: $20,000
- WA $13,000
Also, let’s say you only put down a deposit of, say 5-10% ($20,000 – $40,000) of the value of the home (after paying for all of the costs above), then you will likely also need to pay Lenders Mortgage Insurance (LMI)
- Lenders Mortgage Insurance – $10,000 (approx.)
Do you know how much these initial costs add up to?
Depending on where you buy and the deposit you have, your upfront costs could amount to a whopping $37,000! That’s just to get your foot in the door and cover some maintenance over the first 6 months.
This means that your property needs to increase in value by about 10% just to get you back to where you started.
Do you know what the average annual increase in property in Australia is?
It’s about 7% each year.
2. Pray for a Tenant (and a good one at that)
The next step is generally to find a tenant. A good one.
You want someone renting the joint don’t you?
You also need to decide whether you are going to manage your investment property yourself, or have it professionally managed by a real estate agency.
If you’re going to get it professionally managed, it’ll cost you around 5 – 10% of the rent being received. So, if rent on our $400,000 property is, say, $400 per week; then agent fees will be $20 – $40 per week. Also, many agencies will also take the full first weeks’ rent, because that’s where the hard work for them is.
If it was me, I’d have an agency managing my property in a heartbeat, because tenants can be a nightmare and I’m not very handy (…our creator gave me two left hands). But if you’re the type of person who is happy to go around and fix things that are broken, willing to take tenant phone calls, do routine inspections, organise rental agreements, and do all the marketing to find new tenants, then go for it. The money you save on agency costs will be very beneficial for your household budget.
But the biggest risk here is trying to find a good tenant, because tenants have a lot of rights when living in your property. It doesn’t take much for a tenant to be difficult and you will need to ensure you are always providing suitable living standards for them as their landlord. This can get costly if things need to be fixed to meet standards.
Be sure that you are familiar with your tenancy agreement.
While a pain-in-the-backside tenant is a risk, having no tenant at all is a bigger risk.
Have you noticed everywhere we drive lately we see more and more housing estates being constructed?. This could create an oversupply of housing.
Who would pay your investment loan if there was no one renting your property?
What about in-between tenants. How many weeks would you be able to continue paying your loan (not to mention all other costs) during the period between someone moving out and another tenant moving in?
Every day that your property remains untenanted is another day that your investment is not making you money. And you costs will piling up.
Speaking of costs….
3. Ongoing Costs
Owing an investment property means the privilege of getting to pay a number of costs throughout the year.
Each of these costs detracts from the return that your investment provides you.
Here is what you should expect to pay throughout the year if you were to own a $400,000 investment property with a $320,000 loan.
Interest on loan (assumed 5% p.a.) = $16,000
Council and Water Rates = $2,000
Insurances = $1,000
Maintenance = $3,000
Total = $22,000
So, if you were renting this property out for $400 per week, and agency fees were 5-10% (lets meet in the middle and say 7.5% – $30 per week), then you would receive $370 in your bank account each week, or $19,240 p.a.
But, if were to assume that you did not receive rent for 3 weeks of the year, due to it either being untenanted for a few weeks or the rental agency taking your first weeks’ rent as a fee, then this annual rent figure would reduce to $18,130 p.a
In this instance, you are receiving $18,130 p.a. and paying $22,000 for the privilege. You are going backwards by $3,870 each year!
4. But doesn’t property always go up?
Over the long-term property does, in most cases, increase in value. This is the second type of return that an investment property provides – with rental income being the first.
In the example above, our income return is negative $3,870 p.a.
But what’s our capital growth return (property prices increasing)?
Over the past 30 or so years, property prices in Australia have increased by approximately 7% p.a. each year. However, this is very general, because it depends on where you buy and how much you pay for the property.
You can use the 7% p.a. figure as a guide, but you should never think your investment property is guaranteed to increase by 7% p.a.
Even if the real estate agent is telling you that the area you are looking to buy in is READY TO BOOM, because shopping centres are being built, schools, hospitals, transport, blah, blah, blah.
Maybe they will be right. But for the most part, it’s bullsh*t talk to get you to buy.
Real estate agents have one job. They need to sell that house for as high a price as possible.
They are working for 2 things:
- The person who currently owns the property; and
- Commission (a fee they receive from the seller)
Let’s make this clear. No matter how ‘friendly’ or ‘helpful’ they are – they do not work for you.
They will do whatever they can to get you to pay as much as possible for the house they are trying to sell, so that their client is happy and so their pockets are happy.
They are experts at this.
But don’t be offended.
They are not bad people.
This is just their job. This is how they earn money. And they are doing what they are legally obliged to do, which is represent the existing owner of the property.
It’s nothing against you personally.
One day you will be on the other side of the fence, trying to sell your property, and you will be glad to have one of these experts in there batting for you.
Anyway, where were we?
Oh, property going up, that’s right.
Now, while property did go up, on average, by 7% p.a. over the past 30 years or so, you need to consider something – during the 80s housing prices grew by almost 10% p.a.; in the 90s it was around 7%; and more recently has been 5% – so different periods of time produce different levels of returns.
5. Are you really going to put all your eggs in one basket?
This is a very important factor.
Buying an investment property is pretty much the biggest investment you will ever make.
By now I’m sure you’ve heard the saying “don’t put all your eggs into one basket”
Yet, despite this, you are still considering putting all of your savings into one property, which sits on one street, in one suburb, in one town.
So, yep, it’s confirmed, you’re putting all of your eggs into one basket.
And, not only are you going to put all of your eggs into one basket, but you’re going to borrow a few hundred grand from the bank so you can put all of your eggs, plus the banks eggs (which you are ultimately responsible for), into the same basket.
I’m not gonna lie, like I’ve said above, property prices generally increase in value.
But what if you got unlucky?
What if the area you bought in began having an unusually high number of sink-holes appear after you bought? Do you think people want to rent from you or buy your home?
What if shark attacks became rampant at the local beach of the suburb you bought in? Would that do well for the price of your property?
What if, after you bought, research found that the soil in the suburb you bought in was contaminated, or the government decided to build a power-plant up the road? Who would want to live there then?
One of these events, and many more like them, might be a less than 1% chance of happening. But what if you were that 1%? This could put you back a decade in savings, or even send you bankrupt.
Believe me, I’ve seen it happen.
This is why they say ‘don’t put all your eggs into one basket’, because any one investment can perform very poorly for whatever reason. There are so many factors that influence the return, or lack thereof, that your investment provides for you.
6. Lack of Liquidity
If you’ve built up savings of, say $80,000 in your bank account, and all of a sudden you need $7,000 for whatever reason – maybe you want to buy a new car, or go on a holiday, or lend money to a friend, or cover the cost of a surgery; then you could simply draw this money out of your bank account and pay for it.
However, had you used this $80,000 as a deposit for a $400,000 investment property, and 6 months down the track realised that you need access to $7,000; then what do you do?
You can’t take the kitchen out of the house and sell it on Gumtree to raise $7,000.
You also can’t cut out 9sq metres out of the back yard and sell that to someone for $7,000.
This is why property is referred to as ‘illiquid’. You cannot sell part of your investment AND if you were to ever sell the whole property, you would need to usually wait 3-6 months for settlement, plus pay a real estate agent about $10,000 in fees.
Compare this to investing in shares, for example.
If you owned $400,000 worth of shares and you needed access to $7,000 in a hurry, you could quite easily sell $7,000 worth of your shares and have this money in 4 days. Better yet, it would cost about $20 to sell the shares through an online account.
This is the difference between ‘liquid’ and ‘illiquid’ investments.
But shares are risky, aren’t they?
Well, that’s for another article. Remind me to write one about shares if I forget.
7. Property is a long-term game
When considering buying property, you need to be thinking long-term.
Your mindset needs to be that you are not going to sell this property for at least 7 years. Well, most people say 7, I’m more conservative and prefer 10 years.
This doesn’t mean that you can’t sell it after 2 years if things have gone well, or if you need the money for something else, but your intention, upon buying the property, needs to be longer-term.
Well, property (and shares) are cyclical investments. The value of properties can be volatile and will fluctuate from week-to-week.
Because of the cyclical nature, you can’t always be completely sure what stage of the cycle you are buying in. But generally, after 7-10 years the ups and the downs have been ironed out, and it is probable (not guaranteed) that your property will increase in value.
Remember though, it all comes down how much you paid for it in the first place and how the area you bought in has performed.
If you can’t look yourself in the eye and say “Once I buy this property, I plan on not selling it for at least 7 years”, then don’t buy it in the first place.
You need to be willing to do this.
Even if the real estate agent “guarantees” that the property has potential and will double in value within 3 years!
Let me know your thoughts … do you invest in property? What are some other risks of buying an investment property that you have encountered?
Author: Chris Strano
After playing a vital role in the creation of his two sons, Chris Strano gave up his former-life as a financial adviser to dedicate his time to providing everyday families with basic money management advice. Drawing on his years of education and experience, he has also developed an affordable 100% digital course showing young families how to build their own custom household budget and savings plan to work towards their goals, using financial planning strategies (without the cost of a financial adviser). You too can get started by grabbing his free 6-Step Budget Cheat Sheet at Build A Family Budget and follow him on Facebook and Instagram @SmartFamilyBudget.