Opportunity cost and nine other risks first time property investors must overcome
There are risks at every point on the property journey, from the initial decision to invest, to selecting, financing and renting.
Unfortunately novice investors often fail to recognise these risks or understand the need to manage them effectively. That is one of the key reasons so many investors sell within a year – often at a loss.
To maximise your chances of a successful investment, there are a number of risks both novice and experienced investors need to take into account:
- Opportunity cost. Property investment can be financially rewarding but it is usually negatively geared, at least in the beginning, which reduces your opportunity to invest elsewhere.
- Overconfidence. Successful property investing requires an ongoing commitment to learning, research, patience and planning (a little bit of luck also helps). Property management is also not as easy as it sounds, and investors who attempt to do their own tenant selection and management need to be careful not to stray outside the law.
- Fear. Spending hundreds of thousands of dollars on a single asset is scary. Sometimes it seems “safest” to buy near your home – even if the area is not a good choice for investing. Research is vital but fear can also lead to “analysis paralysis”. If you never take the plunge, you’ll never profit.
- Naivety. There are plenty of property spruikers who take advantage of the unwary. Do your own research – don’t just rely on your accountant, financial planner or mentor’s opinion.
- Failure to plan. Things change. You need to go through the major “what ifs” to avoid a situation where you may be forced to sell. What if you have a child? What if interest rates rise? What if you can’t find a tenant for several months? What if your tenant absconds or, accidentally or deliberately, damages your property? What if you need a new car?
- Over-ambition. Banks sometimes lend more money than investors can comfortably repay, particularly if personal circumstances change. Property investors should think about a safety net – access to a cash buffer to shield them in case of unemployment; income protection insurance in case of injury; buildings and contents insurance; and landlord insurance.
- Lack of a coherent strategy. In order to choose the correct investment property for you, you need to know what you’re hoping to achieve. Even well-respected property commentators and authors use very different approaches, so it’s important choose a strategy which suits you.
- Getting side-tracked. Buying for negative gearing or depreciation benefits alone is a bad idea – the aim of the game is to make money long-term, while managing the risks to ensure you are never a forced seller.
- Impatience. Property is a long-term investment. Your property may grow at an uneven pace, including years when its value remains static or even goes backwards.
- Herd instinct. Buying with the herd, when property prices are reaching records, can expose you to several years of sub-par financial performance. In the words of legendary investor Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful”.