Is Residential Property Really an Investment Risk?
Think about it. Of all the things that could be an investment risk, residential property has to rate fairly low on the scare metre. Especially if you let the numbers of a proposed purchase do the talking instead of the colour of the kitchen.
Would it not be fair to say that by not investing you actually partake in about the riskiest thing you could do for yourself. Especially if any sort of financial comfort is your goal in retirement.
CAUTION: To also leave your future in somebody else’s hands is almost as dangerous.
As an investor you will always carry a degree of investment risk however, this can be perceived or real due mainly to a little or lack of knowledge. Recognise this and give yourself time to digest and understand information that takes you outside of your comfort zone. Recognise also that your experience of investment risk tends to lead you to be over cautious when making your first investment.
However your evaluation of investment risk and your confidence will expand with experience.
Understand at the outset that:
• Investment Risk is INCREASED with incorrect information
• Investment Risk is REDUCED with CORRECT information.
Look at what is perceived to be a risk and evaluate it to see if it is real to you. This requires a healthy dose of common logic, lack of emotion and accurate research! I will touch on some common investment risks perceived or real.
There is no way around this one. However, debt when used for investment is fantastic. It is the magic of doing more with less or working smarter not harder. Think about the statement from Always Noze’s son Geoffrey and Mary Hasdone’s daughter Jessica.
Geoffrey says “My dad is so poor he owes the bank $2,000!”
Jessica says “My mum is so rich she owes the bank $2 million!”
Geoffrey’s dad, unfortunately, has consumer debt that is a depreciating asset and is a liability that he alone has to pay for. Jessica’s mum has investment debt that is an appreciating asset to her and funded principally by other people. Jessica’s mum has learnt the valuable difference between the two.
If you owe money on a positive capital-appreciating investment that is mainly funded by the tenant and taxman, then you are making money out of debt.
More accurately, you are building wealth using other people’s money. It can seem quite ridiculous that owing money measured in the 100s of 1000s, can make you wealthy and put cash in your pocket. Get over it, because it is costing you money if you don’t understand this!
The choice of fixed interest for a period or variable interest will depend on your cash input and your knowledge of and comfort with investment risk. At planning stage consider your worst-case scenario of interest rates and use this rate in your calculations.
Should interest rates remain below this projection, you will be comfortable. If you want the best interest rate, then the interest-only variable rates will generally be the lowest.
Remember, variable rates are variable. If you want security, with a repayment that remains fixed, maybe elect for the five-year interest only fixed rate. This may also be easier for you to budget accurately.
A “cocktail loan” or “split loan” will give you a bet each way. 50% of the loan will receive the best interest rate and 50% of the loan will give you the security of a fixed rate. These percentages can be varied in mix. Choose what you are comfortable with.
Ideally, investment property loans should be interest only because:
An I.O loan is a smart wealth building catalyst.
An “Interest Only” investment loan is FULLY tax-deductible.
It is the best cash flow solution when used with good capital growth.
Possible loss of income
Eventual loss of earned income is perhaps the very reason that you should consider investing in the first place. It should be the intention of every investment to eventually pay you a net dividend whether you work or not. The sooner this is achieved of course the better.
The question of being injured and not being able to work is not relevant to you owning investment property, but the answer is the same for both. Carry the appropriate insurance!
Insurance is like petrol to a car. You must have it! Insurance is a tax-deductible tool that covers a measurable risk with investment.
Some of the insurances that should be considered are:
c)Malicious damage/theft by tenants
d)Legal expenses for point c) above
e)Loss of rent
i)Loss of income/sickness and accident
Most are necessary, prudent and cost effective.
Property damage by tenant
A good property manager will reduce this investment risk substantially. However, costs for damage of a minor nature can be recovered from the bond money held in trust. Most other shortfalls should be covered by insurance.
The positive view of this inconvenience, should it be a wall requiring a repaint for example, is that you end up with a fresh new paint job that will be most attractive to new tenants. If it is an item of furniture, this replacement becomes a tax-deductible depreciating item. At the end of the day, you must have tenants and they are a necessary and to a large extent totally manageable risk that drives your investment.
Property maintenance interstate
Once again, a good property manager will manage this sometimes over emphasised risk. Whether you have a water heater blow interstate or just around the corner, the solution is to have your managing agent handle the situation. You really are effectively building your own business, so run it like a business.
Have professionals do what professionals do best.
This certainly keeps the emotion out of doing business with your tenants, here or interstate! Consider professionals for tenant selection, inspection reports and organising a plumber for your water heater. The list goes on...
Thinking small is A BIG RISK. Many readers have heard it and unfortunately it has been said by respected investment advisers: “Your home will be the largest investment you will make”. I am here to tell you that as an investor it won’t be!
We have all heard about the “mum and dad” investors in the share market because of the smaller amounts that can be invested. Those same “mums and dads” can also be property investors with larger borrowings and leveraged returns. You now know the requirements and some possibilities.
Don’t let anyone, including your financial advisor try to tell you any differently! They are obviously not a “do as I want to do type of person.
Thinking small is one of the biggest risks you can have in your retirement planning
The solution is to realise the consequences of not investing and to learn more.
We are all at risk of an audit of any type from the government. While this might sound daunting and even threatening, it really is quite simple to do what is required. When you purchase investment property, you must keep records of virtually everything.
Records for tax return purposes relating to rental property of both income and expenses should be kept for a period of five years from the date you lodge your tax return.
Records for Capital Gains tax purposes should be kept if you purchase or inherit receive as gift or divorce settlement or make improvements to a property. If this property is sold then these records must be kept for a further five years after disposal.
The records should document in English:
The date you acquired the asset
The date you disposed of the asset and anything you received in exchange
Any amount that would form part of the cost base of an asset and the applicable date that this value was effective.
NOTE: It would appear that government audits sometimes reveal people making dubious claims in an effort to reduce their taxes. You will find that sticking to the rules of property investment will give you ample deductions to do this perfectly legally.
So now you know:
You should deal with do as I do people, not do as I say people
To target your property purchase starting with the big picture first
Buying blind is an unacceptable risk
Risk is reduced with more knowledge
Investment debt is good
You must have insurance
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