The work ‘risk’ conjures up a different beast in the mind of every investor.
If you are a speculator, you might tremble at the thought of it. If you are an opportunist, you might redefine ‘risk’ as ‘volatility’ and jump straight into it. If you are a veteran, you have probably developed emotional immunity to it over the years.
No matter what your attitude or philosophy is towards risk, as property investors we all recognise that it is an unavoidable part of the game and that it is our job to find creative ways to minimise downside risk and maximise upside potential.
Here are 10 practical ways you can guard your portfolio against various risks:
- Buying Well
There is a saying in the property investment community that says “You make your money when you buy, not when you sell”. A little foresight will reveal that some of the biggest risks for a property investment include 1. Not being able to rent or sell when you want 2. Not receiving enough rental income to cover financing costs 3. Physical threats to the property such as flooding or structural issues, just to name a few. By setting predetermined heuristics and processes for conducting due diligence on your investment and sticking to them no matter what, you have eliminated most of the risk by simply filtering opportunities and notbuying overly risky properties.
2. Buying at a Discount
This ties into the concept of “Buying Well”, but it is so important that it deserves a spot of its own. Negotiation is a core skill in any property investor’s toolbox, and one that needs constant practice and sharpening. Good investors know that there are often factors outside of the price such as the speed of the transaction or creative financing terms that can be offered in exchange for a fair discount. By identifying and solving the seller’s problems, the investor secures an ‘equity cushion’ against market fluctuations. If you purchase a £100,000 property at a 20% discount, you’re not too worried if the market drops by 10%.
3. Adding Value
By renovating and/or converting the usage of the property and adding value to it in the eyes of the bank or the buyer, the investor reduces risk by increasing the ‘equity cushion’ previously mentioned. Generally speaking, the more equity you have in the property, the less risk you have. A simple analogy to illustrate this point is to imagine a large block of marble. By itself, it might cost £1,000, which I borrow from my friend. Let’s say I hire a sculptor and pay him £500 out-of-pocket to turn it into a beautiful work of art worth £3,000. I now have an equity position of £2,000. Even if the art market stumbles by 30% and the sculpture is now only worth £2,100 – again – I’m not too worried. My equity cushion absorbs the hit, and simply shrinks down to £1,100.
4. Cash Flow
Cash flow is the name of the game for many property investors looking to build personal wealth and financial freedom. By buying well at a discount and adding a lot of value to the property, you can make sure that the rental income you receive from the investment surpasses the total mortgage payments and management expenses, providing you with passive income month after month. If your investment positioned correctly in the rental market and provides you with steady cash flow, you don’t have to be too concerned with the risk of the market fluctuations. You simply hold on to the asset over the long-term and sell when it makes sense to you, if you wish to sell at all.
5. Responsible Leverage
Leverage is the double-edged sword in every investor’s toolbox. Used correctly, it can accelerate your acquisitions, increase your ROI and build wealth. If on the other hand you over-leverage and get caught at the wrong end of the market, it can wipe you out and destroy your credit and confidence. My personal opinion is that the risk of leaving some money on the table in the short-term is preferred over the risk of over-leveraging and potentially permanently cutting your investment career short. To remove excessive credit exposure and de-risk your portfolio, keep your debt-to-equity ratio at manageable levels.
6. Cash Cushion
Most property investors have a love-hate relationship with cash. They love having it, (who doesn’t?) but at the same time they get antsy if they’re holding too much of it and always look for properties to put it in. One of the drawbacks to property is that it is not as liquid as other assets. Holding at least 10-15% of your portfolio’s value in cash can come very handy if interest rates are rising and you find yourself with more debt to service than you would like. Instead of being forced to fire-sell some of your properties, you can simply use the cash you’ve been holding to pay down some debt and buy yourself peace of mind.
7. Good Property Management
At the end of the day, property is a people business. A piece of land or a building is worth nothing if it can’t be used to bring some form of utility for someone who is willing to pay for that space. Not having the right property management systems in place can expose you to the risk of your property falling into negligence and suddenly having a very expensive problem to fix on your hands. Making sure that expectations are aligned with the tenants and there is a good communication and management system in place can save you a lot of money.
This one is very obvious so I’ll keep it very short, but it definitely deserves a spot on the list. There is no excuse for not having the right insurance policies to cover yourself for unfortunate potentialities.
9. Professional Team
Investing is a team sport. No matter how brilliant, a single investor simply cannot do everything that is required to build and maintain a successful real estate portfolio. It’s necessary to continue to invest in networking and finding the best professional team to give you the support that you need. Having the support of great agents, solicitors, accountants, insurance brokers, builders and other professionals can protect you against risks you may not even know that you were exposed to.
10. Continuous Self-Development and Portfolio Management
Being a successful real estate investor is not something that happens overnight. The industry is always changing, and new challenges, opportunities and trends always present themselves. New policies and regulations are introduced. Demographics shift and either bring demand to you or away from you. Central banks toy with the interest rate and the lending climate shifts. One of the best way for an investor to reduce risk is to continuously invest in their own education and monitor these changes to avoid being blindsided.
I hope this gave you some ideas to protect your portfolio from the various risks of property investing. Risk is an unavoidable part of investing, but if framed the right way it is also the thing that provides the opportunities and makes your investment journey exciting!
To quote the Zuck:
The biggest risk is not taking any risk… In a world that is changing really quickly, the only strategy that is guaranteed to fail is not taking risks – Mark Zuckerberg