Risks of investing?

April 8, 2012

Someone asked me the other day – ok Alan, if I should be looking at about 15% return plus capital growth, there MUST be some risk involved there. What are those risks?

So I thought I’d share my thoughts on this with you.

1. Management
Good management is the overriding factor in making the difference between a successful investment and a bad one. Having bad or ineffective management of the property leads to the downward spiral of the house falling into bad repair, leading to lower quality tenants (good tenants wouldn’t want a run down house) and often ends up with an empty unlettable house and a large renovation bill. Always mitigate this risk and use a reputable recommended management company.

2. Condition
When you buy the house, unless you’re a handyman and live locally, always try to get something recently renovated. This gives you a headache free income, and fewer headaches for the tenants. Key things to look at are the roof, and the boiler/heating/water system.

3. Tenant quality
Tenant quality has a lot to do with what you buy and where, but it pays to try to avoid bad tenants. Having good management and a house in good condition will give the agents a wider range of choices re tenants and lessen the risk that your tenants will be non-payers/messy/causing damage. If you are concerned about the quality of an existing tenant, it is possible to take out insurance to mitigate risks like tenant vandalism and even non-payment.

4. Location
The location of where you buy is a big risk factor in your investment. Of course the cheaper the house and higher the yield, in theory this should mean the riskier the location. Stick to cities with positive economic dynamics, and avoid the very worst areas unless you plan to buy every house in that neighbourhood. Look for locations near to the usual nodes like transport and employment centres, and also nearby to more upscale areas, to win from possible gentrification, and improvement in tenant quality that comes from this. In Hackney, London for example my tenants changed in ten years from being mainly DHSS (government welfare funded) tenants to upwardly mobile professional people, as the transport improved and the area gentrified.

5. Legals
I’ve seen situations before where a buyer uses the cheapest lawyer, or none at all in a transaction. While it may work out quite ok, its often worthwhile trying to simply find a reliable and efficient one, who you know has made all contracts correctly. Strange although it may seem, I’ve seen situations where the buyers lawyer forgot to check the water bills were paid, and after closing the new buyer was obliged to pay the back bill of several hundred dollars! In short, use a lawyer, and preferably one recommended by someone you trust.

I have just outlined the main technical risks that will be in your control that you will be taking when investing in real estate. As you can see there are numerous ways of mitigating those. I always recommend a good attorney, and a good management team who I’ve used for years positively. There are also however many risks that are out of your control – Political risk, currency risk, and also ‘black swans’ connected to those – what if Canada attacks USA? Well I wouldn’t worry too much on that…

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