6 ways to mitigate risk in a sellers' market

I am often asked by prospective clients “are we at the top of the property cycle?” or “should I wait to see if the property market slumps?”.

There is a lot of conjecture in the media about where our current market cycle is at and whether we face doom and gloom – and there always will be. However, these are both valid questions and I am always mindful of the fact that we are experiencing a strong property run in our eastern seaboard capital cities right now. At some stage we are likely to face a correction or, at the very least, a slowdown.

After all, our low interest rate environment is fuelling the property run at the moment and it’s fair to say sub-5 per cent interest rates can’t last forever.

There are six elements I like to guide clients through before an investment purchase strategy is locked in. These elements aim to help mitigate some of the risks associated with buying in a strong market (or better still, buying at the peak of a market cycle).

The first is to ensure that the rental yield the investor is targeting is realistic and achievable. After all, rental yield determines the cash flow shortfall that investors faces every month. They need to be certain this shortfall won’t exceed the surplus funds assigned to the property.

The second is to be confident that rental demand in the area is consistent and will remain so: vacancy rate is integral to understanding any property type or area and, if overlooked, the outcome for the investor can be dire.

The third is to buy well. Stretching a couple of per cent over the appraised value at auction to be competitive is one thing, but overpaying or being emotional about the purchase is another. Paying a high price at the peak of the market can leave some investors with negative equity if the market slumps. The best way to ensure that you are buying well is to be clear on what other comparable properties in the area have sold for, and to get a second opinion from an independent source if in doubt (that is, another agent you trust in the area, an advocate or a licensed valuer).

The fourth element is to have a buffer in place. The buffer can be “buffered interest rate” calculations (for example, factoring in interest rates at a higher margin in the event that things change) or simply a cash surplus (such as a line of credit) for unexpected costs or vacancies. To invest without a buffer is to take a risk. All properties bring surprises and unexpected expenses; it’s just a question of when.

The fifth is to consider where your purchase price sits on the bell curve. In a down market, it’s not unusual for the higher-priced properties to experience greater days on market and higher price discounting. To have a saleable property within the broad median spend range of the market is one more layer of insulation. It is rare, as an investment property advocate, that I recommend clients spend more than a $1 million on an investment property. The typical spend range for a client would be $400,000 to $900,000 and it is for this very reason.

The sixth and final element is insurance. Whether it be landlord insurance, income protection insurance, life insurance or any other, it is always a strong recommendation that an investor has the unimaginable covered. Life is full of surprises and so is property. Being able to deal with these surprises is what makes or breaks an investment strategy.