3 big risks to your positively geared portfolio

The property settles, and for the first few months you enjoy the benefits of owning a piece of real estate that generates a good cash flow and has long-term appreciation.

But sometimes as a real estate investor, things don’t go to plan – and what was once a promising and profitable investment can suddenly become challenging. As property owners, it’s important to be aware of these factors well before you begin building your portfolio, so you can prepare mitigation strategies in advance to help you overcome changes in your plan.

Some of these unexpected situations – and strategies to help you cope with them – include:

1. A major weather event

Several years ago, property owners in far north Queensland were able to insure their homes and investments for a reasonable fee. However, a series of major weather events, including the severe Tropical Cyclone Yasi in 2011, brought about a surge in insurance premiums. The result for property owners is that home insurance policies began to cost double, triple and even up to five or six times their original amount. This can have a nasty impact on cash flow.

How can you minimise this risk?

Obviously, it’s impossible to know what weather events are going to take us by surprise; wild storms, floods, cyclones and bushfires have devastated various regions throughout Australia in the last decade.

It’s crucial that you do your due diligence to ensure that you minimise your chances of buying in an area likely to be affected by a major weather event – for instance, the Brisbane City Council offers free tools and information to help people understand their property's potential flood risk.

It is worth noting that areas that tend to flood are usually in older suburbs, before tighter building regulations were introduced. Councils will not allow new properties to be built if they have no flood immunity. It does not mean that you should not invest in locations like Townsville because of frequent cyclones, but you should just make sure that you have allowed for the right level of premium in your projections.

2. An increase in competition

When a new apartment complex is completed and released to the market, a flood of similar-style properties become available all at once. It’s unlikely that they will all be rental properties, as some owner-occupiers will have purchased in the building as well, but what impact do you predict that this huge supply of new apartments will have on the rental market? I’ll give you a hint: when tenants have their pick of dozens of different properties, this significantly reduces competition – and can therefore have an impact on asking rents. It can also reduce the rental potential of established property stock, as tenants generally prefer newer accommodation, and will want to pay less rent for an older home.

How can you minimise this risk?

Thorough due diligence is the best way to mitigate your risks of purchasing in an over-supplied market. Aim to invest in real estate in a sought-after, blue-chip location where the local economy is diverse, the population is growing, amenities and transport are plentiful and unemployment is low. These fundamentals will underpin long-term growth and help you ride out any short-term uncertainties due to potential property over-supplies. You could also negotiate a first tenant guarantee with the developer. This means that the developer would pay you an agreed rent until the first tenant moves in. This removes the uncertainty of not having a tenant from day one. Be wary if the developer offers rental guarantees for years. This usually means that the property is not competitive in the market.

3. A mortgage adjustment

I’ve seen many investors get burnt when their home loan moves off a fixed rate to a higher variable rate, and they’re financially unprepared for the change in their monthly mortgage payment. With interest rates in the four per cent band, this may not seem like a huge concern… until you consider that the banks began lifting interest rates for investors earlier this year in response to pressure from APRA, taking everyone by surprise.

How can you minimise this risk?

Firstly, you need to ensure that you run “what if” scenarios when you do your projections. It today’s market most properties are cash flow positive, but what happens when interest rates start increasing and reach, say, seven per cent? Most properties become cash flow negative at this rate. It’s crucial for all property investors to take an active role in managing your own finances, which includes keeping a close eye on your mortgage. If your interest rates have changed recently or you’re not sure where you stand at present in terms of your rates, mortgage products or borrowing power, it would be worth giving us a call so we can review your situation and look for opportunities to improve your situation.

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