Managing risk in a challenging market

Australia has had a wild run lately, with property prices in Melbourne and Sydney enjoying growth well above average over the past five years. However, with these markets beginning to stagnate and property prices in general becoming sluggish, it is vital that investors not only spread their risk but ensure their portfolios retain their value.

Managing risk does not mean investors should quit investing. There is always an opportunity in every market, regardless of market conditions.

However, investors do need to apply caution to the way they go about this activity.

Avoid hot markets where there is little opportunity for capital growth

This includes Sydney and Melbourne, both of which have had solid price growth over the past five years. Also steer well clear of Brisbane’s $600,000 residential market, which has become extremely competitive.

Ideally, buy in markets that haven’t performed for the past five to seven years but have had consistent rental growth of more than 20 per cent, such as residential properties in Brisbane’s $700,000 to $1 million category and Adelaide’s blue-chip school belt and middle ring.

While Melbourne and Sydney don’t currently represent the best value for investors, there are pockets in these locations worthy of consideration, such as the ‘lifestyle market’ within an hour’s drive of these cities.

Avoid markets that are over-supplied with dwellings targeted at investors 

These investments are notoriously difficult to rent out – particularly to the right sort of tenant – as they are not in sought-after locations and neither are they the appropriate stock.

Top of the list in this regard are inner-city high-rise apartments in Melbourne, which typically attract transient, student and short-term single and young couple tenants.

Other no-go zones are areas of over-supply, such as greenfield development projects and areas zoned for high-density living, with a full pipeline of planning approvals near CBDs.

These areas are located in all capital cities. Focus instead on areas where home buyers dominate and that are close to public transport, job nodes, schools, village-type shops, restaurants and recreation facilities.

Buy quality residential stock 

This will not only guarantee you the best capital growth when you finally sell, but will also attract the best possible tenants.

Ideally these purchases should be free-standing homes (three to four bedroom), single and double storey terrace homes or apartments in small blocks.

They should primarily be located in highly desirable blue-chip areas or locations undergoing gentrification, usually within a two to 15 km radius of our capital cities or close to universities, schools and hospitals and near employment growth corridors.

Investors with inferior assets will find the market increasingly difficult over the next few years, so you need to adjust accordingly by selling down these assets.

Don’t panic-sell

For many Gen Ys who have never experienced a downturn, there could be the temptation to sell.

If your investments meet the ‘quality stock’ test, there is no need. You would be best served to hold on to these assets. The market will pick up. It always does.

However, if you have inferior stock, now is the time to get rid of it. It is also worth pointing out that flattening market conditions are generally the ideal time for investors to pick up bargains in markets no-one is buying in.

Maximise the performance of your portfolio

You may have quality stock, but is it paying its way? Are your rents covering the costs of your mortgage repayments and is there enough left over for repairs or to act as a buffer should you be faced with long-term vacancies? You may consider pushing up rent. As a rule of thumb, rents should increase by 5 per cent each year.

Also, do you have the right loan structures or are you locked in to fixed interest rates long-term? If you are locked in, this will reduce your opportunity to sell down non-performing assets and increase the value of your portfolio with better stock.

Make sure your portfolio isn’t carrying too much debt – the Loan to Value Ratio (LVR) on your residential stock should be 70 to 80 per cent, and 50 to 60 per cent for commercial. The LVR is the proportion of money you borrow compared with the value of the property. A higher LVR will leave you unnecessarily exposed in the event of market fluctuations where capital values fall, or should your employment situation change.

Your financial or lending adviser can help you address the latter two issues, enabling you to free up cash flow by improving your debt position.

Refurbish

Now is the time to consider refurbishing one or more of your properties. Many investors are reluctant to refurbish, afraid of over-capitalising and not getting their money back. Refurbishment should be done as a matter of course every 12 months and should be part of your portfolio strategy. Any property manager worth their salt will manage this on your behalf.

Refurbishment generally involves cosmetic updates to the kitchen and bathroom, painting throughout and either new carpeting or conversion to polished floorboards. A good refurbishment will not only increase the value of your property but will enable you to push up rents, allowing you to more quickly reduce your debt.

Consider other asset classes

Given that yields in Sydney and Melbourne are currently the lowest in the country, commercial and industrial stock now represent much greater value and the opportunity for a more solid passive income stream.

Commercial stock generally has higher yields than residential and brings the added benefit of asset class diversification. Commercial stock can include anything from offices or shops in suburban strips to entire office blocks. 

Currently, the best buys for commercial stock are on Melbourne’s city fringe in suburbs such as East Melbourne, Brunswick and Footscray. However, there should be increasing opportunities in regional locations such as Geelong as the Victorian government looks to ease commercial zoning restrictions and encourage businesses to move their offices and headquarters to these areas.

Like residential investment, commercial stock should always be blue chip – that is, high-quality, highly desirable stock with the capability to attract stable tenants such as government organisations and major corporations.

Remember, investing is about creating your retirement nest egg and as such is about the long term. If you follow our advice, you will be well placed to ride out the stormy seas ahead and to make the most of calmer conditions when they return.