14 Tips for Reducing Risk in Property Investment: A Guide for Landlords
by Property Investments UKThe Property Investments UK editorial team have been researching and writing about the UK's property market for more than a decade.
Property investment can be very rewarding and profitable. But property investment can involve many risks too. Here we will look at some ways to reduce the risk of investing in property.
What are the Risks of Property Investment?
Property investment involves risks at several levels: You might not make any money from your property investment. You might lose the money you put into your property investment. In a worst-case scenario, you might lose more than the money you originally put into your property investment.
Here are some of the specific risks of property investment: Property prices might fall. Interest rates on borrowed money might rise. Taxes on property or investments might rise. Laws may change making property investment less favourable. You may incur unexpected costs, such as repairs or maintenance. You may become involved in legal disputes. You might not be able to find a suitable tenant. Tenants might fail to pay their rent. Rents might fall. Yields might fall. You might not be able to sell your property when you want or need to – property is a fairly illiquid asset.
Ways to Reduce Risk in Property Investment
The good news is that there are many ways to reduce risk in property investment. Some approaches include avoiding risk in the first place, limiting the risk or transferring the risk elsewhere.
- Have a Business Plan
- Know Your Market – Do Your Research
- Take Expert Advice
- Go for Income (and Cash Flow) Rather Than Growth
- Buy Property Below Market Value
- Time the Market
- Invest in Property Through a Limited Company
- Diversify your Property Investments
- Use Lower Risk Methods of Finance
- Carry Out a Risk Assessment
- Have a Contingency Fund
- Vet Prospective Tenants Carefully
- Play safe – Avoid Unproven Property Investments
- Have an Exit Strategy
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1. Have a Business Plan
Property investing is a business that can benefit from a business plan like any other business.
Key things a property investing business plan should include are: What you can offer to a property project. What skills do you need to source from others? What is your budget? How you are going to finance your business. What type of projects will you pursue, eg. buy to let, refurbishment or development etc? What is your timescale? What is your exit strategy?
2. Know Your Market – Do Your Research
Investing in a property market you know well and thoroughly understand is less risky than investing in the unknown.
Take time to get to know the market you are planning to invest in and do research. Aim to understand prices, rents and yields. Aim to understand supply and demand. Read market reports, market news and expert opinion and use data to build up a picture of the market you want to invest in.
3. Take Expert Advice
By taking the best expert advice you should be able to reduce risk by benefitting from the best current thinking and best practice within each subject area. In property, there are many different sources of expert advice. For example:
- Accountants and financial advisers can provide advice on raising finance and on tax-efficient property investment.
- Lawyers can provide advice on your rights and obligations when purchasing a property, and on possible legal risks.
- Surveyors can provide advice on the building's condition, repairs and costs.
- Estate and letting agents can provide advice on the sales and rental markets plus current market prices, rents and trends.
4. Go for Income (and Cash Flow) Rather Than Growth
Most property investors invest either for income or growth. Often, the two are opposed: property projects which produce a strong income have less potential for capital growth. Properties which have good prospects for capital growth may produce less income.
Income-producing property effectively reduces the risk by putting cash in your bank account now, rather than an expectation of it at some point in the future.
5. Buy Property Below Market Value
By buying property for less than it is worth on the open market you reduce the risk of losing money if property prices fall. (You also make more money if property prices rise and even if they stay the same.)
Ways you might buy property below market value include buying through a sourcing company or at auction.
6. Time the Market
Aiming to time the market can help to reduce the risk of property investment. Although investing in property when prices are on the rise and everyone else is buying property may seem like the best time to buy, this may not be the case. Investing in property when fewer people are interested in buying property, and prices are static or falling, maybe a better strategy in the long term.
Timing the market may help to reduce risk due to the cyclical nature of the property market.
7. Invest in Property Through a Limited Company
By investing through a limited company you can limit your risk if things go wrong to the amount of your stake in the company. (There could also be tax advantages by investing this way.)
It’s best to take individual expert advice if you are considering investing in property through a limited company.
8. Diversify your Property Investments
Diversification in property investment involves investing in projects with different and perhaps opposing risk profiles. The theory behind diversification is that if one type of investment does poorly or fails others with opposing risk profiles may still succeed or even prosper.
In property, you can diversify on an asset-based basis. For example, by investing in both residential and commercial property or developments and buy-to-let. You can also diversify geographically, by investing in different areas. For example, higher-value areas and lower-value areas.
9. Use Lower Risk Methods of Finance
While short-term, higher interest methods of funding have their place in property investment longer term, lower interest types of borrowing reduce the cost and so reduce the risk. For example, mortgages are generally less risky and much cheaper than bridging loans or development finance.
Also, utilising fixed-rate lending products gives you cost certainty and eliminates the risk that you will be impacted by rising interest rates over the fixed term.
10. Carry Out a Risk Assessment
When you are considering a project carry out a risk assessment before committing yourself to it. List all the possible risks of the project and, in each case, consider what you can do to avoid, limit or transfer them.
11. Have a Contingency Fund
With every property project, allow an amount for unexpected contingencies. For example, unexpected problems, delays or extra costs. Around 10% of your anticipated project costs could be considered a useful contingency fund.
By allowing for a contingency in your initial calculations you can maximise the chances of a project being successful even if costs are greater than anticipated. You also minimise the risk of failure due to unexpectedly running out of money or having to pull in extra short-term finance which can be expensive.
12. Vet Prospective Tenants Carefully
If you are investing in buy-to-let, then tenanting a property involves risk. There is always a risk that any tenant will not pay the rent on time (or at all), will damage the property and will prove difficult to evict.
You can reduce these risks considerably by vetting tenants carefully – or using a letting agency that can do this for you. Methods of vetting tenants include asking for and taking up references and interviewing them before offering them a tenancy.
Vetting tenants is likely to become an even more critical element in reducing risk if the Renters (Reform) Bill becomes law. This may give tenants more rights to stay in a property and ban Section 21 ‘no fault’ evictions completely.
13. Play safe – Avoid Unproven Property Investments
Although this is obvious to some extent, it’s often overlooked. But if a particular type of property project is untried, untested and has no track record of success it’s more risky by definition.
Offers of returns that are unrealistically high can also indicate that a project involves a high level of risk. (Projections of returns that are more modest and realistic generally involve lower risk.)
Although it’s no guarantee a good way to reduce risk in property investment is to go for types of projects which have a proven track record of success. Residential buy-to-let generally has a good track record of success.
14. Have an Exit Strategy
You can reduce risk in property investment by thinking about when and why you will end/cash in on your investment before you get started …. not after you have invested.
For example, will you exit your property investment when you have made a specific amount of money, or when you reach a certain age/plan to retire? Alternatively, if property prices or rental yields fall will you have a ‘stop loss’ exit plan, ie. selling at a certain minimum portfolio value or when yields or profits fall to a certain point?
Part of your property investment exit strategy should be to consider how you will exit your property investments. For example, by selling them or transferring them to someone else, such as your heirs.