Managing risk in a challenging market

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Managing risk in a challenging market

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

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

 

My top tips are:

 

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 which haven’t performed for the past 5-7 years but have had consistent rental growth of more than 20% such as residential properties in Brisbane’s $700,000-$1M 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 oversupplied 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 neither are they the appropriate stock. Top of the list in this regard are inner-city high rise apartments in Melbourne which typically attracts 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 which 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 attract the best possible tenants.  Ideally these purchases should be free standing homes (3 to 4 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 2-15 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% 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. Similarly if your portfolio is carrying too much debt – the Loan to Value Ratio (LVR) on your residential stock is more than 80% and your commercial stock, more than 60%. The LVR is the proportion of money you borrow compared with the value of the property. Ideally your LVR should be 70-80% for residential and between 50-60% for commercial.  A high 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 reducing 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. A 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 rentals, allowing you to more quickly reduce your debt position.

 

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 increasingly there should be opportunities in regional locations such as Geelong as the Vic Government looks to ease commercial zoning restrictions and encourage business 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 of attracting stable tenants such as government organisations and major corporations.

 

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