How to Reduce Risk When Buying Investment Property

Investing in real estate is a major cornerstone of wealth creation.

Successful investing in property has the capability to produce sustainable returns for many years. For this reason, many people see Commercial real estate as a long-term and secure investment. Commercial real estate has the additional bonus of providing asset diversification, inflation hedge and the potential for appreciation. As an asset it is always seen as an active alternative to stocks and bonds.

The journey of property investment can be deadly if not approached correctly. The risks when investing, range from equity issues to legal partnership complexities. Each can have a significant influence on your return.

These are a couple of common mistakes made early on with property investing. I’ll walk through a couple so you can identify them and steer clear.

1) Buying an overpriced property

2) Getting too emotionally attached to one type of property or location

3) Failing to consider other potential risks.

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Buying an overpriced property

When it comes to property investing, there are some mistakes that are typical of new investors. One of the most common is buying an overpriced property. Make sure that you are not paying more than market value for your property. One definition of “Market Value” is the value of the property based on comparable sales of other similar properties in the area. This is a mistake because if you buy an overpriced property, you have essentially paid more than anyone else would in that market for that asset. This may make sense if you have a unique way to add value, a stellar tenant waiting or an amazing redevelopment plan. Also consider your tenant-mix before jumping into a deal. This will ensure that you are not just buying into an overpriced neighborhood or area but that the rents are not too high already for tenants to maintain. As you raise rents to justify your high acquisition price, if no tenants in the market can afford it, you will find yourself with a non-performing asset.

Making assumptions about what others are doing can also lead to failure. If you end up buying into an area that is too expensive, simply because you think everyone else wants it, this can set you into an “auction mentality”, where you overpay for an asset. When the going in price is too high on the asset you are purchasing, you have to then wait for the value to catch up to what you paid.

Getting too emotionally attached to one property or location

Investing in property can be one of the most lucrative lifetime investments for many. A common mistake made by early on is investors getting too emotionally attached to one type of property or location.

People should always be open to investing in properties that are in different areas to ensure they don't end up holding onto something in an area without growth and appreciation. It is important to be mindful of the golden rule of property investment, location, location, location. This rule applies to the suburbs as well as the city. If you are looking for a growth area to invest in, then look for one that is near amenities and transport links.

Consider your time horizon before buying an investment property as well. Are you looking at this as a short-term fix? Or do you intend on owning it long term? Different areas and properties suit different time horizons. It is important to know what yours is before you commit. Are you attracted to a property for emotional reasons, like wanting a quick buck or higher returns? You should always defer back to a solid strategy where your goals and timeline are clearly stated. That way your emotions are confronted with clarity.

Failing to consider other potential risks

What are some of the risks of investing in real estate that people often do not consider? Major risk factors for an investment in real estate can be broken down into three specific categories: economic, social, and regulatory.

Economic risks are risks that are related to the financial viability of the project or investment, such as fluctuating market prices. The three main types of financial risks are the risk of market value fluctuations, the risk of interest rate fluctuations and the risk of liquidity. The real estate market is very sensitive to the changes in the economy. The drastic instability in the real estate market, has always been a major factor in economic turmoil. When this happens, real estate prices can drop dramatically, and commercial real estate investments may lose their value. Another example, if there is a drastic increase in interest rates, it will make it more difficult for investors to secure property because their cost of capital will be more expensive.

One way to help avoid these risks is to diversify your investment portfolio by investing in a variety of assets. This will help lower your risk exposure, by not putting all your eggs in one basket.

Social risks are risks that are related to social issues of the day, such as changes in policies, local and national. These changes have an impact on the way people do business, which can affect commercial real estate. For example, if a new bill is passed modifying immigration or refugee policy, this may effect housing demand in larger neighborhoods where the renters are predominantly that ethnic group. The same applies for regulations (i.e., new regulations on smoking in public places), new legislation (i.e., legislation akin to Brexit), or locally based legislation (i.e., legislation proposed by a city council).

Regulatory risk is the risk that some new regulation will render an investment useless or too costly. For example, A new presidential administration can announce tax increases/regulation on real estate. A big part of commercial real estate's value is based on the property taxes and expenses. Those taxes can be assessed annually or on an ad hoc basis. Some of the most common taxes (or expenses) that effect commercial real estates are business occupancy tax, sales tax, property taxes, employee wages and benefits, utilities like water and sewerage rates. These increases may be levied by local authorities or by states and the federal government. A giant increase in anyone of those categories will lower your total cashflow and directly effect the property’s value.

Investing in any asset is not without its risks. There are constantly probable pitfalls that can lead to failure. However, there are also so many ways to avoid these common mistakes and begin investing intelligently. The decision to invest in property is one that should not be taken lightly, but if done well it can provide a secure future for generations. Reduce risk by educating yourself and consulting with an expert.