Updated: Sep 1, 2019
I've met many property investors who regret their investment purchases and I've met few who are happy with their investments.
According to news reports, property auctions are on the rise. According to people on the ground, it is getting harder to find tenants in some segments.
The stakes seem high and this question is now pertinent - how risky is property investment?
Risk Is the Name of the Game
Investment by definition carries risk. Yes, ALL investments - even fixed deposits with banks. You may be frowning, but yes, keeping your money in a bank is not risk free.
Under a fractional-reserve banking system, banks loan more money than they actually keep in reserve. Therefore, when all of a bank's depositors withdraw their money at the same time, a bank can default on payments. This is called a bank run.
It happened in Malaysia with MBF in 1999. In the 2000s, it has happened in Argentina, Uruguay, England, the US, Iceland and China among other countries.
What you as an investor can do is mitigate your risks according to your appetite for it.
The risk of a bank run for example, is very low. On the other hand, venture capital investments can be extremely risky. So, if you have a low risk appetite, you might find a fixed deposit ideal for you.
The degree of risk you can take may vary with many factors. If you're reaching retirement, you should be reducing your investment risk. If you've just started working, you may be able to take on a higher degree of risk.
But why should anyone ever opt for high risk?
Generally, higher risk comes with higher returns. For example, only 15 out of 200 startups a venture capital company funds will become financially viable. That is a 92.5% failure rate! However, these 15 companies will make enough money to provide economic gain for the venture capital company.
Naturally, most people want higher returns and therefore take on a higher degree of risk.
And this leads us back to property investment...
Property Investment Is Risky Under Certain Conditions
If you can't afford to invest in property, it is very risky. Look, home ownership and property investment is great, but I don't subscribe to forcing home ownership on the masses. A healthy property market is good as it's a major driver for the economy but at the same time, high household debt is risky.
Therefore, buying or investing in property should only be an option for those who can afford it. How do you know if you can afford a property?
There are other costs to a property besides its purchase price that you must be aware of.
First, there are closing costs with buying property. For a RM750,000 property, you would likely pay about RM38,000 in closing costs. What are these closing costs? Legal fees, stamp duties, and valuation fees.
If you're buying directly from the primary market, the developer may subsidise these costs for you but you still have the other costs below.
Second, there is the cost of renovation. Depending on how much work needs to be done, renovation costs can range from small to very big. Buying an investment property and then not being able to make it attractive for prospective tenants puts your investment at risk because your property may be vacant for a longer period.
Third, there are operational costs. You will need to pay for taxes (assessment and quit rent for example), insurance, repairs, and annual improvements. If it is an investment property, vacancy is also a cost.
As you can see from the costs above, you need much more than the 10% downpayment to buy a property. Your operational cost is also much more than the mortgage.
Knowing all the costs involved can give you an indication of what your capital expenditure and cash flow will be. If you're scrapping the bottom of the barrel to manage the cash flow, you definitely can't afford the property.
If you're unsure how to derive the closing costs and cash flow on a property, I've got your back. You can download the property investment calculator that comes together with my book, The Ultimate Guide to Buying Property.
So when is property investment not risky?
The Risk Is Greatly Mitigated When You Have Holding Power
Because the market is cyclical, you simply have to be able to wait out a downturn so you can ride the next upswing.
This is called holding power. It is a critical element of buying or investing in property but does not get enough attention. Most people lose money on property because they don't have holding power.
When you are forced to sell because you cannot pay the mortgage, or you're unable to manage a long vacancy period, you're in trouble. Sellers in a forced sale rarely get the price they want. They're desperate and buyers know it.
With holding power on the other hand, the seller can opt not to sell if the price is not right. Novice investors panic when their property price is not appreciating or depreciating during a recession.
Seasoned investors understand that this depreciation has no real consequence. The depreciation is only on paper. It is not realised if there is no sale. They just hold on to the properties that they have carefully selected and bought until the market picks up.
Historically, the long-term price of property in general has been upwards (this trend could change in the next 80 years).
How do you give yourself holding power?
You must have a very clear understanding of your cashflow with your properties. As I pointed above, your running expense is not only your mortgage payment. You have maintenance, repairs, insurance, taxes, vacancy, annual improvements and Indah water.
So if you bought an apartment for RM750,000 with a 90% mortgage over 30 years (4.5% interest rate), your monthly instalments would be RM3,420.
You'd probably have to fork out a further RM1,200 per month for the additional costs. In effect, you'd be paying RM4,620 every month.
If you're renting out this property for RM3,000 per month and had a vacancy rate of 1 month every year, your cash flow would be -RM2,104. That's a negative cash flow situation.
The question you should be asking is - can I handle this?
What happens if you are retrenched from work? Do you have reserves to handle the cash flow on the property?
Always buy your properties with a long-term outlook. This will encourage you to think of contingencies and build reserves to manage your properties. I have a radical suggestion, which is to think of property investment as forced savings for high returns in the long-term.
Other Risk Factors
So far we've been looking at risk from a macro perspective. There are other risks on the micro level. If you're buying an investment property in a location where the supply of tenants is low, you may suffer from higher vacancy which impacts your cash flow and ultimately capital appreciation.
Check occupancy levels in the area before buying a property. I have a simple method to estimate this. Let's say I want to buy an apartment in Verve Suites Mont Kiara. To understand the occupancy, I will first go to iProperty and search for Verve Suites Mont Kiara.
At the bottom of the search results, you'll see how many properties in total are listed for Verve Suites.
Usually, there will be many duplicate listings here (the same listing listed by different agents or the same agent running 3 different listings while actually only having 1 listing). To clean this, I would divide the number of properties listed by a number ranging from 3 to 5 (yes, some areas have up to 5 duplicate listings on average).
In this case, I'll divide the number of listings by 3. So, 231/3 = 77. My estimate is therefore 77 real listings for Verve Suites.
Next, I'd find out how many units in Verve Suites in total. You can Google this or just ask the management office. I know that there are 933 units in total for Verve Suites Mont Kiara.
77 out of 933 units are available which means the occupancy rate here is probably around 91.75% (please note that this is only an estimate). This is a very healthy occupancy and if I'm buying an apartment here, I can probably expect nothing more than a 1 month vacancy period.
You can't do this for off-the-plan or under-construction properties. In this case you can have to look at the occupancy of neighbouring projects to get a rough understanding.
Besides occupancy levels, you also want to look for demand boosters in the area you're going to buy. Things like infrastructure, amenities, entertainment and recreation, public transportation, and jobs are very important. Properties that lack these boosters may appreciate very slowly or not at all.
If you're buying an under-construction property, check the developer's reputation. Delays in completion is common and some developers may have a record of delivering low quality products. Beware.
So, How Risky Is It?
To conclude, property investment can be very risky or low risk. It really depends on how you approach it. If you have a long-term outlook and a solid understanding of the cash flow, you have already mitigated a significant portion of the risk.
Then look at the micro details like occupancy levels, demand boosters and developer reputation (if you're looking at an under-construction property).
Buying or investing in property is most risky if you cannot afford it and therefore do not have holding power. This is especially pronounced if you do not have good personal finance skills.