How to minimise your risk when investing in property

I am risk adverse and I believe in minimising risk where possible, so I always have a back-up plan for making money and for getting out quickly if I have to.

The Trident Strategy is my way of reducing risk to the absolute minimum.

It’s a simple strategy. There are three prongs on the fork. If one of the prongs breaks, there are two other prongs to back you up.

Essentially there are three ways of making money through property investing: make money when you buy; make money in the medium term by renovating; and make money over the long term through capital growth. Hence, if one of my “prongs” is wobbly — for example, I overcapitalise on the renovation, or I pay too much or the area does not grow as expected, I still have two strong prongs that enable me to make money. The skill is in having all three working for you.

In addition to this strategy there are ways you can further reduce your risk, for example:

• Renovate to a point just above the median so you can rent and sell faster.
• Understand what the median property is and who the average tenant is so you know that the property you buy will be in demand, thus minimising vacancies and enabling you to sell quickly if you need to.

What are the risks?

There are many risks associated with a property purchase. Consider the following, which generally apply to any property investment.

Personal risk

This is essentially the risks associated with you: not being able to afford the property, losing your job, and so on. The factors to consider are:

• What is the risk of losing your job?
• What is the risk of the property being vacant for long periods of time?
• How will you cover emergencies? Do you have cash reserves you can access quickly?

Economic risk

This is largely out of your control. It is how the Australian economy is performing, how the world economy is doing and the availability of funds or buyers — and any special one-offs such as the effect of a natural disaster.

Let’s face it, even economists can’t agree on whether interest rates will go up or down, this is hard to predict and control. You need to be aware and consider the risks. With this in mind you might want to start reading reports and listening to the market commentary to become aware of risks.

These risks include tightening of banks’ lending criteria (making it harder for you to get funds), high interest rates, high unemployment and higher costs of living — much of which is discussed in newspapers, on websites and by other media.

Asset risk

Essentially, lenders look at any property investment — be it a home, an investment property or a commercial property — through risk filters. They ask the hard questions that you should be asking; for example, “If this person defaults on the loan, how hard will it be to sell this property?”. Each type of property or security (as lenders consider it) has different types of risks. We can learn from lenders and how they consider risk so that we can apply their methods to our own investment plans.

If your mortgage broker tells you that your lender requires a higher deposit for a particular property it means the lender sees it as a risky purchase and wants you to have more skin in the game — and that should give you a heads up to reassess how risky the purchase is for you as well.

Consider the following scenarios:

• a three-bedroom house within 10 kilometres of the CBD of a capital city
• a one-bedroom, 40-square-metre unit within 10 kilometres of the CBD of a capital city
• a three-bedroom house within two kilometres of the CBD of a small regional town with only one industry (an abattoir that is closing down).

Which is the riskiest? You would have to say the third scenario, followed by the second one and then the first. Why? Because if the lender — or you for that matter — needs to sell your property quickly (for example, if you have defaulted on repayments), the likelihood of being able to do this is much higher under the first scenario than the third one.