Don't burn your fingers.

Following on from the previous weeks discussions concerning property investors and the risks associated with it, lets turn to risks in today's market. Novice investors are following the herd instinct and following the tremendous boom over the last 3 years are now deciding to invest in property. The property investor is different from the property owner in as much as an investor is looking to realize some positive cashflow or profit through the method that they choose to invest. Last week's discussion of some of the types of investors will give you an idea of what I'm talking about.

Most of the investment methods have as an aim a realization of gain within a relatively short timeframe except for the buy-to-let investor that looks to build up a property portfolio that realizes a positive cashflow either immediately or at some future time. Refinancing as positive equity increases and re-using this money is also sometimes an aim of these investors. Most of these investors are banking on an increase in price/value of their investment property to realize this profit and this is where a caveat comes in. Property prices haven't always scorched ahead at 30% plus and even if they have in the last three years there have been some very good once-off reasons for that and in future will almost certainly not match these increases.

Nevertheless, as discussed previously, it doesn't make sense not to be an owner-buyer in today's market unless you're expecting a decline in prices in the short term. It might make sense not to invest in property but rather invest into other asset classes that you expect to give you a better ungeared after-tax return than property investing. Again this is where the trick in property investing comes in: you need to invest in the market such that most changes in the market will still favour your investment. Or in other words take into account most possible scenarios to avoid running into trouble.

In my view it isn't the possible decline in prices that is the greatest risk but rather three other culprits that we need to be careful of:

1) Tenancy
2) the high transaction costs and
3) the relative volatility of the interest rates in this country.

The first risk is the most debilitating. Investors sometimes are mislead by sellers as to the rent that can be achieved and other costs such as rates and taxes are often not worked into their calculations. Investors need to do their homework and invest where there is a ready supply of tenants. The quality and management of the tenant can also become an issue for these investors.

To mitigate these last two risks is relatively simple but doesn't always happen. The second is obviated by not transacting. That is buy and don't sell for as long as is possible or as long as it makes sense not to sell. Selling now because you can realize a profit is shortsighted and will erode the profit that you'll make. Equally important is that the cost of re-entry into the market is probably going to be higher than the last time.

The last risk, that of a volatile interest rate, must be taken into consideration so that you don't end up in the poor house. The past decade has seen interest rates almost double in the space of a single year and although I believe South Africa to be in a much more positive and stable economic environment, it doesn't preclude economic shocks. The London bombings are a case in point and it is events like these that can trigger a sudden rate change. One of the best ways of planning for this contingency is to build up a reserve of cash that can tide you over in such dire times. Another way of specifically dealing with this risk is to finance your purchase using a 20-year fixed bond option. These have just been launched in this country and are pegged at about 11.9% or 1.4% above the prime lending rate. A portion of your bond can be financed this way and that reduced the cashflow risk if rates skyrocket for a time.

If you expect a high return in the short term or need a rapid increase in value within a short time frame and are banking on this to realise a profit or protect your cashflow, you might be in trouble.

Happy investing.

Article by: Dave Welmans - (www.thepropertygame.co.za)