8 Things That Can Go Wrong When You Buy An Investment Property

LM b W

Laine Moger

Journalist and Property Educator for 6 Years
Introduction

If you’re a long-term property investor, at some point something will go wrong.

That’s not to scare you off, or to say you shouldn’t invest in property. After all, here at Opes Partners we are a property investment business.

But you need to be aware of the most common things that go wrong … so you can avoid them.

That’s why in this article you’ll learn the top 8 problems investors often face when buying and holding property.

You’ll also learn how to manage these risks. So when your old mate, John, says: “Property is risky … what if X happens?” you’ve already got a game plan for how to tackle the issue.

Market Falls

#1 The Market Drops

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One of the biggest worries property investors have is: What happens if the market falls?

Spoiler alert: house prices go up and down. They don’t increase every single year forever.

So, if you are a long-term investor house prices will go down at some point.

But a dropping market is a particular concern for investors who are about to make a purchase. Because if you buy a property for $1,000,000 and the market falls by 1%, you’ve just lost $10,000.

Whereas, let’s say you bought a property 10 years ago for $500,000, and it’s now worth $1 million, it’s less of a concern if the price then drops by $10,000. You’ve already made $490,000.

This first situation happened to Opes Partners Managing Director Andrew Nicol, in 2008.

He signed up to buy a property in Rangiora, Canterbury in 2007. He agreed to pay $390,000. But by the time the property was built, it was only worth $370,000. He bought at the peak of the market.

What Do I Do To Avoid A Falling Market?

The good news is that over the long term prices tend to recover and increase. So your first major protection if prices fall is – don’t sell.

If you sell your property after it’s gone down in value, you have “crystallised” your losses.

Here’s an example of what that means – let’s say you buy a property for $1 million. It then decreases in value by $20,000.

If you sell now, you have lost $20,000. This is a real loss that you have to face.

But, let’s say you continue to hold that property. Perhaps in 2 years’ time it’s worth $1.02 million.

Sure, you made a temporary loss – on paper – when the property’s value fell. But because you continued to hold, you never actually faced that loss in reality.

But, in some rare cases, total avoidance isn’t possible. Sometimes investors are forced to sell, for instance, if they lost their job or if they are facing a relationship breakup.

But generally, if the market drops, the only thing you can do is hold your nerve.

For proof, Andrew’s Rangiora property is worth $780,000 in today’s market – he’s made a gain of $390,000 in total, almost 20x the amount he initially lost on paper.

No Value Increase

#2 Property Doesn’t Increase in Value As Expected

When you create a property portfolio plan, you’ll often ask “how much equity will I have if the price of the property increases by 5% a year?”

That’s a normal (and industry standard) way to forecast your investments. You then use these figures as part of your retirement or long-term financial planning.

But the truth is property values don’t increase in a straight line. They’re not easy to predict. And while property prices have increased quickly in the past, there is a chance they won’t increase as quickly in the future, or as quickly as you forecast in your plan.

That can create an issue if you then get to retirement and you don’t have as much money as you thought you would have.

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What Can I Do To Protect Myself?

The first thing you can do is to use a lower capital growth rate.

For instance, over the last 21 years (Jan ‘00 – Dec ‘21), the average property value in Mangere Bridge, a suburb in Auckland, increased 8.52%.

However, when you’re forecasting your property portfolio you might use a more conservative figure.

Here at Opes we use a 6% growth rate for a New Build in Auckland. This means that even if the property market didn’t perform like it has in the past, you’re more likely to meet the projections you’ve written down.

The next option is to aim for more wealth than you actually need.

For instance, if you think you’ll need $1,000,000 by the time you retire you might aim to create $1.1 million of wealth. So then even if you under-shoot your target you’re still within the ballpark of what you needed.

Finally, you can strategically choose the right property in the right area. For more info, check out our houses vs townhouses vs apartments article and should I invest in big cities or small towns?

Bad Cashflow

#3 The Property Has Bad Cashflow

Good capital gains are only half the pie.

Property investors need to ensure they receive regular income (in the form of rent), which covers most costs of owning the asset.

This leads to a property investor’s second worry: What if my property has bad cashflow?

This could happen because the property doesn’t earn a high enough rent, or has high expenses like an expensive body corporate or high maintenance costs.

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What Do I Do To Make Sure I Buy A Property With Good Cashflow?

There are two ways you can guard against buying something with bad cashflow. The first is to know what yield you’re aiming for. The second is to make sure the numbers stack up.

Know what yield to aim for

The yield you should expect to aim for depends on the properties you are buying.

If you buy growth properties – those that increase in value more quickly, but have a poorer yield – here at Opes we aim for a gross yield of 4 to 4.75% (depending on location).

Comparatively, if you buy a yield property – which has good cashflow, but grows in value more slowly – you should expect to see a 5.5 to 6.5% gross yield.

To learn what else to look for check out the Epic Guide to Property Investment.

Run The Numbers On The Spreadsheet

The second thing you can do is to run your numbers the right way. This means doing a boatload of number crunching when eyeing up a new investment property.

You’ll need to consider things like the gross yield, the net yield, the property price and the current rent.

The best way to do this is to use a spreadsheet. Here at Opes we’ve created the ultimate Return-On-Investment spreadsheet to run the figures for you. Click the link to download the spreadsheet for free.

Building Problems

#4 There’s Something Wrong With The Building

The next problem investors face is if there is something wrong with the building itself. This can happen if the property was a leaky building or has bora or rot underneath the floors.

This can become an issue if the property then becomes structurally unsound. In that case, the property might not be habitable, so you won’t be able to get a tenant. Or, in some cases, the value of the property might go down.

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What Do I Do To Avoid Buying A Troubled Property?

Here are two ways you can best protect yourself against buying a property laden with issues.

Know what you are looking for

Properties built in the same decade tend to face the same issues. For instance, properties built before the 50’s tend to have issues with electrical wiring.

Whereas those built in the 2000’s sometimes have issues with leaks or weather tightness.

For a full run-down of what tends to be wrong with buildings in each decade, listen to episode #420 of the Property Academy Podcast.


 

Buy New

The second option is to buy a New Build. Newly-built homes comply with the most up-to-date building codes, so tend to avoid mistakes made with properties built in prior decades.

They also come with a 10-year builders’ warranty, so if there is something wrong with the property structurally you are covered by the warranty.

Builders’ Report

Most buyers purchasing an existing property will also commission a builders’ report. This will surface any issues about the building itself. Any issues uncovered during this process will usually make or break any contract.

They usually cost around the $600-$700 mark, and are well worth it for existing properties.

Builders’ reports are less common for New Builds, but are sometimes commissioned by investors who want additional reassurance their property is well built.

 
Bad tenants

#5 Bad tenants

Many first-time investors are terrified they will get a bad tenant. You know, the sort who would feature on the show Renters.

The truth is there are bad tenants out there. There are tenants that pay the rent late (or not at all); tenants who are anti-social and who’s behaviour will annoy and disturb their neighbours; tenants who will damage the properties they occupy.

This can have a real impact on the finances of the landlord if they’re left with unpaid rent or need to shell out thousands to repair their investment.

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What Do I Do To Make Sure I Don’t Get A Bad Tenant?

Here’s our top 4 things to do to make sure you avoid bad tenants.

Insist on Good Screening and Background checks

The best way to steer clear of any potentially unruly tenants is to adopt a good screening.

For example, you want your property manager to conduct:

  • A background check – where they call other property managers to make sure they are a good tenant
  • Credit check – where they make sure the tenant doesn’t have unpaid bills to electricity companies or to any lenders
  • Employment checks – to make sure the tenant is employed and has the income they claim they do.

These three checks will confirm your tenant can afford the rent and is of good character.

Invest in Tenant-Rich Areas

You can be more choosey over tenants if you invest in an area where there is high rental demand.

Let’s say you invest in a desirable area like Fendalton in Christchurch. There are a lot of people who want to live in Fendalton, so you are likely to find and choose a good tenant quickly.

On the other hand if you invest in a small town of 1,000 people, there are so few tenants you’ll likely be forced to choose the first one that comes along.

Invest in the Right Sort of Properties

To get a good quality tenant you’ve got to buy the sort of property they want to live in. If you only buy old, run-down, cold properties, you are going to attract a certain type of tenant.

But if you purchase a better maintained or New Build property, you are likely to attract a premium tenant.

This is one of the reasons here at Opes Partners we tend to recommend New Builds because they tend to attract low-hassle tenants.

Landlords Insurance

If the worst comes to the worst, your final safety net can be landlord’s insurance.

This means that if your tenants do consume the wrong type of substances (meth) in your property, damage appliances, or maliciously damage your property, the insurance company will cover the cost of what you’ve lost.

 
Debt Overload

#6 Too Much Debt

 

You don’t need us to tell you this, but mortgages are expensive.

But if you want to acquire a few investment properties it is likely you are going to be looking at quite a bit of debt.

If you think about it, an investor with 3 to 4 properties will have more assets than most small businesses in New Zealand.

Many Auckland properties are worth over a million dollars. So if you have 4 properties, you might have $3-4 million worth of debt … that’s a decent-sized business.

The thing is, not everyone should continually take on more and more debt.

For instance, older Kiwis who don’t have long before retirement might need to rethink taking on a mega-mortgage. They could be forced to sell when their income drops once they decide to stop working.

Similarly, when taking on debt investors should just make sure they really can afford an increase in interest rates.

What Do I Do If I’m Not Sure About How Much Debt I’m Taking On?

If you want to make sure that you’re taking on the right amount of debt for you it’s best to speak to a financial advisor or a mortgage broker about your personal situation.

Redundancy

#7 You Lose Your Job

Nobody plans to be made redundant, or have their business fall over, but it does happen.

Earthquakes, Covid-19, an accident at work … these could all stop you earning an income.

This is a problem for property investors when your property is negatively-geared. That means that the rent coming in doesn’t pay for all the property’s costs, so the investor has to top up the bank account.

If you then lose your job, this could become a struggle. And the other issue with property is that it is an illiquid asset – it takes time to sell. That means you can’t get rid of it quickly if you do face tough financial times.

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What Do I Do If I Lose My Job?

Here are 2 things you can do if the worst-case scenario happens.

Revolving Credit

A classic strategy investors use is to set up a revolving credit. This is like a big overdraft secured against your home.

So, let’s say you set up a $50,000 revolving credit – and you don’t spend any of the money. If you then lose your job, you then have a $50,000 line of credit which you can use if cash is tight.

But, you MUST set this up before you lose your job, and while your income is secure. If you try to do it once you’ve lost your job, there’s little chance you’ll get the lending approved.

Income Protection Insurance

The second option is income protection insurance. This is where if you are unable to work (temporarily or permanently), an insurance company will pay you a portion of your salary.

This means if you can’t work, you still earn a living.

 
Keeping Up With Regulations

#8 Ever-Changing Regulations

The regulations surrounding all things property investment are constantly changing. Not only can they affect your chances of getting finance, but they can greatly impact your income stream as a property investor.

In the last 18 months property investors have faced:

  • The reintroduction of higher deposits required through LVRs

No buts about it, they can be intimidating. And you can bet that these regulations are likely to change again in the future.

How Do I Keep On Top Of All These Changes?

If you enter investing with the mindset that rules will change you’re off to a good start. It does no good to be spooked by them.

Rather, you want to work with the changes and inform yourself on how best you can still achieve your goals.

You don’t need to become a tax expert, or a mortgage broker either. But you do need a team of professionals around you who can help you respond to all of these changes.

Conclusion

So … Should I Start Investing In Property?

Phew, we hear you – there really are a lot of things that can go wrong.

But, while there are things that can go wrong, it is highly unlikely that everything will go wrong. If you invest in property the right way you probably won’t buy a property that immediately falls in value, has bad tenants, and turns out to be leaky, all while you lose your job.

This list isn’t to scare you, or to make you think property investment can’t work. After all, here at Opes Partners we are a property investment business.

No, this list is to help you become a better property investor. Because if you understand what can go wrong, you’ve got a much better chance of making sure these things don’t happen.

LM b W

Laine Moger

Laine Moger has been a journalist and reporter for the last 6 years. She previously worked for Stuff, The North Shore Times and Radio NZ. She has a Bachelor of Communications (Honours) from Massey University and a Diploma of Journalism from the London School of Journalism.