Managing (or even eliminating) risks when investing in Property (Part 2)
In Part 1 we spoke of the many common risks that property investors face in building a property portfolio. We also covered key strategies to remove or reduce those risks. In Part 2 of this topic, I want to cover some of the more uncommon risks, as these can also cost an investor tens of thousands of dollars and additional stress. Here are some of the more uncommon risks and the solutions to deal with them:
- Valuation – ‘What if the bank thinks it’s worth less than what I paid, and I suddenly need to come up with a lot of extra money to settle (or I lose my deposit)?’
Banks and financiers will ask a registered valuer for a ‘mortgage valuation’ of the property to lend against. These are usually conservative (approx 5-10% below the actual market price). This protects the bank’s risk but it may mean that you have to make up a substantial capital shortfall just before settlement. If you can’t then you may lose your deposit AND potentially be sued by the developer for any further losses they may incur.
A way to protect yourself is to buy property that is less likely to experience this obstacle AND follow the best procedure. For example, buyers of an apartment in a large new building are mostly likely to suffer, as all the apartments settle at once and it is probably more expensive than any older comparable properties, so valuations may be quite low. In contrast, for house & land, the valuer would value the block of land (especially easy in a masterplanned, price-controlled estate) by looking at the $/m2 of the current stage. Then they would add the building contract price (as its probably similar to other houses). Plus being predominantly owned by owner occupiers, it is less risky for the bank than a lot of investment purchases.
As for the procedure, very few developers (or real estate agents) have an in-house settlements team like Resimax – these teams work closely with buyers and finance brokers to know which valuers & lenders are closer to market price, thus helping buyers settle with minimal extra capital requirements at the last minute.
- Foreign Exchange (FX) denominated loans – ‘I can get cheaper interest rates in my country though?’
Some banks will lend money to you to buy in other countries. For example, SG/MY banks may finance a property purchase in Australia. In the past, there has been big differences with the interest rates charged in different countries, or the credit policy may be more favourable in your home country vs. the target country. However, banks will often protect themselves by offering a lower LVR and charge a lot of extra fees. If the exchange rate moves against you (i.e., beyond the loan to value of the asset ratio), the bank may make a ‘margin call’ on you – where you may need to deposit tens of thousands of dollars within 24hrs.
- Rate change before mortgage – ‘It’s off the plan, what if interest rates rise a lot before I can settle?’
If you think rates will rise, some banks/financiers offer a ‘rate lock’ facility, which lets you lock in a rate of a fixed rate mortgage for a period of time up to 60 days (sometimes they will extend this too) – expect to pay around 0.20% of the loan amount. Speak to your financier/broker about your situation.
- Loan approval lapsing – ‘What if the approval isn’t long enough?’
Most lenders will give an approval that lasts between 30-90 days (some longer). With off the plan, you may not be settling for several years – much can change in that time (e.g., bank’s credit policy, property prices, interest rates, etc). Generally, unless your personal situation changes there is a good chance you will be re-approved for the same property with the same financial situation (NB: some banks have even checked your Facebook page to see if anything has changed e.g., job change/loss just before settlement!). To put yourself in the best situation, it is important that you don’t overpay initially, plus start a regular ‘savings plan’ as you head towards settlement. Speak to your financier/broker about your situation.
- Building delays – ‘What happens if it takes a long time to build?’
With house & land packages, a major benefit is only paying stamp duty on the land and then building a house on ‘your’ land, – as opposed to paying more than double in stamp duty on and off the plan property of similar value. However, a risk is that you’re paying a mortgage on the land component during construction period (approx half of the total loan amount). With the current shortage of materials and tradespeople, some builders are taking 12 months+ to complete a build. Volume builders, such as Tick (part of Resimax Group), usually have long term tradespeople working in teams fulltime with massive bulk buying capacity, – so they can usually build a house in a much shorter period of time. This can save the buyer a lot in mortgage payments and other holding costs before earning rental income.
- Cancelation of contracts (‘sunset clauses’) – ‘What if they don’t build it?’
Sometimes problems occur (e.g., costs of materials/tradespeople, planning approvals, site costs, etc.) that make it impossible or commercially unviable to build. So, a builder may cancel a contract by waiting for the ‘sunset clause’ date to pass. Luckily in Australia, deposits are usually held in a trust fund, so the return of deposit will occur automatically (NB sometimes it can take a few months). However, the buyer has an ‘opportunity risk’ where they have missed out on capital gain in this project, whereas they could have invested in another and received the capital gain. A good way to minimise this risk is by dealing with a combined land developer and builder – as the builder knows what they are getting from the land developer and have fewer surprises. It is also important to check if the builder/developer has a history of cancelling contracts due to the sunset clause expiry to then profit by re-selling the property at a higher price. You are better off trusting a developer/builder that is willing to honour contracts even after sunset clause (i.e., so the buyer receives all the capital profit).
Resimax Group, and their partners, can provides many protections against these less common risks (plus the common risks discussed in Part1) with its industry leading 5/10/20 guarantee. That is 5 years capital protection, 10 years monthly cashflow guarantee to underwrite your rent (plus you get the upside when the rent increases!), and a near tripling of the government’s statutory 7 year building warrant to 20 years – speak to us to find out more.
Disclaimer: This article is for general information purposes only and should not be taken as advice. Always seek professional advice from suitably qualified professionals familiar with your situation and goals.
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Steven Molnar is Head of Research and Education for Resimax group. With over 25 years in property and finance in Australia and internationally, he brings a unique perspective to each interview with interesting guests and property insights. Resimax group is one of Australia’s largest private property developers, Resimax Group Investor is headquartered in Kuala Lumpur MY.