The decision to invest in buy-to-let property should be a carefully considered one. Besides the associated costs of owning a rental property, there are a number of risk factors which investment property owners should be aware of. For those wanting to navigate the rental property space, here’s a complete guide to what it entails.
Access bond: If you’re financing your rental property using a home loan, consider applying for an access facility. If you have paid extra money into your home loan over and above the required minimum bond repayments, an access facility will allow you to withdraw the extra funds at a later stage. Keep in mind that any surplus money paid into your bond will have the effect of reducing interest and, in turn, increasing your net returns.
Annual rental increases: When it comes to putting through annual rental increases, you will no doubt want to ensure that these increases keep pace with annual inflation. While there are risks associated with having bad tenants, don’t lose sight of the fact that there are also risks associated with having good tenants. Many landlords, reluctant to put through market-related rental increases for fear of chasing good tenants away, cut their losses by keeping rentals lower than what the market is charging.
Bond originator: If you are financing your rental property, consider using a bond originator to find you the home loan with the most favourable terms. A bond originator will help you prepare a single application which will then be submitted to a number of banks on your behalf. They will help you fix your credit score, put all the necessary documentation together, obtain pre-qualification, and secure the most favourable interest rate from among the banks applied to.
Diversification: If you’re planning to purchase a rental property, it’s important that you keep in mind that the lack of diversity is an investment risk. As an investment, a single rental property is considered a concentrated asset which requires heightened risk awareness. If you’re intent on owning rental property, consider spreading your risk by investing in other asset classes or investment structures such as a unit trust portfolio.
Forced sale: Keep in mind that fixed property is an illiquid investment. The buying and selling process is generally a lengthy one which can create liquidity problems if you need your money urgently. If you’re forced to sell your investment property in order to access your capital, you may need to settle for a price lower than its market value.
Gearing: Gearing is the practice of borrowing money from a bank to fund the purchase of your investment property. As such, investment property is one of the only asset classes that you can finance with borrowed capital. Borrowing money to purchase a property allows you to generate wealth over time as the value of the asset appreciates and the bond amount decreases as a result of using rental income earned to reduce the bond.
Home loan: Negotiating the most favourable terms possible for your home loan upfront is key to your longer-term investment returns. Your credit score is an important factor in determining the interest rate offered to you by the bank. If you’re planning to invest in property, take all steps to boost your credit score to increase your chances of being offered a better interest rate.
Insurance: When purchasing a property, you will need to factor insurance costs into your budget. If you have a home loan over the property, it is likely that your bank will insist that you have appropriate bond cover in place to provide security for the loan. Your bank will also probably insist that you have building and contents insurance to protect the property and existing structures against fire, flood and other natural disasters.
Interest rates: If you’ve financed your property with a home loan, interest rate fluctuations can impact your bond repayments and, in turn, your net profits. An interest rate hike can affect your monthly cash flow.
Joint ownership: If you and a partner or friend intend to purchase an investment property jointly, be sure to put the appropriate legal agreements in place to protect your interests. Joint ownership of property comes with a unique set of challenges so it is vital to ensure that your agreement clearly sets out who is responsible for what costs, when the properties will be sold and a strategy should one partner want to exit the arrangement.
Landlord: To ensure that there is no confusion between you and the tenants in terms of what falls within the ambit of the landlord’s duties, be sure to specify your duties in your rental agreement.
Maintenance: Property maintenance is generally ongoing although the requirements in terms of maintenance can fluctuate from month to month. As such, it is wise to budget around 0.5 – 1.0% of the property’s value per year to maintain the property in good order.
Net rental income: As an investor, calculating the real return of your investment will be important to you so that you can determine whether the investment is generating a profit or not.
Ongoing costs: Calculating the ongoing costs of owning a rental property is important as you will want to ensure that these costs do not eat into your profits. These costs could include water and electricity, Wifi, armed response, levies, garden and cleaning services, and so on.
Passive income: Once you have paid off your bond, the net rental income you receive – being less rates and taxes, insurance and maintenance – will be classified as passible income and is taxable.
Rental agent: If you intend to outsource the management of your property to a rental property agent, be sure to factor these costs into your budget. Generally speaking, rental property agents charge upfront advertising and placement fees of around 8% of the value of the lease, plus ongoing management fees of around 8% of the monthly rental amount.
Rental insurance: Rental property owners are able to mitigate the risk of tenant vacancy by taking out rental insurance, although this type of cover is generally expensive. There are a few insurance companies that offer risk cover protection that cover three months’ worth of rental, limited legal costs and damage to property.
Rates and taxes: The rates and taxes on your rental property will depend on the municipal valuation of the property which in turn is based on the market value. Each municipality sets its own rates which are dependent on the use of the property and the geographical location, so be sure to ask your estate agent for these numbers.
Saturated market: Rental property markets fluctuate and as a property investor you need to be prepared for times when the rental market is saturated. In a saturated market, you may find it difficult to increase your rental in line with annual inflation as this could chase good tenants away. Be sure to factor such eventualities and risks into your planning.
Tenants: The quality of your tenants can have a huge bearing on your profits, and it is, therefore, important to vet them carefully. Disruptive, overly demanding or litigious tenants can make your job as landlord unenjoyable and costly, so put steps in place to ensure that you vet them carefully.
Transaction costs: Buying and selling property is expensive, largely because of the high transaction costs involved which include bond origination and registration costs, transfer duties and deeds office fees. As such, it is important that you are prepared to take a long-term view of your investment.
Upfront costs: Be sure to do the maths when it comes to the upfront costs you may be faced with such as connection fees, alarm installations, renovations, carpet fittings, painting or landscaping, to name just a few.
Unexpected costs: Budgeting for unexpected costs can be difficult, but it’s important to assume that you will be faced with unanticipated costs at some stage. As a guide, consider keeping the equivalent of one month’s rental in accessible savings to cover unexpected costs such as insurance excesses, costs not covered by insurance, thatch repairs, pool leaks and other expenses associated with running a home.
Vacancy risk: All investments come with varying degrees of risk, and property is no exception. The risk of tenant vacancy is a real one that should be factored into your planning. Most investment property owners assume a half-month per year of occupancy for tenant risk.