The dangers in risk:reward blindness

One of the foundational elements of the property game is selling. Whether it’s real estate, professional services or a particular investment strategy, the seller’s plan is to convince the buyer that they’d be mad to pass up the opportunity.

The unfortunate thing is that many people lose money because they want to believe they are on a ‘sure bet’. They focus on the return and ignore the risks.

While we’d all like to find that diamond ‘low risk/high return’ opportunity, the truth is they’re as rare as a four-leaf clover.

Yet every day I hear about shifty “advisors” looking to fleece unsuspecting mum-and-dad investors out of their hard-earned money by selling the dream of wealth without risk.

Here are some of the issues to look out for and what you can do to avoid risk:reward blindness.

 

Confirmational bias

A huge part of the challenge is a concept called ‘confirmational bias.

Confirmational bias is where humans unconsciously seek out evidence that will support their already predetermined conclusion.

For example, if we’re already convinced cashflow properties are the best strategy for our investment plan, then our due diligence will have us leaning into research that supports that opinion. We will write off evidence to the contrary about the superiority of capital gain assets and will not knowingly entertain the idea we may be wrong.

This can see us investing in a range of property types that come with some serious risks. Here are a few of the main offenders:

 

Dual key

This is where a single block of land has a detached property containing two adjoined living areas. The big sell is that for the cost of a single holding, the landlord gets double rent. It looks good on paper, but (if the floorplan design is wrong) the downside risk is that on exiting this property, the only buyer for this type of property is investors or families who specifically need two separated accommodations. This limited buyer pool means you have less chance of achieving a premium price at resale.

 

NRAS

The National Rental Affordability Scheme was introduced back in 2008 to promote affordable housing options. Private investors purchase homes that enter the scheme, and the federal government subsidised the rent for 10 years.

But you are locked into the scheme and at the whim of legislation, which means there are very few buyers who will want your property when the subsidisation is running out. In the wrong areas, capital gains on these properties are atrocious.

 

Short-stay accommodation

Strata-titled units in a pooled management complex used for short-stay options. Think serviced apartments where each unit is separately titled.

The problem is you’re locked into the management agreement, and if the management company goes bust, or is a poor operator, your hip pocket will suffer. Again, a limited end buyer pool for these.

 

Student accommodation

Similar to short stay. These are purpose-built student bedsits and units in managed complexes. They’ll include furniture, WiFi and cool common areas.

The risks? Well, you only need to see what happened during the pandemic when the population of overseas students disappeared. These units also have atrocious capital gain potential. No one wants to buy them second hand and they can not be purchased to live in*, limiting the resale buyer pool.

*except as a student for the period of study

 

Five ways to balance the risk:reward ratio

 

 1. Start with the end in mind

It’s a classic Stephen Covey saying but it rings true in property investment. You must think about what your exit strategy looks like before you buy the asset, not after. Will there be enough buyers to ensure you can sell? Are capital gains likely? How will the sale fit into your strategy? What price do you expect to achieve?

 

2. What’s your worst-case scenario?

This is where you think about what the worst that could happen would look like, and whether that scenario is financially survivable. For example, what happens if your tenant base (e.g. students) dries up? How about if an industry (e.g. small-town mining) shuts down? Will you be left with an unsaleable asset, or is there still a pool of buyers out there?

 

3. Who are your tenants and who is your buyer?

We need both sides of this equation to make the investment work. The greater the number of tenants and buyers your asset could attract, the better your rental and sale prospects are. Will the home only suit a very particular demographic of tenants – say, students or shift workers? Will it only attract a small percentage of the available buyer pool, e.g. just low-spend investors, or multi-generational families?

 

4. Who is selling you the property?

Think about the motivations of the person selling you this asset. Are they the builder/developer who is directly profiting from this deal? Are they marketeer-type agents who are spruiking it at a seminar? Is it a property investment “advisor” who seems to only deal with one type of property (e.g. off-the-plan units in regional centres)? Ask some questions about the arrangements and look for anything fishy.

 

5. Check the details of any agreements.

Look at whether the asset you’re buying is subject to any additional agreements or deals. Is there a management agreement you must contend with? Is there government incentives or legislation at play? First, you must identify these influences, then you must understand them. The devil will always be in the detail, so don’t get lazy or you could lose money. Take the time to fully comprehend what you are signing up for.

 

Balancing out risk and reward takes effort, but the downsides can be huge. If you feel overwhelmed by the task, be sure to talk with a truly independent property advisor. They can lay bare the downsides so you can determine if the upsides are worth the peril.

 

Always review any property location research and investment analysis data, with a professional, QPIA (PIPA Member) qualified & accredited ASPIRE Property Advisor Network Advisor. Never rely on glossy sales brochures or property marketing information, ensuring a property is right for your strategy. Property Investing is about BUYING a property that matches your goals and aligns with your investment strategy, never be SOLD an investment, know your numbers!

Visit www.aspirenetwork.com.au or call our office to be connected with an accredited and independent Property Investment Advisor on 1300 710 933.

 

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