Working with property investors day-in, day-out for the last 8 years has given me fantastic insights and taught me valuable lessons.
I’ve been able to observe the way people make decisions, the quality of those decisions and the consequences – both good and bad.
Today, I thought I would share with you the top 3 most common property investment mistakes that I see real estate investors make.
In my opinion, avoiding these mistakes increases your chances of being a successful investor by a factor of 10 – if not more. Therefore, if you own property or are looking to make a start, read on…
A) No written plan
People generally fall into four categories. First, there are people who are not investing (they haven’t taken action yet).
There are people who are not investing enough (i.e. who are not maximising their opportunities). There are people who are investing too much (yes, that’s possible).
They think that the clock is ticking and they must buy another property before the bell sounds. These people are probably unnecessarily taking too many risks. Last, there are people who are investing the right amount – not too much and not too little – just right.
There are very few people in the last category.
The sole reason for this is that people fail to stop and ask themselves; “how much property do I need to own (in dollar value), when do I buy it and what do I need to do with it?”
Instead, they buy one to “see how it goes”, get distracted by all things work and family and wake up one day and realise that retirement is just around the corner. Alternatively, some people make a promise to themselves to “buy one property a year”. That is such a meaningless goal and smacks of zero planning (although I must admit that it’s better than doing nothing).
As the old adage suggests, “aim at nothing and you’ll hit it every time”. Having a goal and a plan to achieve that goal significantly increases your chances of success. Here are just a few benefits from developing an investment plan:
- You’ll know exactly what you need to do. How many properties, what purchase price, ownership structure, when and so on. You’ll have something to aim for. You won’t leave your run too late or expose yourself to too many unnecessary risks.
By committing to a plan that is in writing, you’ll significantly increase the chances of following through and implementing the plan. The good thing is a plan breaks down your goal into little bits and these seem more achievable and less daunting.
- Developing a plan will allow you to manage risks significantly better. For example, if you know that you need to add another property to your portfolio in the next 12 months but (at the same time) you plan to start a family, you can ensure that you buy the next investment property before you reduce to one salary. Alternatively, you can take into account future changes in debt levels when setting Life and TPD insurance and the like.
- Developing a financial model (projections) will allow you to see what are the key assumptions driving your financial plan. This will allow you to focus on what’s really important and what will ultimately make your investing a success.
B) Not reviewing performance
Could you imagine a long distance runner training for the Olympic marathon but not timing each run – just training and crossing his fingers that he runs a good time on the day?
It would never happen. The same should be true for property investment.
Why should you invest in property, close your eyes, cross your fingers and hope it performs. How many people reading this article could honestly tell me what capital growth rate their properties have generated? If you can, well done! You are one of the special few. I’d bet that more people could tell me how much their super dropped last year.
Time is irreplaceable. There is one thing that most property investment strategies need and that is time. Therefore, if you are holding investment properties, you must ensure that they are using time efficiently. You don’t want to hold onto a property for 10 years only to realise that it’s a dud and hasn’t increased in value by anymore than 5% per year.
You’ll never get that time back again. You need to find out if your property is a dud as soon as possible, so that you can sell it to the first person silly enough to buy it.
It is absolutely critical that you review your investment properties’ performance periodically (probably annually). Look at the growth (change in value). Compare it to what the general market has done. If we select good quality assets, then we should expect them to outperform the general market.
Therefore, if the median value in your State has increased by 10%, you should expect your property to increase by more than 10% (because after all, the median value is made up of good and bad properties).
Be careful with what data you use and make sure it includes a large number of sales (for this reason I think State medians are better as opposed to suburb median values). Remember, the median is only one guide.
Someone who bought a property for $200,000 10 years ago might be happy that is now worth $325,000. Not me! That’s only a 5% growth rate. I would want the property to be worth $520,000 (being a 10% growth rate). It is easy to get seduced by the dollar value change in property value. A property increasing by $125,000 to $325,000 might seem attractive because $125,000 is a big number – no doubt. However, you must focus on the percentage growth.
Therefore, my best advice is review your properties’ performance and don’t get emotional about it. Some people make up really poor excuses like “$125,000 isn’t too bad. It might pick up”. If it hasn’t grown well in value in the last 10 years what makes you think it will have a dramatic turnaround in the next 10? It’s not. Sell it! You have already missed out on $200,000 of growth because it should be worth $520,000. Review your property’s performance like your least-favourite school teacher reviewed your grades – strict and uncompromising!
C) Not being smart about managing risk
Risk comes with all investments. The higher the risk, the higher the expected return. However, you can exploit this equation by developing a smart risk management strategy aimed at mitigating or transferring as many risks as possible. A risk management strategy is normally developed after the investment strategy. Therefore, once you have determined how many properties, when, where, how much and so on, you can sit down and identify each and every risk. A risk is something that can prevent you from meeting your goals. The most common risks for property investor are:
1. Under-performance – the investment’s capital growth or rental yield (income) do not meet expectation.
2. Ability to acquire sufficient property – this relates to borrowing capacity, having a debt plan and managing cash and equity.
3. Ability to hold onto the property long enough to “do its thing” – this relates to your ability to support the property with other income such as salary. What happens if you lose your job or fall ill and can’t work?
Most of these risks can be mitigated (reduced) or transferred. Fixing your interest rate on your investment loan is one way you can mitigate risk (as your interest rate exposure is therefore capped). Obtaining income protection insurance is one way of transferring risks (as you transfer the risk to the insurance company). It is important that you have a plan to reduce risk as much as possible, as this will greatly increase your chances of success in the long run.
The four letter word
Developing a plan is critical.
In fact, making these three observations led me to writing my latest book: The Property Puzzle.
I felt investors needed to be given the tools to develop their own investment plans. Doing so will empower them and help them to become smarter investors. The book takes investors through a simple 7 step process to developing their own property-based financial plan and avoiding these common mistakes.
Laying robust foundations is critical when building a home. Without foundations, the house will fall to pieces in a matter of years. Planning and investing have the same relationship. Spending (investing) a bit of time upfront to develop a smart investment strategy will make a huge difference. Become one of the smart few who develop a plan.
Of course, I highly recommend grabbing a copy of The Property Puzzle.
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