Potential pitfalls of property investment

What the free property seminars usually won't tell you

Free property seminars will tell you all about the wealth you can create with investment properties and how you can retire early and live the good life. While this can be the truth, there are certainly some speed bumps you need to watch out for along the way. Here are some of the issues that may crop up.

Timing
You can pick a flat time to invest where your properties may have zero or even negative growth for a period of time. Take Sydney in 2003 for example. If a you purchased a house in Sydney at the peak of the boom in 2003 then you would have had to wait six years for the value of that property to begin to increase.

Source: Australian Property Monitors (apm.com.au)

Bad tenants
No matter how diligent you are when reviewing tenant applications, eventually you will get bad tenants. They could be late on rental payments, they might trash your property. Having a bad tenant when starting out with property investment can put a dent in your confidence and even lead to people giving up. Take out landlord insurance to protect your property and make sure you use a good rental agent - one that has a keen eye for spotting bad tenants and one that has the experience of moving them on.

Prolonged vacancies
Prolonged vacancies can have a profound effect on your cash flow, especially when you are starting out and have only a couple of properties in your portfolio. If you have a prolonged vacancy in a property, you need to determine if the cause is something to do with your property, something to do with the suburb, your rental agent or just a factor of the greater economy. If your property is not attracting applicants, consider a renovation - a paint job and new carpet can go a long way to attracting more renters. If it is your suburb (high vacancy rates) then review whether you want to hold the property long term and consider selling to re-invest elsewhere. If your agent is not putting in the effort then shop around for a new rental agent.

Interest rate increases
Interest rates are currently at their lowest point in recent history. They will certainly rise at some point. Be sure to factor-in an increase in rates when planning your cashflow. Interest on your property loans is typically forms the largest expense and fluctuations in interest rates can have a dramatic effect on your cash flow. Can your portfolio survive if rates were to move up to 8%? Consider moving to fixed rate loans to lock in the currently low rates.

Source: rba.gov.au

Slow suburb growth
Growth rates will vary across regions and even suburbs. You may see high growth in a neighbouring suburb yet low growth in your suburb. Assess why it is that you are seeing low growth. If it is a long term trend then consider selling and re-invest in areas with more potential. If your suburb is just lagging a little compared with neighbouring suburbs then be patient - prices are likely to catch up when your neighbouring suburb starts to become overvalued and buyers move your way.

Changes in tax legislation
There are rumblings in federal government about the depreciation expense allowance for rental properties. The government sees the depreciation legislation, introduced by the Hawke government, as the main cause for inflated residential prices. Don't assume that tax legislation, and the associated benefits, will always remain in place.

Special strata levies
When purchasing recently constructed strata (units and townhouses) there will usually be building defects that require fixing. Normally this will be fixed by the builder if it falls within their warranty period and often covered by the body corporate's building insurance. However, there are occasions where a "special" levy may be imposed on owners for expense that fall out of the regular strata expenses. These can be in the order of thousands of dollars per year and can really put a hole in your cash flow. Be sure to check the strata report of properties before purchasing and steer clear of those that have a recent history of special levies.

Depreciation life-span
Building depreciation won’t last forever. When you purchase your property, you can depreciate the cost of building construction and recent fittings over a period of time. This can have quite a positive effect on your after-tax cash flow. However, this will run out eventually and once it does, your depreciation expense claims, and associated benefits, will start to dry up.

Land tax
Some states charge land tax once you pass given thresholds in land value. Regardless of whether you by a house or strata, there will be a land value associated with your investment and once your portfolio grows to the point where land tax is applicable then you will start to pay. Again, this will begin to reduce your after-tax cash flow. Be sure to talk to your tax adviser about this.

Lack of diversification
Many new investors put all their eggs in one basket - purchasing only one property to get started. Having only one property puts you at risk of falling foul to any of pitfalls discussed here - you could have bad first tenants, you may experience prolonged vacancies which hit your back pocket, you may pick a sleepy growth suburb. All of these can deter an investor from continuing. When starting out, try to pick up two or more "less expensive" properties rather than one more expensive property. Mix up the type of dwelling - try a unit and a townhouse. Pick them in two different cities. This will spread the risk of having one bad egg and get you off to a less stressful start to your investment portfolio.

The information provided is general in nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. You should consider whether the information is appropriate to your needs and seek professional advice from a financial adviser before making any investment decisions.