Investor Mistakes: Not understanding the risks and downsides.
Not having a Plan B and Not understanding the risks and downsides.
By James Upton
Disclaimer: Nothing is this article is meant to constitute financial advice of any kind, and is the opinion of the author only. Seek professional advice before making any financial decision.
When I tell people that I am a property investor their response is often;
“Oh really, you must be a bit of a gambler… Bet you are hoping the market rises again soon?!”
When I hear this response time and time again, I have a little chuckle to myself.
In my opinion I could not be less of a gambler if I tried and I have strategies no matter what the market is doing, not simply being a speculator and waiting for it to increase. In all reality, my risk tolerance is very low and I have a number of exit strategies or Plan B, C and D’s for every trade property or buy and hold property I purchase.
For example, I just completed a trade in South Auckland. The property was a 3-bedroom, 90sqm house of fibre cement construction on a 607sqm plot of land. The first port of call is buying well and knowing the Plan A strategy.
In this case it was a Do-Up property, so the formula, which I thought would produce the greatest profit with a minimal risk was to settle the property, carry out a cosmetic renovation and then sell the property, targeting a first homebuyer. I negotiated hard and with the help of an agent I have dealt with on a number of occasions I was able to get the deal across the line at $525,000. I knew this was a good buy as I had seen similar properties selling in the mid $500,000 and once it was renovated, I saw it as comparable to properties selling at the $650,000 mark.
So, the first Plan B was buying well enough that I could do a nomination or contemporaneous settlement to another trader. I knew there would be traders around that I could pass this onto for $535,000, make $10,000 and not have to settle the property. That’s a great Plan-B but I believe it was more profitable to settle and carry out the renovation, so that is what I did.
The renovation took five weeks to complete and cost $37,000 plus GST. Over that 5-week period the agent and I worked on lining up a buyer, so that the minute the property was ready we had genuine, qualified buyers. The property ended up selling for $660,000 and very quickly, thus meaning everything went to plan and it was the best-case scenario. However, for the sake of learning I had a couple of other strategies up my sleeve should the market have completely dropped or I was struggling to sell the property.
Plan C was having enough margin in the deal to be able to drop the price and undercut all the comparable competition in the area. This might have meant making $25,000 less in profit but the property would have flown out the door at a $635,000 price point.
The Plan D for this property and the last line of defence for all my trading endeavours is to hold the property and either rent it out short term if there is just a small speed bump in the market conditions or rent it out long-term if the market has had a major “road closure”.
Luckily, in all the trading I have done I have not had to implement this strategy but it is great to have it there as a worst-case scenario. This property, even in this hypothetical slumped market would have still valued at $660,000 so I am realising instant equity of almost $100,000 straight way. Because I deal at the lower end of the property market with lower buy-in and sell-out the rent from this property would cover my mortgage. With the renovation completed I see similar properties in the area renting for $600 per week. It obviously is not ideal for a planned trade to turn into a buy and hold but having that last resort backstop in place puts my mind at ease, knowing all of my bases have been covered.
By going into a deal with your eyes wide open to all the downsides that could affect the outcome means you can put measures in place for each and every one of those.
This does not just minimise the risk of the deal but in my opinion gives the investor a lot of confidence. Remembering, most of property investing is based around working on the investor rather than the investment and confidence in ones decision-making process is gold.
In short, plan for the worst but hope for the best, and be confident in the backup plan that is in place.
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