PROPERTY investment is arguably one of the most secure investments, especially in the current volatile market. After all, as the world’s population continues to increase, it will become harder to obtain land, which is a limited commodity. Real estate prices might depreciate briefly at times due to some foreseen or unforeseen circumstances, but prices can only appreciate in value over time due to the ever-growing demand for living spaces.
History can testify that property investment is a marathon that investors often emerge as winners in. One can gain from the value appreciation the longer they endure holding the property while the rental yield can help sustain the endurance.
However, risks are part and parcel of any business venture or investment. There is the possibility that an investment’s actual returns might be different from what is expected. This is usually expressed in terms of volatility of return.
One could end up with a windfall when the risk taken pays off, or one could end up with scraps when it does not. Generally, the greater the risks, the greater the rate of returns an investor will expect.
Here are the five “L”s of property investment risks:
1. Legal risk
(i) One must ensure that their title deed is genuine, as there have been the odd cases of fraudulent title dealings in the past. You must be certain of the identity of the person whom you are dealing with.
(ii) As we are living in a developing economy, town planning and zoning are constantly evolving in response to new circumstances. What was built for a residential purpose could be zoned for commercial and retail purposes later.
(iii) The status of the entities involved in a transaction is also critical. When a person is pronounced a bankrupt, his or her assets will be liquidated to pay off the creditors and this includes his or her properties. More importantly, the bankrupt person can no longer make decisions on the property. The same goes for a company undergoing winding-up proceedings or when a receiver is appointed to take over the conduct of the company. In dealing with a company, it is also crucial that the person making the representation has the right authority to do so.
(iv) Occupants of the property are a risk themselves. Property owners cannot take the law upon themselves when dealing with tenants and squatters who do not pay rent or damage or trespass on a property. Malaysian law generally favours those who are in possession of the property.
2. Liquidity risk
(i) The nature of a property investment is such that one cannot withdraw his or her investments quickly. One will not be able to buy or sell an investment as and when one likes. There are inherent liquidity risks to property investments. This is precisely why property investment is favoured over others as high liquidity enables speculation.
(ii) Funds obtained from the disposal of properties will not be instantaneous. Tenants to fill a vacant property cannot be conjured from thin air. During that period the property owner will have to contend with the necessary holding costs. Property transactions also take time to conclude.
3. Leverage risk
(i) The beauty in property investment is one can leverage on other people’s capital so the risk is shared as well. However, there are inherent risks in leveraging on various financial instruments or borrowed capital.
(ii) These leverage risks come not just from banks, but also from the borrower’s own profile. Loan callback as a result of the borrower’s default in servicing the loan is very detrimental as it would be difficult to raise the repayment of the whole outstanding loan sum beyond the default monthly payments in a brief period of time.
(iii) Monies raised from foreclosure proceedings might be insufficient due to market conditions that may require the borrower to top up the difference although the substantial part of the outstanding loan would have been covered by the proceeds of the court-sanctioned forced sale.
(iv) Revaluation of properties (although not common in Malaysia) might also result in a borrower having to top up his or her loan in compliance with the terms of the lending institution.
4. Large sum risk
(i) Investment returns are proportional to the amount invested. With larger investments come the potential for larger returns thus larger risks as well.
(ii) The discerning investor should always aim to make as much money as his or her risk profile can tolerate. Some stress test can be simulated before hand on one’s ability to hold in the worst case scenario of no income for a period of time.
(iii) Large investments will almost certainly demand the investor’s full attention due to the high stakes involved.
5. Long-term risk
(i) It is fair to say that property values appreciate over time, therefore investors must never ignore the importance of investing in time as well to ensure a reasonable return.
(ii) Events of the world are unpredictable. There could be acts of God or natural disasters that may cause havoc, including to the property market.
(iii) Accumulated values over time may come to nothing during a market downturn. It is up to the investor to maintain his or her holding power and this can be very challenging.
(iv) To minimise this risk, a discerning investor has to understand his or her risk profile. Take time to examine one’s risk requirements, capacity and tolerance.
(v) Identify the issues concerned based on the risk profile as well as the external circumstances. One must also understand and communicate with all the stakeholders who are assisting him or her with the transaction.
(vi) Decisions should always be based on accurate information from a credible source. A property portfolio should also be insured and common packages include asset protection, income protection, legal liability, terrorism protection, etc.
(vii) Thus, it is wise to always increase and diversify your options. You should never put all your eggs in one basket.
If you have any property-related legal questions for Tan, please go to the Tips section of TheEdgeProperty.com.
Chris Tan is a lawyer, author, speaker and keen observer of real estate locally and abroad. Mainly, he is the founder and now managing partner of Chur Associates.
Disclaimer: The information here does not constitute legal advice. Please seek professional legal advice for your specific needs.
This story first appeared in TheEdgeProperty.com pullout on Jan 27, 2017, which comes with The Edge Financial Daily every Friday. Download TheEdgeProperty.com pullout here for free.
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