Stress testing an Australian property investment
January 23, 2014 / Written by Rich Harvey
Buying investment property can be highly profitable, but it can also leave you vulnerable to risk.
It's with this in mind that you should do all you can to ensure your risk exposure is minimised when purchasing property in Australia.
One easy way to accomplish this is to conduct a stress test of your property investment portfolio.
In short, this means determining how certain changes in the market will affect your holdings, giving you a better idea of how much risk you're exposed to and any changes you may need to make to better protect yourself and your investments.
Chances are you obtained finance from a mortgage lender when purchasing your investment property, so one area that deserves your attention is interest rates.
If you took out a fixed-rate home loan, you'll be protected from interest rate increases for a set period. However, many investors find themselves utilising variable-rate mortgages, which means they are vulnerable to sudden rises.
You can stress test your interest rate risk by calculating how much your mortgage repayments would increase based on rises in interest. You should also determine how much longer it would take you to pay off your mortgage if this were to occur.
Even if you can still afford your repayments, a hefty rise in rates could eat into your investment profits considerably.
Next, it's a good idea to research which way rates are looking to move in the foreseeable future, and decide if it might be time to lock in current rates to protect yourself against fluctuations in the loan market.
Another factor to test concerns vacancy rates. This is particularly important for investors who depend on tenants to rent out their properties.
You probably already researched vacancy rates in your area, as well as the region's history and potential for vacancy in the short-term. However, you should still determine how your investment would be affected by a prolonged vacancy.
How long would you be able to go without tenants? How much would it cost to keep your property running each month that it sits empty?
One strategy to protect against this is to invest in a vacancy allowance, or a specific amount of money you can have on hand to keep your property afloat in the case of a prolonged vacancy. Conducting a stress test will help you determine just how much money may be necessary for this allowance.
A positively geared property means profit, but Australian property investment doesn't come without its own costs.
The two biggest expenses investors typically need to watch out for concern utilities and taxes.
Utilities such as gas, electricity and water typically go up in price over time. For this reason, it's a good idea to compare how often and by how much utility costs increase, as well as how these costs compare to inflation.
There may come a time when paying utility costs in a certain area is no longer feasible. Even though many property owners have their tenants pay for utilities, it could become increasingly difficult to find renters if utilities rise too high.
Meanwhile, taxes and council rates are always the owner's problem, making it essential to find out how much tax costs will come to in a certain region, as well as how likely they are to rise. It's also a good idea to figure out how future increases in taxes may affect your profit from a sale.
If the numbers don't add up, it may be a wise move to find a property more suited to your requirements.