Investment Risks Worth Thinking About
Posted by Yoofi Gerard Hagan on Thursday, January 3rd, 2013 at 11:28am.
When investing in real estate no one really wants to think about risk any more than they have to. But it is best to know the potential problems and risks that you take when you sign on that dotted line. Here are some to pay special attention to.
Looking at Economic Risk
Canada’s economy and the real estate market are in good shape, much better than that of other global markets. Foreign investors are increasingly turning to Canada as a place to safely invest funds. Domestic investments are also doing well. Still there are risks to consider.
One is the interest rate. Right now and throughout 2013 the rate is expected to remain low. The rate has been low for quite a while and we need to avoid becoming complacent. Eventually things will start inching up. For now the Bank of Canada’s governor Mark Carney has decided to leave the rate at one percent. The risk is that when the rate starts to go up, it will go up too quickly and do some serious damage to your cash flow. If the rate goes up high enough, you could go from a positive to a negative cash flow.
You can help keep interest rates somewhat stable by taking out financing for a longer term, say anything between five to ten years. This will give you a predicted payment amount for a fixed number of years and you will be better able to manage your cash flow and have a steady pay down on that mortgage. Another idea is to take out CMHC mortgage insurance, which can give you a discount off your interest rates for as long as you hold the mortgage. Currently, availing yourself of both options can get you a ten year rate of between three and four percent.
Managing the Vacancy Rate
At present, landlords are enjoying low vacancy rates in most metro areas across Canada. CMHC recently released a report that covered 35 of the major metro area in Canada. The average vacancy rate nationwide was 2.3 percent in April of this year. That is lower than the 2.5 percent seen in the prior April. The thing with having such a low vacancy rates that odds are that it will go up rather than down.
Avoiding a rising vacancy rate is not always possible. But you can put the odds in your favour by investing in an area where the economy seems to hint at continued or future low vacancy rates. Look for area with growing employment, a steady increase in population, plenty of construction and development projects in the works and that already have low vacancy rates.
The Political Part of the Equation
Rent control is a form of risk that should be considered. Each province has its own rules. As an example, PEI, Ontario, Manitoba and British Columbia all have rent control laws on the books that require landlords to raise rents using provincial guidelines. Not only that, the rules can change. Take Ontario for example. Their rent control legislation required landlords to use the Ontario Consumer Price Index for increasing rates. But, in 2013, that law changes and landlords will only be able to raise rents up to 2.5 percent.
Knowledge of rent control laws and pending legislation in areas you are planning to invest is your best bet in avoiding or at least mitigating this type of risk.
Licensing also varies from one province to another, and often from one city to the next. Going back to Ontario for an example, we can look at Waterloo which just passed legislation that added new fees payable by the landlords. In Hamilton, a proposed new bylaw may allow that city to further regulate rental units that have between one and six units. Landlords are fighting this but it’s too soon to see what the outcome will be. Just as knowledge is your friend as far as rent control, knowing about the licensing laws in a potential investment area can also help you avoid that risk.
If you haven’t done your homework and/or don’t know what you are doing, the very act of selecting a property is a risk. Buy a property that has unforeseen repairs in the works and that’s money out of your pocket. That’s called a negative cash-flow investment. Not a good idea for a novice investor. These can be managed by seasoned investors but are still risky.
Things you should consider are your available cash flow, rental rates, risky tenants, properties not up to code, environmental concerns, accuracy of cash flow and structural problems. The key here is to study. On your own you can read books or study online, perhaps even find a mentor. Find a realtor that deals with investments, that is key to avoiding risks.
Looking at the vacancy issue, this can also have an effect on your cash flow. If a property has a consistent high vacancy rate it could adversely affect the value. It could be due to the screening of the tenants or the conditions/reputation of the property itself. Properly vetting your potential tenants including credit checks and following through on references can go a long way in preventing at least some vacancy risk issues.
Unexpected expenses can be an investor’s worst nightmare. Most investment properties run on a budget, usually a pretty tight one. Having an expensive surprise can dampen your cash flow. Getting your prospective investment inspected by a professional and asking for information on the buildings history of maintenance and prior work can help you make a more informed decision as to whether this property is the right one for you.