How To Reduce Investment Risk In The UK
There will always be a risk to investing. Regardless of the type of investment you’ve made (or are planning to make), there will be periods of high returns and sometimes, potential loss. As it turns out, risk is part and parcel of the world of investment.
While the mere presence of risk is enough to turn some people away from making even the smallest investment, you shouldn’t be deterred by this. Merely saving money in a bank isn’t enough to generate wealth. In fact, it has been proven to be one of the most ineffective methods of investing money. Without the aspect of risk, growing your money will be an impossible task.
What exactly is investment risk? To put it plainly, it is that exact uncertainty felt when making an investment that defines “investment risk”. The two key factors of investment risk are volatility and liquidity.
Volatility refers to how much investment value goes up or down – with high volatility investments providing the potential for bigger rewards.
Liquidity, on the other hand, relates to the ability to quickly sell or buy an asset without causing a drastic change in its price. The more “liquid” investment is, the easier it is to buy or sell. Liquid investment examples include company shares, money market funds and foreign currencies. In contrast, an example of non-liquid, or illiquid, investment is real estate.
Real estate or property investment is one of the most popular forms of investment in the UK. However, the housing market is both illiquid and volatile, making it one of the more risky investments a person can make. Thankfully, there are ways to reduce uncertainty in these types of high-risk investments.
Things you should not overlook if you want to make a real estate investment with minimum risk
Whether you’re a first-time buyer or a seasoned property investor, there are a number of basic rules of thumb to keep in mind when wanting to reduce investment risk in the UK.
Here are the top four things you shouldn’t overlook when making a real estate investment:
1. Make a prior internal analysis
An internal analysis refers to the deep and thorough audit of a person or company’s assets, resources and risk factors. There are seven methods of conducting internal analysis:
- Gap analysis
- Strategy evaluation
- VRIO (Valuable, Rare, Inimitable, Organised)
- Organisational Capacity Assessment Tool (OCAT)
- McKinsey 7S Framework
- Core competencies analysis
Running an internal analysis prior to taking any investment risk is crucial to determining whether the investment is worthwhile. This essentially allows you to gain as much detail as possible regarding the property and gives you the opportunity to analyse it from various angles.
When it comes to property investment, the best internal analysis method to use is “SWOT” analysis with SWOT standing for strength, weakness, opportunity and threat. Conducting a SWOT analysis specifically will allow you to make more informed decisions regarding your potential real estate investment. The SWOT analysis will also help you come up with a practical plan or to develop a valid strategy to improve the investment over time.
2. Search for properties and check all the details
One of the most overlooked aspects of property investment is time. In this day and age, instant gratification is everywhere in a world where we can access everything we want and need with a tap of a button. The worst part is that real estate agents are good at feeding into this need for instant gratification, with subtle yet direct pressures to “buy now”. However, a hasty decision can lead to terrible investments.
When looking to make a real estate investment in the UK with minimal risk, it’s important to take your time. Unlike the rental market, buying a property isn’t as hot – you are less likely to find a property sold as quickly as you might find rentals to be. So, make a list of potential properties to invest in, and be sure to obtain as much detail about each of them as possible.
Here is a quick checklist of all the important information you’ll need when searching for properties to invest in:
- Investment purpose
- Profit opportunities
- Age of property
- Condition of property
- Overall housing market
3. Study the expenses and income of the investment
When looking at investing in property, a key piece of information that you need to learn, on top of the nine points mentioned above, is the expenses and potential income of your property investment. On top of the total purchasing price, you need to find out the expenses related to owning that property.
Expenses can include but are not limited to: mortgage payments, property taxes, stamp duty, insurance, maintenance costs and potential structural replacements.
Before you decide to purchase a property to invest in, you also need to calculate the potential income that will be generated. Incom from a real estate investment typically relates to rent but could also include late rent payment fees and, if the property is a penthouse or apartment, income could come from renting extra parking spaces, storage space or even laundromats.
The best types of high-risk investments are those you know you’ll be earning a profit from. With property investments, you can calculate potential profits by deducting the value of expenses from the value of the total income.
4. Don’t be impatient
On top of allowing yourself time to evaluate a potential property investment (per point #2), you need to ensure that you remain patient throughout the process – from research to even after making the purchase. Impatience is an excellent way to making riskier investments which can turn out to be detrimental in the long run, especially when it comes to property investment in the UK.
Property investment requires time to work its magic and its illiquid nature means that property isn’t something that you can simply buy and sell on a whim like with stocks or foreign currencies. Those who wish to invest in property with the best possible return on investment risk need to practice delaying gratification. In property investment, patience is indeed a virtue.
Tips to reduce the risks of a real estate investment
Keen on investing in property? That’s great news! Although property investment may not be as glamorous as owning stocks or shares, they are some of the largest assets any investor can have within their portfolio.
With that said, here are six tips to reduce the risks of real estate investing:
1. Take advantage of the benefits of renting
When buying property, there are generally three reasons why people make that investment:
- Buy and self-use – This is where you purchase a property for your own use. Investment returns tend to be lower since the property doesn’t make any income except after a long period of time, if its intrinsic value appreciates.
- Buy and sell – Where short-term tactics seek small- to medium-gains when selling, long-term selling tactics focus on large intrinsic value appreciation over a longer period of time.
- Buy and rent – In this case, a property is bought and then leased out to tenants over a specified and agreed-upon period of time.
The best purpose for property investments is to buy and rent. Renting out your a property that you own offers tons of benefits, such as:
– Passive income stream
– Protection from inflation
– Property value appreciation
– Investment risk diversification
– Security blanket
2. Avoid vacancy
The worst thing a property investor can do is to leave their property vacant, especially when their purpose is to buy and rent. Not only will a vacant property not generate any income, but it is also at risk of becoming a black hole of expenses.
Regardless of whether you’re planning to use the property for short- or long-term rentals, the property should be occupied for at least 90% of the duration of a year. Any less, and you may discover that you’ll generate a loss.
Not to worry, there are tried and true methods to ensure that a property doesn’t stay vacant for too long. Here are some of the best ways to avoid property vacancy to minimise investment risk:
- Be proactive with current tenants
- Stay on top of maintenance
- Update security features
- Reward existing tenants
- Hire a rental agent
3. Take out the necessary insurance
Even if you’re not planning on staying within the property yourself, a smart way to reduce investment risk is by ensuring that you take out all the necessary insurance for the property. Insurance protects yourself, and your property from various forms of damage and legal liability, plus it will normally cover the cost of rebuilding the physical structure of the property itself, such as with renovations.
Here is a list of the necessary insurance that property investors need to reduce the types of high-risk investments attached to properties:
– Liability insurance
– Landlord insurance
– Loss of income coverage
– Content insurance (for furnished properties)
4. Diversify your investments
While this is true for any investor, diversifying your investments is especially important for property investors. Diversifying one’s investment means spreading out their capital across different types of investment classes and/or products.
A well-diversified property investment portfolio will normally consist of a good mix of the different types of property – residential and commercial. Property portfolios that are diverse will also include properties across different geographical locations, whether different regions, states or even countries.
Allowing yourself to diversify your portfolio helps to manage investment risk with the added benefit of improved long-term returns.
5. Leverage your investment
In investing, leverage is the use of borrowed capital or debt as a way to increase potential returns on investment. Leverage is a technique that is most commonly used by real estate investors, and it is the best way to reduce the types of high-risk investments attached to a property portfolio.
Typically, property investors will make use of mortgages as leverage when buying property, although you can also apply for a housing loan to purchase it instead. However, the latter is not a recommended tactic. A mortgage requires you to put down only a percentage of the overall cost of the property as a deposit, while the bank covers the rest of the payment. Although you’ll need to pay back the money to the bank on a monthly basis over a long period of time (with interest), the property will be 100% yours.
Not burdening the full upfront costs of buying property means that you’ll be able to keep more of your own capital. If you have the means, this also allows you to buy more properties down the line to invest in.
6. Control expenses
Unfortunately, the cost of expenses does not remain stable over time. As we’ve seen in recent months, things like energy and maintenance costs can rise drastically due to inflation and global events. However, despite this, it is still very possible to keep control over expenses when it comes to making real estate investments.
Earlier, we recommended that you calculate the expenses that you’ll burden when owning a specific property. In property investment, there is something called the 50% rule, where it is recommended that a maximum of half of the gross income generated by the property through rental should be allocated to expenses. In the long run, you should consider setting aside an additional percentage for expenditure purposes in order to maintain control over expenses.
How to bet on profitable real estate?
One way you can bet on profitable real estate is by house flipping, which you might have seen in television programmes. House flipping refers to the act of buying a low-valued property, renovating and repairing it, and then putting it back on the market by selling it at a higher price. Some property investors are professional house flippers, and they can earn high amounts of profit in a short period of time after purchasing a property.
Another way to bet on profitable real estate is to invest directly in the overall market. You can do this by shorting or putting options on real estate investment trusts (REIT), the stock of a real estate company or a real estate ETF. However, as you might have guessed, this is much like betting on the regular stock market and, thus, is an extra volatile affair. Only do this if you are completely certain that you can handle potentially great losses.
How much money do you need for a real estate investment?
In the UK, the amount of money you’ll need to invest in property differs greatly from location to location. Typically, properties in the south of the UK will be more expensive compared to the north, and properties in rural areas of the UK are cheaper compared to those in cities.
As of May 2022, the average property price in the UK is £283,000, according to the Office for National Statistics. This means that you can expect to need £56,000 on average for a minimum deposit, if you’re planning on using a mortgage to purchase property.
For more advice on property investment opportunities, please visit the news section of our website, or call one of our senior investment consultants on 0203 819 7366