Property is unlike other assets you can invest in such as shares or financial instruments.
Owning property comes with substantial holding costs including repairs, property management, land tax, rates, strata fees etc. To manage your risk position, it is important to consider these factors and hold appropriate buffers to cover these costs when they occur across your portfolio.
As mentioned above, these are large potential costs associated with holding property. While known ongoing costs like rates, property management and strata fees should already be factored into your cash flow, it is important to hold buffers for unforeseen expenses.
As a general rule, having $5,000 in buffer funds available for each property you hold is a good start. Obviously you can adjust this figure based on the type of property you own. For example an older, run-down property is likely to need more funds than a new 1 bedroom apartment. Likewise, replacing an oven in a luxury home will likely cost more than a cheaper residence, so adjust your buffers accordingly.
As the buffer is fairly intuitive, we find most property investors do make reasonable attempts to have appropriate buffers in place for some unforeseen expenses across their portfolio.
Unlike repairs and unforeseen expenses, rental reliance is a risk often overlooked by property investors. However, this is definitely a risk category banks look at when they assess your ability to repay a loan, so at the very least it is something you should have awareness of. Rental reliance is the percentage of your total income that comes from rent. For example, if you and your partner make $150,000 in wages per year and earn $50,000 in rental income from your investment properties, your rental reliance would be 25%.
Banks are interested in this figure because it reveals to what extend your portfolio is funding your life and what capacity you have to use other income sources to cover any fall in rental income. A lower rental reliance is considered safer as your income from employment is still the driving factor of your cash flow. This means that you can better absorb any downturn in your rental income due to unforeseen circumstances like a fall in the rental market or a fire that makes your property unliveable for a period of time.
On the other side, a high rental reliance indicates that your property portfolio is driving your cash flow position more than your income from employment. This puts you at greater risk of being unable to weather a fall in rental income, as it represents a greater percentage of your overall income.
The key benchmark for rental reliance some banks use is 50%. Under 50% is considered relatively safe while over 50% raises some risk factors. Some lenders will even go as far to refuse to use any rental income over this 50% limit for servicing because they are concerned about the balance of your overall income.
You should also factor this concept into your own consideration of risks and buffers. When less than 50% of your total income is from rent there is little need for concern. However when this approaches or passes 50%, you should consider how you would respond to an unexpected fall in your rental income. Can you support a fall in rents out of your income? Do you have sufficient cash buffers in place that can be used to plug a temporary shortfall? If rents did fall would you be prepared to make lifestyle sacrifices (e.g. reduce your living expenses) to cover the shortfall?
If your portfolio has a high rental reliance, these are the sorts of questions that you should ask yourself and make sure you are comfortable with the mitigation strategies and buffers you have in place.
Like income insurance, property insurance is also a consideration you should have for your risk profile. Naturally, if you have insurance in place to mitigate potential costs, then you will need to hold less buffers.
In the main, property insurance can assist with periods where the property is not rented out (a feature of some landlord insurance policies) and to any structural damage or repairs that are required.