What are the critical risks of investing in UK residential property?
The first big risk is a contracting economy. In the past (1990s, 2007/8) this has led to price corrections, then strong recoveries. And it will happen again one day. The trick is not to be a forced seller in a downturn. Which means avoiding over-leverage, and ensuring that rental income easily covers the costs and more. Also make sure you get one of the better properties, which tend to be more resilient in bad times.
The second risk is regulation, particularly by the central government. Many changes are positive for all concerned. Smoke alarms. Electric tests. Deposit protection. But others, such as rent controls, might have unintended consequences. The jury is out for other regulations - such as landlord licensing and limiting deposits to one month's rent. Most regulation comes with a cost, and you need to take a view on where this is heading. Ultimately, though, the extra costs are likely to be passed on to tenants. So the authorities have to manage a tricky balance between protecting consumers and increasing costs.
The third risk is a big hike in interest rates. Because mortgages need to be paid. And indeed the only way is up. However, the correlation between rising interest rates and falling house prices is by no means clear. In fact house prices tend to rise as the economy booms, which is when central banks increase interest rates... Perhaps the real risk is a sudden and large hike in interest rates. But the central banks spend a lot of time trying to ensure that things are done gradually.
The other big risks are operational. Voids between tenants. Rent arrears. Property damage. Building issues. If these risks are properly understood, they can often be mitigated. A proper budget should cater for arrears and maintenance costs. Selecting the right tenants, doing the right checks and references, and maintaining the right tenant relationships, can go a long way too. Building issues can be minimised to some extent by avoiding risky situations at the purchase stage.
Another way to think about this is to compare the risks to the alternatives. So in theory, house prices could fall 20% if things got really bad. But look at what happened to the FTSE100 between September 2000 and March 2002. Now that is really something to lose sleep over. A good financial advisor would no doubt suggest that you have a good spread of different types of investment.
Note: this blog is not intended to be investment advice. It is meant to spark thought for investors. One of the many inputs into the decisions they make.
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