Risks of investing in property

I have allocated a substantial part of the retirement portfolio to property. Property is attractive as a core retirement portfolio position for much the same reason as shares are attractive - an asset class that has the potential to produce a stream of income (net rent) that will rise over time to compensate for the risks of inflation.

Like all investments, property is not without its risks including:

1. property requires a large lump sum - far more than is required for most other asset classes - making diversification more difficult;

2. property is less liquid than many other investments - in adverse market conditions a seller may be faced with a difficult choice of having to wait a long time for a sale or accepting a lower price;

3. properties require maintenance - maintenance costs are not trivial and need to be realistically provided for when evaluating the attractiveness of a property. Also, longer term maintenance may need to include periodic refurbishment;

4. properties have outgoings - maintenance, rates, management fees etc - which must be paid regardless of whether or not the property has been rented out. Also, there is the possibility of outgoings rising faster than rental levels, effectively reducing the net income from the property;

5. properties require active management - either by the owner or an agent appointed on behalf of the owner (for a fee of course);

6. compared to shares, transaction costs are significant - in Hong Kong stamp duty can be as high as 3.75%, agents fees are typically 1% and there will be legal fees as well. Lastly, lenders typically impose stiff penalties for early repayment in the first three years of a loan;

7. deflation is generally considered bad for properties.

Ultimately, property is priced much like many other assets - on the basis of supply and demand. Property though has two different supply and demand considerations - purchase price and rental value. While there is some relationship between the two, a number commentators have suggested that the relationship has become weaker in recent years - particularly for residential property. The other distinguishing feature about property is the fact that no two properties are the same, giving tremendous scope to either negotiate attractive pricing or to be taken to the cleaners (I should write a post about why I would never want to do business with a property developer). This makes it easy to understand the often quoted rule about investing in property - you make your money when you buy.