Risks in Property Investment



Property investment involves an initial capital outlay in return for the expectation of future income receipts. As property investment can be very capital and cash flow intensive for medium or long term, it is therefore important to evaluate the risks involved before making an investment decision. The risks may involve uncertainty concerning the degree of rental increment and uncertainty over obsolescence, declining rental values and the need for further capital injection (i.e. for refurbishment, etc.) as well as uncertainty as to how long the investment will be retained and what it might be worth when eventually sold. These uncertainties together other factors such as liquidity, cost and inconvenience of management etc., should be considered and reflected in the overall yield when assessing the feasibility of the investment.

 Rental value and rental growth 

 Typically, for property investment especially for a property purchased on mortgage, the rental plays a very significant factor in balancing the owner’s cash flow (e.g. to offset the monthly mortgage repayment, maintenance fee, etc.) in maintaining the property. A healthy and positive income from the rental collection will also greatly increase the return of investment when liquidating the property. For cases where the property is generating good rental value, it may be decided to keep the property for long term to maintain the positive passive income.

 However, in reality, future net income (e.g. rental received minus the maintenance fee, Cukai Tanah, Cukai Pintu, utility charges, refurbishment cost, etc.) may vary from expectations due to changes in economic growth and inflation, competition from new/adjacent development and timing of rent reviews and the cyclical nature of the market. For example, the Kuala Lumpur's high-end high rise residential rental market has been on the downward trend since 2015 partly driven by the slowdown in the oil and gas industry, which one of the major employers of expatriates in Malaysia. This has impacted the number of expatriates employed in the Malaysia's oil and gas sector directly affecting the demand in the rental market causing the asking rents to fall. 

 For investments involving high mortgage, this uncertainty may be more relevant than for others such as industrial investments that typically have higher yield where little growth in income is anticipated. Similarly, low yielding retail investments may be considered more risky than high yielding industrial investments simply due to the higher rental growth expected.

Yield on sale and timing of sale

Although property has traditionally been considered as a long term investment it is likely that it will be sold at some stage. In Malaysia context, increasingly this holding period has become shorter and performance over the short term has become vitally important. Considerable uncertainty therefore exists as to when a property will be sold and what price will be achieved. The price in turn will be affected by the rental income and rental value and the capitalization yield which may be lower or higher than at the appraisal date. The strength of the property investment market may also affect the capitalization yield. For example, the following chart shows the KLCC high-end non-landed residential property average transaction price between Q3 2012 to Q3 2016. The transaction price has peaked in 2014 and start decreasing due to economy factor.

                                                                                                       (Data source: The Edge Property)

 Aging property and obsolescence

The problem of obsolescence (i.e. the property or location of the property becomes less attractive over time) can affect both the rental and re-sale values of a property. For example, initially when a shop house was bought, it was a prime location popular to the local residents. However, as time passes over years, new sites have been developed with better infrastructure that has attracted the local residents. Consequently, the rental and re-sale values of the property will depreciate. For a prime retail investment where site value will be a high proportion of investment value and where ‘refurbishment’ will probably be undertaken periodically by the tenant, uncertainty will be greatly reduced compared to a suburban/provincial office investment.

Similarly, a residential property can go through the same situation over years due to continuous aging of the neighborhood and infrastructure with minimum maintenance  or refurbishment. 

Rental cycle

The rent tenure and timing of rental review will have a significant bearing on uncertainty . Property that requires renewal of the rental agreement on annual basis will increase the uncertainty as the income stream will not be guaranteed once the rent tenure ends. The tenant may not want continue to rent the property and if the renting market is weak, there may be difficult to re-rent the property. Not only will there be uncertainty about the level of rent but also about how long until that the property will be re-renting out. There may be an extensive void period. When eventually re-rent there will be uncertainty about a future tenant’s covenant and therefore the security of that income, relating both to the rent tenure and the reliability of the tenant to pay the rental. Even for a new prime investment, where the above problems are less relevant, the time from the appraisal date to the date of the next rent review will affect capital value and its certainty. Typically, the nearer the rent review date and the more reversionary the investment, the greater the uncertainty of investment value. Just after a rent review uncertainty is minimized, just before a rent review uncertainty is maximized.

Liquidity, management costs, taxation and inflation

Uncertainty will exist about the value of an investment at such time as a disposal occurs. This will be compounded by the ease of selling - how long it takes and how much it costs to sell. In this sense a prime investment may be considered less risky than a secondary investment as it will be more marketable, particularly in a weak property investment market. For example, a low yielding residential investment may be considered more risky than a high yielding retail investment due to the higher rental growth needed to provide the same equated yield. In this sense the equated yield of the retail investment is more secure as it may be achieved largely from the initial yield, requiring little or no rental growth. However, in terms of marketability (and obsolescence) the uncertainty of the retail investment may be much greater than the residential investment.

 In addition, the tenure (freehold or leasehold) of the property may also affect the resale as the transaction for leasehold property will take a longer process for approval by the state authorities and subject to further assessment by the financial institutions for the loan application of the next buyer. Refer to the difference between freehold and leasehold for further information.

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