Steve McKnight’s Market Update Summary, April 2016

Last week, Steve McKnight visited Brisbane, Sydney, Canberra and Melbourne to offer his expert insights on the current state of the real estate market in Australia. Over 1,300 investors attended, seeking answers on where property prices are headed and how to invest accordingly.

For those who were unable to attend, I’ve boiled down over two hours of training and education into four key takeaways:

1. Watch Out For Pitfalls On Your Journey To Financial Freedom.

Your Investment Property magazine’s 2012 investor of the year award went to Kate and Matt Maloney. From their late teens, they had a passion to achieve financial freedom and to retire as soon as possible. They took action and sought properties that would offer the highest yield, while also providing the greatest growth.

They first identified “the ideal places to invest.” Before long, they had built a portfolio of 16 properties with an estimated total value of nearly $8.5 million. By age 24, they were in a position to retire, with around $100,000 in passive income.

“We’ve done the hard yards, starting our investing when we were teenagers, and now we just want to enjoy ourselves,” said Kate.

Unfortunately for them, their blissful feelings were short-lived. They had chosen to buy in Moranbah, Queensland. Had they heard Steve’s fervent warnings to avoid one-industry mining towns, perhaps they could have been spared the pain that was to come.

If you saw the 60 Minutes special in February, you know the end of the story. Currently, Matt and Kate owe $5.8 million on a property portfolio that is now worth $2.3 million.

To their credit, they have been brave enough to share their story as both a warning and an encouragement to others.

“We bought too many properties. We bought them too quickly and with high leverage. We absolutely did the wrong thing…It was just debt on steroids. We’ve gone from the poster child of success to the poster child of financial screw ups.”

Here are the five lessons that Steve offered from their story:

1. Markets Change. This is true everywhere, and not just in mining towns. How would you cope if the market where you invest suddenly changed?

2. You Bank Dollars, Not Percentages. If you’re measuring your wealth on the basis of unrealized gains, just remember, that’s not money in the bank.

3. Your Investments Are Only As Good As Your Assumptions That Underpin Them. The biggest assumption of most investors is, “Someone will want to buy my property at the price I expect, when I’m ready to sell.”

4. Grow Your Asset Base Using Cash, Not Equity. If you’re doubling down on debt, using equity to fund more purchases, then you’re adding significant risk to your financial future.

5. Invest in Areas Where People Want to Live and Work. Don’t just invest where a lot of other people want to invest.

If you want to hear directly from Kate about the lessons she’s learned along the way, check out her website: www.katemoloney.com.

2. Remember That Not All Real Estate Will Make You Money.

Many investors enter the market assuming that all real estate inevitably increases in value and that someone will want to buy their property in the future at the price they expect.

Matt and Kate’s story is proof that not all real estate will make you money. In fact, some real estate could break you financially.

So, where should investors be looking to buy now? We’ve seen a lot of capital growth in some areas over the past few years, but other areas still seem affordable, at least by Australian standards.

Steve used a metaphor of rafting down a river to teach four simple steps to making money through real estate investing:

1. Find a Fast Flowing Stream. You’ll want some paddles to keep you on course (think manufactured growth), but it’s the momentum of the market that will multiply your gains.

2. Get Equipped. You’ll need skills and expertise to navigate some dangerous waters.

3. Get In The Boat. You can’t make any progress standing on the edge of the water while watching others raft downstream.

4. Ride it Until The Current Ends. There’s always a time to sell – when you can do something better with your money.

So, where are the fast moving streams in Australia? Ultimately, that’s up to you to decide.

Steve looked at the largest capital cities and challenged everyone in the room to use the most recent data to grade cities on four key indicators:

1. Market momentum, measured by changes in median house prices.
2. Employment trends, measured by the unemployment rate.
3. Finance availability, measured by housing finance commitments.
4. Housing supply, measured by building approvals.

After assessing our capital cities on each of these specific indicators, he suggested averaging the grades to give the city an overall value. This assessment becomes your guide to establishing an opinion on which markets show the most potential for future strength.

Here’s how Steve graded each of the capital cities:

 Steve also recommended a helpful online resource for researching and assessing areas, Herron Todd White’s “Month in Review.”

3. Overcome your greatest hurdle: financing deals.

If you aim to achieve financial freedom through real estate investing, you’re most likely going to need access to other people’s money. Here are six finance tips that Steve offered:

1. Money Flow is Critical. The ability to access credit is more important than the cost of credit. If a few percentage points will break you, it’s probably a bad property deal.

2. Relationship Matters Most. Connect with a lending gatekeeper, either a highly skilled broker or a bank manager, who can allow you to access credit that most people in your circumstance can’t.

3. Renegotiate Your Current Interest Rate. Banks get rich on investor laziness.

4. Structure For Success. Start with the right vehicle for your investments, for asset protection, tax minimisation and maximum borrowing capacity.

5. Think Long-Term. It may be tempting to borrow as much as the bank is willing to lend, but you should be conservative, as it may help you gain finance for the next deal.

6. Aim to Eventually be Debt Free. There’s no such thing as good debt, only bad and worse debt. It’s hard to go broke when you don’t owe anyone anything.

If you’re looking for a competitive mortgage interest rate, as low as 3.99 percent, get in touch with Alistair at the PropertyInvesting.com office on 03 8892 3800. He would be happy to assist you.

4. Be Able to Recognize When You’re Investing in a Bubble.

The fast flowing stream is the place to be, as a rising market covers over a multitude of investing sins. Even unskilled investors have made some significant gains over the last few years.

But it’s important to remember that markets don’t go up forever. They often overshoot on the upside, and sometimes they overshoot a lot. Then they can snap back quickly, like a rubber band that’s been stretched to capacity.

To borrow language from the Financial Times Lexicon, a property bubble occurs when the prices of real estate in a particular area rise so sharply and at such a sustained rate that they exceed valuations as justified by market fundamentals, making a sudden collapse likely.

There’s been much debate about whether Australian real estate is currently in a bubble. Some say the market fundamentals of employment, lending and housing scarcity fully support current prices. Others point to the disparity between home prices and incomes as proof we’re currently in a bubble.

Steve believes there’s nothing wrong with investing in a property bubble, as long as you are aware that you’re actually in one. So how do you know?

Here are Steve’s three indicators of a bubble:

1. Talk of a “New World.” People believe that the fundamentals, or the “old rules,” no longer apply to the market.

2. People Justify Irrational Buying Behaviour. “If I don’t buy now, I might get locked out of the market.”

3. Things Just Don’t Make Sense. The disparity between home prices and incomes keeps growing way beyond common expectations.

The problem with bubbles is no one knows when they’re going to pop. Just when you think prices couldn’t rise any more, they shoot up again.

Bubbles can take many years to inflate, but then they can burst in an instant. Since we can never precisely predict the bursting of a bubble, many investors exit the market too soon and sit on the sidelines while property prices rise.

As an investor, you must decide how much risk you’re comfortable with. The longer you own real estate in a bubble, the more likely you become one of the people who are left holding an asset that has depreciated. But if you sit on the sidelines, you run the risk of missing out on capital growth.

If you’re clear you’re in a bubble, then your timing for selling will depend upon your appetite for risk. Would you rather cash out now and realise your gains, or keep rolling the dice?

So is Australian real estate in a bubble now? I’ll leave that to you to decide.

Here are six factors that Steve mentioned that cause bubbles to inflate:

1. Low Interest Rates: Cheaper borrowing costs bring forward demand as those who would otherwise continue renting decide to buy into the market.

2. Tax Advantages: Government spurs demand by encouraging speculation and rewarding those who invest inefficiently.

3. Debt Accumulation: People borrow on their borrowing by using their equity as down payments for additional property acquisitions.

4. Speculation: Investors choose strategies that rely exclusively on capital growth.

5. Preservation Over Yield: Investors buy homes as a store of wealth rather than as an income producer. Chinese investors are a good example. They just want their wealth out of China.

6. Ignorance: Investors are too dumb to know that properties are overvalued, relative to median incomes or the fundamentals of supply and demand.

Do you see any of these signs presently in the Australian property market? If so, what should you do?

Steve listed six things to watch out for that could cause a bubble to pop:

1. People are Forced Sell When No One is Buying. Supply grows as demand wanes. This causes prices to decline as more and more sellers are competing for fewer and fewer buyers.

2. Interest Rates Spike. While interest rates will eventually rise, borrowing costs may continue declining for the foreseeable future. The RBA and world central banks are currently in monetary easing mode.

3. Unemployment Shock is an Issue. We’re in safe territory now, but if the unemployment rate rises to eight percent, expect to see an impact on property prices.

4. Banks Call In Loans. Developers with commercial loans are most at risk when banks begin to tighten up. During uncertain times, banks have been known to require LVR adjustments from 80 percent down to 60 percent. Land-rich but cash-poor developers are then forced to sell land at a discount to pony up more cash for the bank.

5. Changes To Tax Laws. If Labor gains power, and negative gearing and capital gains tax concessions are rolled back, expect some volatility.

6. Black Swan Events Occur. Any number of catastrophes could occur overseas, such as a European banking collapse or geopolitical conflict.

In Conclusion

How would you cope if things changed for the worse? Are you in a position to profit?

The most effective safeguard against risks in the property market is to increase your investing skills. In Steve McKnight’s Property Apprenticeship course, our aim is to empower you to think and act like a profitable investor.

You can learn more about our training options here: https://www.propertyinvesting.com/store/property-apprentice/

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.