How to Cope in a Crash
When the property market was running hot and prices rising rapidly, we had people acting irrationally because of FOMO – Fear of Missing Out.
Now that prices have retreated, FOMO has been replaced by FOOP – Fear of Over Paying. That is, avoiding committing to the purchase of a property that might be worth even less in the near future.
Meanwhile, Millennials have coined their own aspirational acronym – FIRE, which is Financially Independent Retiring Early.
So, it seems you might have FOMO-FIRE-FOOP… fear of missing out, being financially independent and retiring early, but simultaneously unable to act because you are suffering acute fear of over-paying!
Arrrrrrrrrrrrrrrrrrgh! Honestly, it’s ALL nonsense.
People only suffer FOMO or FOOP because they lack a plan and are instead caught up in the hype or hysteria of the day. Furthermore, people are unlikely to ever FIRE up because they don’t have a plan, and instead have to rely on long-term luck.
Reality Check
You don’t need to be Nostradamus to predict that property prices will, for the foreseeable future, be more likely to go down than up.
Economics 101 reveals that when there are more sellers than buyers, prices will decline because people have to sell, but people don’t have to buy.
You should expect even fewer buyers in 2019 for these three reasons:
Reason #1: it’s become harder, and it will become even harder, to borrow money in 2019 when the Royal Commission in Bank Bastardry is over. Less borrowing means less buyers.
Reason #2: sentiment has softened, so the appetite to speculate has vanished.
Reason #3: foreign buyers have either flown, or been chased, away.
Simultaneously, with loans becoming more expensive, either because interest rates are going up or because loan terms are changing from interest-only to principal and interest, debt is becoming less affordable and so the number of forced (or about-to-be-forced) sellers will increase too.
In other words, the property market is poised to suffer a double whammy: a drop in demand, and an increase in supply. That said, it too will pass, and one day the sun will come out and dry up all the rain, and real estate will be back in vogue and prices will bounce back.
What To Do?
Remember this time-worn money mantra: (capital) preservation first, profit second.
If you aren’t making a profit, then you must be making a loss, because breaking even is really going backwards (because your investment capital could be invested risk-free in a term deposit), and the bigger your loss, the faster your hard-earned wealth is evaporating.
So, here’s what I recommend you consider, depending on which category best describes your circumstances:
Growth Orientated Investors
For this reason, if you are a growth-oriented investor and the market(s) where you have bought is not appreciating, then you need to choose whether you think it is a short-term glitch you can survive, or whether you would be better off selling up and jumping back in after conditions improve. Survival is a question of how easily you can ‘fund the loss’, and the risk that later on, if you do want to sell, you will be able to exit at a price point that pays out your debt.
Highly Geared Investors
You never want to be a forced seller in a down market, as the price you’ll pay to move on in a hurry could be heavily discounted, even to the point of values dropping to less than you owe. This is a recipe for a financial bloodbath.
Highly geared investors face pressure from two angles.
First, ensuring there is sufficient margin between what the property is worth and what you owe, so if you do have to sell, you’ll walk away with some money in your pocket. If your loan to current market value is more than 80% then you’re in quite a high risk situation. If it were me, I’d be trying to get that down so I had more ‘margin’
Second, ensuring you can afford your loan repayments. This has two elements to it: ensuring the cost does not spike (because interest rates rise, or loan terms become more onerous e.g. they go from IO to P&I thus your loan payment increases), or because you suffer a hit to your income (if you lose your tenant, job, etc.) and so have less money to service your current loan. It would be wise to run a ‘worst case scenario’ what-if analysis and form a plan for what you would do to escape in the unlikely event of an emergency.
Highly Geared, Growth Orientated Investors
If the market has turned where you own, then you are implementing a very, very risky strategy. Only fools take risks when the downside is much bigger than the upside. It’s time to reconsider. Fast.
The Bargain Hunter
As Warren Buffet says, be fearful when people are greedy, and greedy when people are fearful! In that sense, a property market downturn is your opportunity to buy a bargain, provided you can hold on to it until conditions improve and prices recover.
Be careful though; do your due diligence. Even a dud deal will make money in a boom, but buy a dog in a downturn and you could lose a lot.
While you wait and watch, you’d be wise to build your cash reserves and also work on improving your credit worthiness, as, if real estate really does ‘hit the fan’, then it will be hard to borrow money because lenders will also be more concerned with preservation rather than profit.
I hope this article has given you some food for thought. As always, if you have any questions then post them below and I’ll do my best to help.
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Headwinds until 2020?
That depends on policy by the US and our FED….eeehhh RBA! RBA is controlled by the same people as the FED! Trumps decision on trade wars is starting to make sense. The US is powering on and the FED is rapidly raising rates. I think they are overdoing it and will have to hit reverse gear….may be?
Here is an another upcoming reason for prices to dip…
Removal of negative gearing, even if Grandfathered, as they term it. A topic for another thread no doubt. But if the next govt remove negative gearing then the market must also take a hit. It will place a significant downward pressure on property prices and an upward pressure on rents. Problem being that the ceiling on rents is linked to wages, and no one will be buying a property to put a tenant in it at a loss, if they can no longer negatively gear the property.
The double-whammy being that the banks will act by hiking up interest rates, as property becomes riskier, and net over-all borrowing reduces. Consequently as they operate on an income stream in order to maintain their income against less borrowing they will have to raise interest rates.
So those keeping a negatively geared property will face an increasing loss as interest rates rise. Those looking to enter as an investment will only do so when the lower buy in price and the higher rents coincide with a neutral or positive return. First home buyers will win, as they will face higher rents and lower buy-in prices, giving them incentive to enter the market. But this rally will be short lived, as there are not enough first home buyers to prop up the market longer term.
Significantly those who can not afford to buy will be also be hurt as there will be even fewer rentals, and those available will be at a higher rental rate.
Cue drum-roll for the next incarnation of an NRAS equivalent. Not that many will be wanting to build new housing stock if the final sales make it no longer profitable.
The thing with negative-gearing, from a governments perspective, either never start it. Or if you do start it then never ever stop.
Just my thoughts on what could precipitate a genuine crash, as opposed to the current significant slow down.
I agree. Lower prices and higher rent in the event that negatively gearing is abolished. The effect of that will be that tenants will begin to see home ownership as more attractive than renting and will push more buyers into the market which will soften the decline in prices. If the government really thinks about it they will see that the complete and sudden removal of all negative gearing will have an undesirable effect.
I think they have tried to give it some thought, by suggesting that it will only apply to homes bought after the date they bring in the legislation. Which will create an interesting bump… as an investor you will be even keener to sell to a first home buyer. Because investors will be valuing homes they buy totally differently.
Thank you Steve. A wise outline and very helpful. Reading your articles in the lead up has placed us in good stead. We’re not in the best situation due to a huge income decrease, but have found that keeping a personal risk assessment and plan updated (in light of changes to personal or political changes), results in less pressure, panic and poor decisions.
Well done Lisa. Bit by bit… and before long you will have made substantial progress.
Bye,
– Steve
Hi Steve,
As a first home buyer, I have been saving and hacve over 25% of the property price (including money I got from my parents). I got pre – approval from bank and everything is ready. I am now looking for a good place to buy in and climbing up the ladder. Anyway, I have to do it as money sitting in the bank doesn’t make any sense.
My question for you, I can’t buy anywhere in Melbourne South Eastern where I really like to live or Eastern suburbs. I don’t like the West as it is too rough, my money I cant even buy in this areas either (like sunshine). I do not like country areas and its kind of risky to invest in these areas as well (like Werribee etc.). I have around $650,000 and I want to buy a house with decent land size in order to enjoy the capital growth. Do you think its good idea to buy in the North like Bundoora or Kingsbury (I know its hard but I see houses sold at 600k or 643k recently). Any advice on the areas. Anything I should be worried for in my strategy (I can rent the place to do negative gearing if its visible)
Thanks in advance
For my 2 cents worth, just sit tight with your money, watch and learn about the property market for the next year or two then start to think about where to buy if the time looks right, I suspect this is more than a correction
As a general rule, when buying a home, buy the worst house your lifestyle can tolerate, in the best area you can afford. You can always bowl it over, renovate or extend later, but at least you have a foothold in your desired area.
The other approach is to buy a ‘starter house’ somewhere and trade up. The problem with this is that entry and exit costs are high, so you will suffer some wealth erosion as you enter and exit.
If you can’t afford a house, maybe a townhouse, then maybe a unit, and last of all an apartment.
Bye,
– Steve
Awesome article, really good read, I really liked the quote from Warren Buffet, when do you personally feel that the property market will bottom out, what % decline will we see from here? When will it start to rise again?
Hi Sam,
“when do you personally feel that the property market will bottom out, what % decline will we see from here? When will it start to rise again?”
I think those types of questions are why we invented the phrase “Your guess is as good as mine!!” :)
Seriously though, I think “some” calls can be worth considering – like, re “what decline do you see”, I am of the opinion that it won’t be a doom-and-gloom fall (some I read are predicting falls of 40%+). That doesn’t make sense to me, but I can foresee 10% – 20%, depending. Most/all cycles have a sharp rise, then reach peak, flatten/fall a small amount, and then stay flat for some years.
But then, a change of Govt next year, and Neg Gearing rules changing would cause a huge upset in these circles – and that could make the difference between a 10% fall or a 20% one. Also, where previously I would have bet that foreign investors would have “propped up” the property market, that has all changed since the current Govt ripped the Welcome mat out from under foreign investor’s feet. So, likely MORE of a fall then?
There are so many variables that could come into play – think overseas events that could put available financing here at risk, the FED raising the US Interest Rates, any wars over oil, etc, etc. Could there be a depression sometime soon? I’m not seeing it yet, but hey – in many ways our world is becoming quite fragile, thus open to “wild swings” in whatever direction.
Sorry, no real answers – a bit of a thought (opinion only) that things shouldn’t be too bad – but who really knows. I like Steve’s final thoughts:-
“Be careful though; do your due diligence. Even a dud deal will make money in a boom, but buy a dog in a downturn and you could lose a lot.”
Reminds me of the old share market warning – “Don’t try to catch a falling knife!” It’s a time for softly, softly methinks,
Benny
Very well put, yeah the investor rates going up is a big factor and the factors you mentioned, let’s hope the market doesn’t stay flat for too long but it probably will as recovery takes time like you said, a recession or depression would obviously not be good for anyone, let’s see what happens, let’s hope potential labour laws don’t cause a major decline in houses prices. The market will no doubt recover and start to rise again after everything blows over post the royal commission, maybe investor loan rates will decline, yes Steve made a very good point with the quote about a booming market.
Will the outcome of the RC & APRA wash up translate to resetting the fundamentals of property investing
in Australia back to cash flow comes first before growth? I think we have had it working for the last 2 decades
or more and perhaps it’s time for a reset?
Rgds,
FXD