There are always people who enjoy predicting doom and gloom for the property sector.
This time, though, they may have some valid points.
This pandemic shutdown has created a drop in demand for rentals, reduced some renters’ ability to pay, and made potential buyers nervous. At the same time, many owners are facing a jump in costs due to their interest-only loans expiring (see the note at the end for more on this).
It’s not great.
Normally, falling or flat house prices aren’t a big issue. It’s only when you sell that you ‘crystallise’ the loss. If you hang in there long enough, the value should go up (not always, but often).
But then someone (maybe) ate bat-soup in China and the world turned upside down.
Now, for some people, it’s pretty scary to be sitting on a falling asset like housing.
Sadly, some people face the prospect of being forced to sell in a market where the value of their property has fallen. In some cases, it will be for less than what they paid, so they could even be left with a debt (and no asset).
I don’t mean to be alarmist, but that’s a really bad position to be in. And this where I begin my rant.
What’s wrong with property investment in Australia?
I’m not against investing in property altogether. In fact, I made most of my wealth that way: I was lucky to buy a home at a good time, in a good place.
What I am against is the reckless abandon with which many Aussies approach this asset class, and the absolute trash that passes as ‘education’ or ‘information’ about it.
Property investment in Australia is rife with greedy people, shitty products, bad advice, lax regulation and a good old dose of hubris. Every man and his dog thinks they’re an expert on property. (And yes, I have left that expression gendered on purpose).
The result is ordinary people getting sucked into poor investments that can leave them in debt, struggling in retirement, and facing years of chronic stress.
One difference between investing in property and shares is that most sensible people agree that they aren’t experts about shares. They leave it to experts. But people read Domain and think they’re the next Harry Triguboff.
The other big difference?
Most share investors don’t take out massive loans to invest.
Sure, some people borrow to invest in shares, but they are a minority. (I’m sure there are some stats somewhere.) That’s because you don’t need to borrow to buy shares. Whatever’s in your bank account is enough to get started.
But not many people have a lazy $300,000 in their account. Thus to buy a property, they have to go into debt.
Now, those following along here for a while know the rule of borrowing to invest (aka leveraging): it can magnify your gains (yay!) but it can also magnify your losses (boo!).
Leveraged investment increases your risk.
However, the gusto with which Aussies jump into property investment would make you think they are just dropping a few hundred bucks on the Melbourne Cup.
Please learn from these unfortunate people
If you think I’m exaggerating, let’s look at the people in the ABC’s articles about the loan issue mentioned above. Not to ridicule them – they are all normal people trying to get ahead.
Things they have in common include poor advice, reckless lenders and a good dose of self-delusion.
“Mike, a former school teacher, owes $1.1 million to the banks … [he] has six investment properties and all the loans have switched to principal and interest… all of his properties had either fallen in value or flat-lined, while rents had also dropped.”
Let’s unpack this. This man appears to be retired, and probably earned no more than $100K per year when he worked. What business does he have going into debt for over a million dollars? That’s not what he paid, that’s what he owes. Imagine retiring with a million bucks in debt.
And the fact that all six properties are struggling suggests he wasn’t that great at picking them either. My guess is there was some property spruiker involved in this strategy (you can read an article I wrote about them here). Then possibly a mortgage broker who knew how to get the banks to say yes. Both of these statements are speculation, but having worked in the sector, I know it happens.
Lesson here: don’t go into debt you can’t afford, especially at the end of your working career. Not all properties go up in value, all the time.
As old mate Mike admits, “People think property investors are multi-millionaires but probably about 40 per cent of them never make a profit.”
Not sure if he made up that stat, but you get the drift.
Now let’s look at Wayne, 50, who said he couldn’t help but laugh when he considered the price he would likely now get for his luxury investment unit in Perth.
“I’m laughing because it is just ridiculous,” he said.
“I bought it for $670,000 … and I’ll be lucky if I’m able to sell it for $400,000.”
Mr Grimes is looking to sell, but at a huge a loss. He faces being left with a $180,000 debt.
Perth is tricky. It was one of the most over-valued markets in the nation, bloated by the mining boom. When the boom died down, turns out Perth is barely even a city population-wise, and can’t support the Sydney-like prices it had run up.
Investors had bought there because they could see pricing rises. They forgot that nobody wants to live there. (Haha just kidding! OK sort of not kidding).
The term ‘luxury investment unit’ provides some hints as to the nature of this ‘investment’. My guess is that it would have been built in the mining boom, when construction companies battled with the mines to get tradies. Sparkies and welders were being paid $200K per year to build apartments – and those costs were built into the inflated sale prices.
Secondly, these ‘luxury’ apartments would have been marketed to buyers with glossy brochures and fancy display units. They would have been sold an aspirational idea of owning a slice of luxury.
But how many renters want to pay hand-over-fist for a pokey apartment, in a city where you can live in a house for about the same price? Stone benchtops and Smeg appliances do not constitute a ‘lifestyle’.
So, when the miners or international students empty out of the cities, the fancy apartments struggle to attract premium rents. Same goes for all those Brisbane high-rises and probably a bunch of those awful shoeboxes in places like Zetland, Sydney.
A pokey apartment that you paid too much for in a boom is still a pokey apartment in a bust – it’s just that everyone notices now.
Lesson: buy quality properties where you have meticulously researched the drivers of rental demand. Don’t buy properties because you like the brochure.
If there are thousands just like it, next door, it’s a red flag. If it relies on transient workforces to fill it? Red flag. If it’s marketed with lots of gloss and glamour? Red flag.
The good thing about paying someone to manage your share portfolio is that they do it with way less emotion.
When you are the one managing your property portfolio, it’s easy to get swept up into your own emotions. Just because you dream of city views and clean, crisp tiles in your fantasy bachelorette pad, doesn’t mean it will make money.
Here’s the take-out
When they get it right, people can indeed make money from investing in residential property.
Unfortunately, a lot of people don’t get it right, and they either break even or lose money.
Even those people who say their property increased in value may not be including the cost of interest in their thinking. If it went up by $100,000 but you paid $100,000 in interest, what was the point?
So if you want property exposure you have a few options:
- Buy a place you enjoy living in and hold onto it for a long time. Hopefully it will just go up in value over time plus you have a roof over your head.
- Buy listed property – called Real Estate Investment Trusts (REITs), they give you property exposure but are bought and sold in units on the ASX. Or you can access unlisted ones directly through property companies or an adviser. This means you don’t need to go into debt to own it.
- Buy an investment property but RESEARCH THE HELL out of it. There are consultants who can help with this if you’re not sure. But generally you want to think about what will drive demand for people to live in the area, and to choose the place you’ve bought.
Side note: Interest-only loans
But before all this COVID stuff happened, there was another property investment issue bubbling away. A lot of investors had purchased their properties using an interest-only (IO) loan, which reduces the cost of servicing the loan and (possibly) increases the tax benefits. It means you aren’t chipping away at paying off that loan – you’re waiting for the value of the property to go up in order to make money.
But IO loans have been falling out of favour with banks, and lots of borrowers who had five-year IO periods may be kicked off that type of arrangement when the term ends. Instead, they would have to pay principal and interest (P&I), which means higher repayments.
This ‘resetting’ of IO loans was on the radar of banks, regulators and the Reserve Bank of Australia (RBA) last year. The RBA wasn’t super concerned overall, but the actual people facing the prospect of a jump in their investment expenses? They were kinda worried. (Read more here). they remain worried. It’s a potential extra spanner in the property market works.