Welcome to the Rentvesting Podcast, the ultimate property podcast that unpacks the facts and explains what’s really going on in property.
In this week’s episode, we’re talking about risks involved and getting doomy and gloomy with it. Hang in there though, because we’ll be covering:
- Risks in property
- Types of risks
- What these risks look like
- How to identify them
- How to mitigate them as best you can
It’s good to be aware of these sort of things. As the reality is, property hasn’t gone up for everyone in every area. So being aware of risks involved is a key part of buying and selling.
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Risky business! What are the risks in property?
In reality, there are risks in everything. But in property, these can be broken into two types, absolute and speculative.
Absolute is that example of the house burning down.
Speculative risks are more so on the investment side of things, like housing prices.
For example: If you’ve bought a lot of off the plan property in a mining area, then mining went down that’s a loss in speculative risk.
The good news is that a lot of these risks can be mitigated against. Today, we won’t really talk about the absolutes because there’s not as much you can do beyond fire-proofing your house. In reality, insurance is the way to get around absolute risks but we’ll be going through speculative risks in further detail.
In the back of people’s mind, people think property is pretty safe. This has historically been true but the other thing is, that it isn’t a daily valued asset. Unlike shares which change every day, it’s a less hard and fast value. A property price is dependent on what someone is going to pay and how much other places are selling in the area.
Ever since 1991 or so, there have been no major across-the-board declines in property prices. During the GFC, lots of areas were hit, but when you look at property as an aggregate around all the CBD’s across Australia there has been no recession where property has gone down. In most people’s mind over the past 25 years property has been going up. So when you don’t see risk, you forget it’s there.
RP Data Pain and Gain report shows people who are doing really well and those who aren’t. In the last quarter of 2016, of the total sales that took place, almost 9.4% of dwellings that sold, sold for less than the purchase price. Even in Sydney where the market has done almost 99% in the last couple of years – almost 3.7% sold for less than they were purchased for. There are a number of reasons why people sell, so keep this in mind.
The major risks are:
We’ve been through supply and demand before, so we’re going to be looking at the major factors. When interest rates go up, there will be less demand for property. That’s purely from an affordability point of view.
In conjunction with unemployment, this is a leading indicator of interest rate movements. If people have less income and there’s more unemployment, that will be a two-prong system. If people have less income, they can’t afford property, they will default on loans and people won’t want to buy as many properties. So interest rates might drop even further and it could have a cancelling out effect as it depends on how massive the changes are.
Property price increases are measured by:
Composite index = The measurement of household income growth x household debt growth.
If income growth is going down, like people are getting paid less or debt is going down, then that actually leads to potential property price decrease as well.
High debt or leveraging (we covered this in another episode on margin loans)
If you’ve got 95% loan and 5% deposit and the property price goes down by 10%, then your loan is worth more than the property is.
You’ve got two options, hold on and hope it goes up in value or sell it and essentially pay money to sell it.
You may have seen in the news, APRA (a governing body) limited the amount of lending to 10% of the market. They were worried the market would be distorted by too many investors. Here, a risk involved is if the banks stop lending, which could potentially affect the market. It’s been only in recent times where you can get almost 100 – 120% loans, prior to that it was pretty standard to have at least 30% deposit on a property. For the last 15 – 20 years however it’s been a relatively low deposit due to affordability issues.
There hasn’t been a recession in Australia for over 20 years
A recession is an economic term to take a step back. If a country is growing more than what it’s estimated to, there’s no recession, but if it drops below that, then there’s a recession.
You need about 6 months of negative growth in a full economy to be in a recession. The risks are, the economy shrinking, fewer jobs, people getting paid less, with less money to buy bigger properties.
The major thing with a recession is that the media will blast it like they did in the GFC. That in itself leads to a self-fulfilling prophecy as everyone loses faith in the economy, so the share market and property prices will drop as everyone will freak out and sell.
There’s not much you can do to mitigate macro level changes or interest rates. But you can mitigate against these factors through factoring in a long-term interest rate when you’re doing calculations for investments (typically that is 7-7.5%).
If you’re paying 3.8% loan, consider if that rate were to change to 7%. Always factor in the difference in rates as it would be double the repayments if rates were to change. Start putting more cash flow into paying that debt down. Episode 25 covered strategies and debt recycling, where you can use debt to build up investments.
Monitoring your debt to leverage ratios
The term is LVR (loan to value ratio), where you take the loan and divide it by the value of the property. That gives you a % term on how much of the value is debt.
If you have $500k property and you’ve got $400k owing, your LVR is at 80%. The risk is that if the property drops by 24%, then you’re worth the same amount as what the loan on the property is.
Always monitor these ratios. If you go in at 95% LVR and then property prices drop, you’ll be left with a property that is worth less than the debt you are carrying. So you’ll be stuck waiting, potentially for years, for prices to go back up or will need to hand extra thousands of dollars to the bank to fix it.
Property is a long term game
Studies have shown those who sold property at a loss owned it for 6.1 years, while those who held it for 9 years made a gain.
You can’t expect to buy property and only take a 3 – 5 year timeframe before selling. It’s not short term, so keep that in mind.
Unemployment or no income
Try to make yourself more indispensable. For accident, injury or illness, there are insurances, which can be structured into superannuation. This will help you make sure you have a backup. The biggest asset you’ll ever own is your income producing ability.
Diversify by having your investments in different spots which mitigate risks from a downturn. Like different house types, locations etc.
Absolute and speculative risk
You can do almost everything to minimise absolute risk and make sure you’re covered.
As for speculative risk, make sure property is positively geared, factor in long-term interest rates and cover your employment options.
Take away points:
- You can’t mitigate the macro factors. If the economy is tanking, you can’t do a lot about that. But diversifying your investments can help. There are still investments that go up during an economic downturn, like bonds.
- Take a long term view on interest rates. Just because interest rates are at 3 – 4% at the moment, the longer term standard variable rate is around 7%. So don’t get comfortable with these low rates.
- Don’t be bad at your job! Cover yourself because that’s the biggest risk. Even if the property is positively geared you’ll be needing to spend money to keep it up to date. So make sure you protect your income. If you’re renting, a lot of the time you won’t be getting enough income from positively geared incomes, so keep this in mind.
As always, reach out to us on 1300 88 73 28 or [email protected] with any questions you may have.
The Rentvesting Podcast, available on iTunes, was created by Red & Co’s Jayden Vecchio and expert financial planner Louis Strange. Together, Jayden and Louis unpack the facts behind the property market, explain what’s really going on & where the market is heading. They believe in challenging the status quo and want to get out there to educate absolutely anyone looking to enter the property market.