Article ‘What’s the Property Market Doing, and Should it Really Matter?’ by Graeme Fowler
Updated: Oct 7, 2019
Article ‘What’s the Property Market Doing, and Should it
Really Matter?’ by Graeme Fowler written in March 2005.
Disclaimer: Nothing is this article is meant to constitute financial advice of any kind, and is the opinion of the author only. Seek professional advice before making any financial decision.
Perhaps the most common question I get asked as a property investor is ‘what do you think the market is going to do?’ I will usually answer with something like ‘I have no idea what will happen, and I really don’t care.’ A couple of months ago I was invited along to a free two hour seminar put on by one of the major banks on property investment. The guy that was speaking had one property himself which he was now selling as he thought it was a good time to sell. The rest of the time was spent going through a whole range of meaningless graphs, charts, facts and figures explaining to us all what he thought might happen to property prices over the next few years. Of course he really had no idea and admitted that many things could affect what he thought might possibly happen anyway. It’s extremely tiresome to me hearing about, or reading about peoples’ opinions in newspapers or magazine articles, about what they think property prices will do. The fact is, nobody really ever knows what will happen, and more importantly – why should it matter anyway?! It matters very little to me whether prices rise, fall or even stay the same for the next 20 years or more. By having investing rules that work whatever happens to property prices is one of the keys to successful investing.
P&I vs Interest Only
Most investors use the traditional ‘buy and hold’ as their main strategy which is fine.
There are also those investors that use buy and hold as one strategy, and also use one or a number of other methods including; – trading, renovating and reselling, lease-options, developing, or building. I use the ‘buy and hold’, ‘renovations’, and the ‘trading’ strategies. Now, if you have an investor that just uses the ‘buy and hold’ strategy and has been investing for a few years, should it matter if the market price of their properties goes up or down in value from time to time over the next 20 - 40 years? The answer of course is no. But what makes it matter to them is when they decide to use ‘interest only’ loans, as opposed to P & I loans. Now they are forever hoping, maybe even praying – for ever increasing prices.
New investors will often ask ‘is now a good time to buy, or do you think I should wait until the market goes down a bit (or crashes)?’ One of the biggest problems I see with property investment is that people go into it for the wrong reasons, or with their own assumptions – and not even knowing they are assumptions.
The biggest assumption of all is that ‘property will always go up in value’. The majority of investors rely on future capital gains before they make any real money. Starting with the assumption that prices will forever keep going up, many people decide to finance their properties using an interest only loan as opposed to a P & I loan. With an interest only loan, you do get a few dollars extra a week in cash flow, but the property never gets paid off unless you pay for it from somewhere else. The investor relies on their rental property going up in value perpetually, thereby gaining more equity in the property, which they often take out by refinancing, and then buying further properties. This now takes them back up to a similar debt/equity ratio as when they first bought the property. This can go on as long as they continue to invest in property, forever refinancing when prices go up and always being heavily geared. To me, this is such a dangerous strategy and one I’m personally heavily against. If they truly are a ‘buy and hold’ investor for the long term, I will often ask these investors if they think there is any possibility of prices dropping by 15 - 20% anytime over the next 30 or so years? Of course the answer is that it is possible and it’s already happened in many other countries in the past including the U.S. and Japan. So, if there is always this possibility, why would they risk all they own on it not happening? All that would need to happen is that you are geared at 80 - 90% over your entire property portfolio say in 10 or 15 years time, and the property market then suddenly slumps 20% within a year. This could happen for any number of reasons including interest rate rises, a change in government policy, war, world-wide share market crash, an outbreak of foot and mouth disease in NZ, baby boomers retiring etc, etc. Now, because of the reduced equity in your property portfolio, your bank manager wants you to come up with at least $200,000 by the end of the month, as he considers you are too highly geared and too much of a risk for their bank. You can’t even sell these properties now for what the mortgage is on them, so you’re forced into bankruptcy unless you can come up with the necessary cash to reduce your debt/equity exposure.
Property investment can be so simple, and I think because it is so simple, most people want to complicate it, and end up losing money long term. With investment in property, business or shares, the majority of investors lose long term. Any investor can make money, or think they are doing well in a rising market, but will their rules and strategies work equally as well in a down-trending market? Most of the time, the answer is no.
Are You Creating Wealth, or Protecting it?
I think before getting into property investment at all, people need to ask themselves the question; – do I want to do this for ‘wealth creation’, or do I want to do it for ‘wealth retention?’
The ‘buy and hold’ strategy is used mainly for ‘wealth retention’ and I think where a lot of investors go wrong is they try to use it for their ‘wealth creation’ vehicle. A business owner or an employee with a reasonable income could use his/her savings for deposits on rental properties, even if it’s just one or two a year over the next 10 years. The tenants end up paying off the loans on these properties over the following 20 - 25 years (N.B. the investor of course needs as one of his/her rules a gross yield that is acceptable before purchasing any rental property). This also acts as very slow ‘wealth creation’, as the tenants eventually pay the loans off (on P & I) in full, but it’s actually a ‘wealth retention’ method. A trader, renovator or developer has the intention of making quick cash profits which is a ‘wealth creation’ method, or strategy. They may then use the income from this to park into property, which then turns it into ‘wealth retention’. Where the thinking goes wrong with many investors is they try to use a ‘buy and hold’ (wealth retention) strategy with their properties as a ‘wealth creation’ vehicle. Often these property investors will talk about wanting a small positive cash flow from a huge number of properties in order to replace their current income from a job, or to enable them to sell their business. They want to use a ‘wealth retention’ method for the purpose of ‘wealth creation.’ This one distinction if not fully understood, could well lead to the downfall of many property investors over the next ten to fifteen years.
Do You Have a Passion For Property?
From the nearly 20 years of experience I’ve had in real estate investing, I’ve noticed that the investors who have a passion for property investing will often use other strategies in real estate such as property trading, renovations, lease-options, writing books, doing seminars, or mentoring others, to help with their own ‘wealth creation.’ Therefore, these investors can have multiple streams of income from one solid base, which is property. And those investors that have property as more of an interest to them, rather than it being a passion to them, use property as a ‘wealth retention’ tool. The problem as mentioned is when many of these investors try to use the ‘buy and hold’ strategy as a ‘wealth creation’ vehicle (instead of ‘wealth retention’) to replace their income from a job or a business they don’t enjoy being at. I think a lot of this way of thinking has been created after people have read books like ‘RichDad PoorDad’ or ‘Cashflow Quadrant’, and then thinking they must be in the ‘ratrace’. They also want to be a ‘Business Owner’ or an ‘Investor’, not just an ‘Employee’ or a ‘Self Employed’. The point to realise is that the wealthiest people in the world today still go to work, even though they don’t have to – because they have a passion for what they do. They love their work, they don’t want to be doing anything else! And at the end of the day they are still an ‘Employee’ as well as a ‘Business Owner’ or ‘Investor’.
So, what are my answers to the previous questions – ‘what do you think the market is going to do?’ and ‘is now a good time to buy, or do you think I should wait until the market goes down?’ My answer is simple – ‘start asking better questions!’