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There is an Australian property crash coming. That’s what several economists and property experts would have you believe — but what would this really mean for your property portfolio?
Every few weeks another report is released about a property bubble in Australia and the inevitable market crash it will bring when it bursts. But are these predictions correct and should investors be worried about their portfolios? How do you handle a drop in property value — is it best to cut your losses and run or should you ride it out and hope your investment returns to form?
Will Australian property values fall?
Much like you can find a million stories on the next property hotspot, you can find a million stories on the Australian property bubble. The bubble, whether it exists and if it’s going to burst soon, is the topic of much contention between economists, property experts and investors. But is it as big, and as realistic, as the big doomsday predictions would have you believe?
There can be no denying that some areas in Australian capital cities appear to be reaching oversaturation. Sky high prices and large developments nearing completion in Sydney and Melbourne have been the catalyst for these debates in 2016. But in terms of a crash which would send all Australian property prices plummeting, that’s harder to believe. Rather than a property bubble bursting, the result would more accurately be a correction of inflated prices which have grown at an unsustainable rate and would only affect those with property directly in these peak zones.
But even outside a possible bubble pop, property has the potential to lose value. You will have often heard property investment described as a long game and the reason for this is the property cycle.
What is a property cycle?
A ‘property cycle’ is the term for the phases of the property market. There are four basic phases to a property cycle — the length of these phases, and therefore the cycle, can be dependent on a number of factors. Learning to identify and take advantage of these phases is one of the key factors in making wealth from property and will help an investor avoid buying in a market slump.
At the beginning of a cycle prices are stagnant. If the area has recently experienced a large fall in prices it can take some time before buyers grow confident and invest there again. Outside factors can also begin to drive prices up — urban sprawl, a rise in population or better infrastructure are factors often seen in up-and-coming suburbs. Once money is being put back into the market the property prices will increase which moves us on to the next phase.
In phase two, prices are rising. This usually begins slowly, but picks up momentum once more and more people flock to the area. Sydney and Melbourne in particular have been in strong growth phases, triggering the talk of an Australian property crash to come. This growth isn’t sustainable and eventually the prices get too high, or the market becomes oversaturated. This is the peak of the property cycle and, depending on which arguments you listen to, is where parts of the Australian market are in 2016. From this point, the only way is down and the correction of these sky high prices is the fourth phase in the property cycle.
The important thing to understand about property cycles is that they are usually locally based, unless they’re triggered by an event such as the GFC. Sydney can be in a very different place on the cycle than Brisbane. There are markets within markets and if one crashes, it should only affect that very direct area. The argument behind diversifying your portfolio as an investor is strongly supported by this fact — having your fingers in many pies will mean that a property performing well in another area may cover the losses you experience during the slump. Property cycles can also be shorter than people usually report them to be — seven years is the expected cycle but investors who hold a property for 10 to 15 years can often see several cycles in that time.
What causes values to go down?
A drop can occur for several reasons: financial institutions can influence the fall as rate increases will drive prices down. An oversupply of property in the area will decrease prices, just as demand for property would increase them. Property is heavily influenced by the world around it — values dropped due to the GFC and the mining crash was caused by a lack of jobs in the area. The mining crash was an extreme example of a property bubble bursting, investors with large amounts of properties in the affected areas experienced dramatic losses and some still aren’t able to sell their properties. But in normal property cycle terms, downswings are usually much less dramatic and those using property investment as a long-term wealth builder won’t be affected as harshly.
Will my investment property’s value drop?
If you hold an investment property for a long period of time, there is a good chance that you will experience rises and troughs, as that is the nature of the property market. Every investment carries some level of risk, and property is no exception to this. One of the biggest misconceptions about property is that purchasing a tangible asset means it will never decrease in value like perhaps a share could, but the unfortunate fact is that bricks and mortar can still be affected by a market crash.
How can you avoid a price decline?
The short answer is sometimes you can’t — when it comes to property, factors outside of your control can cause a market drop despite you doing everything correctly. This is why one of the safest ways to secure your investment is to have a buffer in place. Keeping some money aside to help in emergency situations will guarantee you retain your property and ride out the slump. The most important thing a property investor has at their disposal is information. Doing your due diligence is important no matter how sure you are of the investment. Enlisting professional help to find you the perfect investment is a great option for those who are a bit unsure.
At the end of the day, with a little bit of research it isn’t hard to spot a danger zone. If supply is overstepping the demand for properties, if there’s a large number of developments close to completion in the area, if prices seem far too high then you should think twice before purchasing in this area. Sticking to the fundamentals of property investment, you should be seeking the areas which haven’t reached their peak — the up and coming areas — so sky-high prices should ring alarm bells.
Another great way to avoid, or manage the impact of, a slump in your portfolio is diversification. Diversification means more than investing in different areas, it also refers to buying different types of properties, targeting different tenant groups and using different financial lenders. A well-performing property in your portfolio can really come in handy if another property has slumped.
A savvy investor should have a strategy in place which will be used as the basis for working out the risk level they are comfortable with. If you have a higher risk appetite and a plan in place to handle losses, you can still make money in a property slump. But if you don’t, and you don’t want to spend time worrying about the prosperity of your investment, then don’t make risky choices. Invest at the risk level you are comfortable with.
The most important way to protect your portfolio from a house price crash is to have a buffer in place. Rental income may not be affected by the decrease, but they could be and you need to have cash flow somewhere else to be able to cover this.
You have to keep in mind the fundamentals of property investment and while capital growth is the property investment dream you need to have other options to support yourself in times of fluctuation.
A steady rental yield, tenants you can rely on, buying in a market which is less likely to be affected by a property bubble — these are all great ways to secure your investment and give yourself some breathing room.
How to handle a drop in property values
Even the best investors can be affected by a property price crash. So what do you do if it happens to you?
Initially you need to assess the situation and decide on the best outcome for your portfolio. If you are financially able to hold on to the property this is the best scenario in the long term. Selling your property in a slump will mean you could lose money and be left with debt. If you have a contingency plan in place and can ride it out then it’s just a case of waiting for the tables to turn. But if holding on to the property is crippling you financially or if you are unable to make your mortgage repayments and are facing losing the property because of it, then it might be time to cut your losses. While the short-term loss will be hard to stomach, you could lose a lot more if you hold onto a property you can’t afford. Nobody likes to admit to failure but selling your property and utilising the information you gained from it into your next investment could be the best result.
At the end of the day, investors who have done their due diligence, stuck to investment fundamentals and informed themselves about an area before they buy should be able to avoid a major house price crash.
Many experts agree that even in times of a price crash there is money to be made from property. People will continue to talk about property bubbles and whether or not Australia is in one but smart investors will already be investing in the next up-and-coming area and be well away from the bubble if it does pop.