Lessons from a falling market

While it’s a challenge to pick the peaks and troughs of a financial rollercoaster, history shows cycles are a well-established feature of real estate markets. In my opinion, this means even those with the most basic understanding of property are aware that what goes up is likely to come down and vice versa.

This year, we’ve seen the effect amplified as home prices in our nation’s biggest property market, Sydney, begin to falter.

It begs the question for those that continued to plough on borrowing to their limits and buying with expectations the good times would last forever – what were they thinking?

The new normal

Human nature is a funny thing. After multiple property cycles I’ve seen it time and again where buyers get comfortable with ‘the new normal’ – whatever they believe that to be.

First time investors are particularly prone because the most recent cycle is all they’ll ever have known.

Imagine if you were one of the fortunate ones who managed to buy a moderately affordable Sydney near-CBD unit in 2012. You have been enjoying extraordinary annual value growth and rental gains for the past six years.

If this was your first purchase then it must feel like the treadmill of real estate investing is a breeze.

This is not and has never been, however, how bricks-and-mortar works. Interest rates can rise, rental returns can drop, days on market can blow out and, yes, property values can fall.

It’s for this reason I believe the current market retraction in our harbour city is not a bust, but a return to more normal market conditions of average annual single-digit growth over the long-term with sustainable, but unambitious, rent rises once the market resets.

What’s different in 2018?

There’s one element this time around that’s throwing a spanner in the works.

We’re undergoing a perfect storm in finance making it increasingly more difficult to lock down a loan. Moves in 2017 by the Australian Prudential Regulation Authority (APRA) designed to slow investor activity have been very successful. They’ve, in fact, helped drive growth in investor lending well below the 10 per cent  target the regulations were meant to achieve.

In addition, the current banking enquiry is causing a lot of nerves among the big institutions. While at this stage, there have been no official recommendations from the enquiry, many lenders are applying rules that make it difficult for borrowers to get a loan approval. Guidelines have become rigorous and while our clients are, for the most part, able to act due to strategic preparation, anyone flying solo right now will be doing it tough.

Is there an upside?

We are now in an environment where those who prepared for the downturn are ready to take advantage. The very smartest are primed for the tighter lending guidelines. It will be these investors who are set to profit from the next upswing.

If, however, you weren’t ready this time around, there are important lessons to be learned.

We have seen cycles before and they will happen again, so let experience be your teacher.

1. Keep liquid

It’s essential for anyone investing in property to remain ready for the inevitable.

I believe having ‘liquid equity’ is key. This is a case where you are not overleveraged and can access funds to take advantage of opportunities as they appear. Why? Because over the coming few years, some of the best buying opportunities of the last decade will rise, and if you’re able to execute a deal, then lucky you.

2. Build in buffers

I don’t mean just having cash at the ready but allowing for changes in the financial environment.

For example, you must ensure you have a cash flow tolerance for an increase in interest rates approaching 7 per cent. I’m not predicting this will happen in the near future, however rises will inevitably come. If you haven’t already factored this into your planning then there could be difficulties ahead.

3. Keep impeccable financial records

There are situations now where the bank won’t just ‘take your word for it’ about household expenditure. Loan applicants are being asked to front up with bank statements, and then to justify their expenditure estimates and home budget.

Keep your records impeccable so you can show, without question, why you should be approved for a loan.

4. Stay on top of the numbers

As I’ve said before – lazy investors lose money! Stay on top of the figures to ensure you’ve got your rents at the right level, you’re taking steps to avoid vacancies in your portfolio and you’re getting the most from your financier.

Property is not a passive investment, and the current stage of the cycle will sort out those who’ve rested on their laurels.

5. Diversification

We are a nation of multiple property markets driven by various economic influences all playing their own tune. The best way to ensure you aren’t stung is to diversify across a broad range of locations.

Sure, Sydney is slowing, but I can name plenty of other areas where the fundamentals are right for making a purchase now that will pay dividends in the future. Seek expert advice and look beyond your region of comfort to ensure you have a well-balanced portfolio.

Being diligent might seem like hard work, but when a cycle turns, you'll find out why it’s so important.