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The 3 Dumbest Things Property Owners Do in a Hot Market

Date: 27/08/2015

The median house price in Sydney just cracked the $1 million barrier last month. That amounts to a 23 percent increase over the last year alone. Add to this the fact that the previous year’s growth was not far off that level, there’s no denying that Sydney’s property market is on fire.

psychological problemIf you own property in Sydney, or even Melbourne, you’ve likely felt the exhilarating rush of watching your net worth increase rapidly, and with practically no effort on your part. You just happened to own property in the right place at the right time, and now you’re basking in the glory of your good fortune.

But there is a problem; a psychological problem. Intellectually you may be able to differentiate between an unrealised gain and cash money in the bank, but emotionally, you probably can’t.

The former Chairman of the Federal Reserve, Ben Bernanke, spoke about this back in 2012. Here’s what he said:

“To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more – more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they’ll, you know, make a better return on that purchase.”

In summary, your unrealised gains make you feel wealthier, and when you feel wealthier, you buy more stuff. But spending money you don’t yet have is, of course, dumb.

Here’s the top three dumbest things property owners do in a hot market:

1. Justify Luxury Purchases

Driving around Sydney a few weeks ago in my Hyundai rental car, I was amazed by all the new BMWs, Mercs, Land Rovers and Porsches I saw. As I pondered the reasons why money is pouring into the luxury car market, I began imagining the inner conversations many people may be having with themselves.

“I work hard and spend an awful lot of time in my car driving to and from my damn job every day. I’m due for a bonus and a raise, and besides, my home has just appreciated by half a million dollars in the last two years. I’m a smart investor. I should reward myself.”

Luxury PurchasesThis was not hard for me to imagine because I had just had a conversation with someone who had similarly justified their purchase of a new luxury car.

During boom times, when people feel wealthy, they want to manifest those feelings.

When assets have appreciated significantly, rather than going to the bank to get a car loan, investors can simply draw down on the equity in one of their properties or take some saved up cash out of their offset account. Psychologically, it’s easier to spend money you didn’t have to work for.

It’s important for us to remember however that unrealised gains do not make us wealthy. They only give us the illusion of wealth. Don’t be psychologically duped into believing that you deserve to spend some of that gain. If properties start moving against you, you may regret that luxury purchase.

2. Draw Down on Equity to Speculate on Capital Growth

Low interest rates and significant capital growth in real estate has created an environment ripe for speculation. Many investors have been redrawing equity to buy more properties and raising their loan-to-value ratios back up to 80 percent. This will only turn out to be a good idea if values continue to rise.

Capital GrowthEarly in Steve McKnight’s Property Apprenticeship course, we try to teach investors to avoid this mistake. The key is understanding the difference between being asset-focused and outcome-driven as an investor.

Asset-focused investors rush out and acquire properties, assuming that all real estate perpetually appreciates in value. In the end, this belief amounts to little more than speculation and reliance upon luck.

Outcome-driven investors first determine their objectives, and then through careful planning and incremental goal setting, strategically acquire the assets that most appropriately correspond to their desired outcome. This outcome approach harnesses skill rather than luck to create wealth.

3. Fail to Consider Long-Term Interest Costs

Hot property markets are most often the result of easy lending policies and cheap money. With interest rates at historically low levels, many investors seem to be drunk on the euphoria of a rising market and failing to think long-term on interest rates.

Long-Term Interest CostsIt’s likely that rates will continue to fall further in the short-term, but eventually all financial variations tend to revert to a mean. Over time, interest rates will tend to move back toward their historical average.

The average standard variable home loan rate in Australia from 1990 to 2010 was 8.54 percent.

At that level, most investors would see their interest costs double compared to today’s rates. How would your cash flow situation change if you were paying over eight percent interest on your investment loans?

Today we find ourselves in a high growth market with low interest rates. The temptation is to take advantage of the season and leverage up, but we need to consider the risks.

Conclusion

I often encourage investors to maintain a healthy fear of debt. If we become complacent, even with what many call “good debt,” it can turn on us when we least expect it. Even worse, if we use property loans to purchase depreciating assets, we short-circuit the ultimate goal of property investing, which is to build a passive income stream for retirement.

In Steve McKnight’s Property Apprenticeship course, we offer multiple sessions on identifying and mitigating investment risk, as well as an entire section dedicated to managing debt obligations in a healthy way. In this unparalleled time of speculative borrowing, it is more crucial than ever that we avoid the status quo and take steps to grow in skill and competency.

Profile photo of Jason Staggers

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.

Comments

  1. Profile photo of sapphire101

    Why quote Ben Bernanke? The horse had long bolted by 2012. In fact Bernanke was slow slow off the mark with that comment, the horse was the glue keeping his reputation together.

    3 good article points though.

  2. Profile photo of Benny

    Hi Jason,
    How easily is this point of yours overlooked :-

    At that level, most investors would see their interest costs double compared to today’s rates … Jason Staggers

    In essence, if Interest Rates go from 4.5% to 9%, it is oft-reported that “Rates have gone up 4.5% over x years”.

    TRUE – but that is hardly the issue!!! As you pointed out, mortgage payments would have DOUBLED in that time. Tough if you don’t have your wages double, or your Rental Income to match.

    We listen to “Rates going up” but few journalists report just how much the average mortgage payment rises as that rate rise occurs. The REAL truth is not reported, so we must watch for ourselves.

    Regards,
    Benny

    e.g. If we are at 5% Interest Rate today, and by 2016 we are at 6%, was that a 1% rise? Not to our mortgage it wasn’t – more like 20% !!

  3. Profile photo of Don Nicolussi

    Actually failing to set up facilities to access equity is the one of the dumbest things you can do.

    No need to speculate – just have your equity facilities in place. No point waiting until values are poor and then asking your bank for money.

    To take advantage of buyers markets equity needs to be converted into cash today and managed well until opportunities arise.

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