How to Cope in a Crash
When the property market was running hot and prices rising rapidly, we had people acting irrationally because of FOMO – Fear of Missing Out.
Now that prices have retreated, FOMO has been replaced by FOOP – Fear of Over Paying. That is, avoiding committing to the purchase of a property that might be worth even less in the near future.
Meanwhile, Millennials have coined their own aspirational acronym – FIRE, which is Financially Independent Retiring Early.
So, it seems you might have FOMO-FIRE-FOOP… fear of missing out, being financially independent and retiring early, but simultaneously unable to act because you are suffering acute fear of over-paying!
Arrrrrrrrrrrrrrrrrrgh! Honestly, it’s ALL nonsense.
People only suffer FOMO or FOOP because they lack a plan and are instead caught up in the hype or hysteria of the day. Furthermore, people are unlikely to ever FIRE up because they don’t have a plan, and instead have to rely on long-term luck.
You don’t need to be Nostradamus to predict that property prices will, for the foreseeable future, be more likely to go down than up.
Economics 101 reveals that when there are more sellers than buyers, prices will decline because people have to sell, but people don’t have to buy.
You should expect even fewer buyers in 2019 for these three reasons:
Reason #1: it’s become harder, and it will become even harder, to borrow money in 2019 when the Royal Commission in Bank Bastardry is over. Less borrowing means less buyers.
Reason #2: sentiment has softened, so the appetite to speculate has vanished.
Reason #3: foreign buyers have either flown, or been chased, away.
Simultaneously, with loans becoming more expensive, either because interest rates are going up or because loan terms are changing from interest-only to principal and interest, debt is becoming less affordable and so the number of forced (or about-to-be-forced) sellers will increase too.
In other words, the property market is poised to suffer a double whammy: a drop in demand, and an increase in supply. That said, it too will pass, and one day the sun will come out and dry up all the rain, and real estate will be back in vogue and prices will bounce back.
What To Do?
Remember this time-worn money mantra: (capital) preservation first, profit second.
If you aren’t making a profit, then you must be making a loss, because breaking even is really going backwards (because your investment capital could be invested risk-free in a term deposit), and the bigger your loss, the faster your hard-earned wealth is evaporating.
So, here’s what I recommend you consider, depending on which category best describes your circumstances:
Growth Orientated Investors
For this reason, if you are a growth-oriented investor and the market(s) where you have bought is not appreciating, then you need to choose whether you think it is a short-term glitch you can survive, or whether you would be better off selling up and jumping back in after conditions improve. Survival is a question of how easily you can ‘fund the loss’, and the risk that later on, if you do want to sell, you will be able to exit at a price point that pays out your debt.
Highly Geared Investors
You never want to be a forced seller in a down market, as the price you’ll pay to move on in a hurry could be heavily discounted, even to the point of values dropping to less than you owe. This is a recipe for a financial bloodbath.
Highly geared investors face pressure from two angles.
First, ensuring there is sufficient margin between what the property is worth and what you owe, so if you do have to sell, you’ll walk away with some money in your pocket. If your loan to current market value is more than 80% then you’re in quite a high risk situation. If it were me, I’d be trying to get that down so I had more ‘margin’
Second, ensuring you can afford your loan repayments. This has two elements to it: ensuring the cost does not spike (because interest rates rise, or loan terms become more onerous e.g. they go from IO to P&I thus your loan payment increases), or because you suffer a hit to your income (if you lose your tenant, job, etc.) and so have less money to service your current loan. It would be wise to run a ‘worst case scenario’ what-if analysis and form a plan for what you would do to escape in the unlikely event of an emergency.
Highly Geared, Growth Orientated Investors
If the market has turned where you own, then you are implementing a very, very risky strategy. Only fools take risks when the downside is much bigger than the upside. It’s time to reconsider. Fast.
The Bargain Hunter
As Warren Buffet says, be fearful when people are greedy, and greedy when people are fearful! In that sense, a property market downturn is your opportunity to buy a bargain, provided you can hold on to it until conditions improve and prices recover.
Be careful though; do your due diligence. Even a dud deal will make money in a boom, but buy a dog in a downturn and you could lose a lot.
While you wait and watch, you’d be wise to build your cash reserves and also work on improving your credit worthiness, as, if real estate really does ‘hit the fan’, then it will be hard to borrow money because lenders will also be more concerned with preservation rather than profit.
I hope this article has given you some food for thought. As always, if you have any questions then post them below and I’ll do my best to help.