Expert Advice with Jeremy Sheppard. 04/08/2015
Most investors stop suburb research once they’ve bought. But the need to make good decisions extend into the period of ownership. So too does the need for intelligent data.
There are three reasons why you need to keep your eye on a market even after buying there:
- Knowing the best time to sell
- Knowing the best time to refinance
- Knowing the best time to offer a lease renewal
When to sell – if ever
My worst mistakes in property investing revolve around missing the right time to sell. The “never sell” philosophy was drummed into me as a noob by well-meaning educators.
I’ve bought property that has doubled in value in a few years. I definitely got my research right. But I stopped my research once I had bought. Prices dropped back to where they started and they stayed there.
Ouchy lessons like that have taught me that there are definitely occasions when an investor needs to sell. So when is it?
Recycling costs vs opportunity costs
The decision to sell is a simple one from a strict investment perspective:
If the cost of recycling equity is less than the opportunity cost, then sell.
The tricky part is estimating the cost of recycling equity and the opportunity cost.
What is recycling equity cost?
When you sell one investment property and use the proceeds to buy another, you’re recycling your equity. There are costs involved. The big ones are usually:
- Exit costs
- Capital Gains Tax
- Agents commission
- Legal fees
- Entry costs
- Stamp duty
- More legal fees
- Building and pest inspections
What is opportunity cost?
If you have $100 invested in an interest earning account at 3% pa but there is another account in which you could earn 4%, then the opportunity cost is $1 pa ($100 x 1% = $1).
In other words, opportunity cost is a measure of the cost of missing out on a better investment elsewhere because your funds are tied up in an inferior investment.
For a detailed explanation of recycling equity, opportunity cost and the factors affecting the decision to sell, read this article previously published in YIP magazine…
Estimating capital growth
The big issue with calculating opportunity cost is estimating the capital growth of your current investment and that of your new investment.
I deal in capital growth every week. I’ve examined literally millions of data points. I’m still not game to publish a prediction of growth with confidence. But I do estimate future growth for my own portfolio to roughly calculate opportunity costs.
I use the Demand to Supply Ratio (DSR) to gauge when demand is ahead of supply for a suburb. It’s a pretty easy indicator to read since it is a score out of 100.
I’d expect DSRs in the 80+ range to have double digit growth in the next 12 months. These are markets in which demand is outpacing supply by an alarming degree. I’d expect DSRs below 50 to have growth around 6% at most. These are markets that are, at best, in balance.
If the next investment opportunity is estimated to achieve 15% growth and my current investment only 2% growth, then I may decide to sell. It depends on how much I would lose with all the recycling costs.
When to refinance
If the recycling costs outweigh the opportunity costs, then I won’t sell. But I may refinance.
A good time to refinance is whenever you have enough equity to invest again. Another good time is when the market is reaching its peak – even if you don’t plan to buy again.
There are 3 indicators I use to try and gauge the peak of the market:
- DSR – Demand to Supply Ratio
- MCT – Market Cycle Timing indicator
- Typical Values
If an historical chart of typical values shows strong price growth slowing, I might be inclined to think the peak is coming. But there are better indicators.
If the DSR has come down from an above average figure to a balanced figure around 50 or less, then there is little pressure on prices to experience further growth.
The MCT tries to score the likelihood of a property market being at the start of its next growth phase based on past growth. The MCT will score lower if there has been significant growth recently.
When to re-let
If vacancy rates are climbing, you might like to lock in your current tenant. You can offer an extension to the lease any time. You don’t have to wait till the end of the current lease.
The tenant may not have access to the data you do. So offering a discount might seem like a bargain to them. But if vacancy rates climb above 4%, you’ll be the one with the bargain. You can bet your bottom dollar, rents will drop if vacancy rates get out of control.
It’s all too much trouble
It’s a lot of effort to keep your eye on all these indicators. And it’s easy to forget to check them every now and then.
That’s why I created the Market Monitor at DSRdata.com.au. It sends me an email every month with the key statistics I selected for the suburbs of my choice.
You don’t need the Market Monitor to keep you up to date. But you really should factor in some time to keep an eye on your portfolio.
Keep making good decisions and good results should keep coming.
Jeremy Sheppard is the property data nut-job responsible for the DSR at DSRdata.com.au
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Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.