Investing when the money is tight

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The current tightness in the credit market has a big implication on the funding available to investors. Bill Zheng, founder and CEO of Investors Direct explains how investors can navigate the present economic uncertainties with ease.
Q. First of all, please tell us how you got involved in the industry?

A. I was born in China and I spent my first 21 years over there and the last 20 years in Australia. It was during my MBA study at Monash Mt. Eliza Business School that I developed a keen interest in finance. In 2000 my first child was born, as a result of this I started to think about my family's financial future, and it didn't take a rocket scientist to work out that something needed to be done to avoid struggling financially in later years.
After extensive study into different asset classes for investment, I settled on residential property as our preferred vehicle because I could understand it and could have good control.

The key to property investing is finance, it took me a while to realize that finance is the main reason why property investors make more money, and property is only a vehicle to obtain finance.

Q. Please tell us about your own company, Investors Direct which you established in 2001?

A. My wife and I started the mortgage broking firm called Investors Direct in 2001, and dedicated the firm's entire workforce to service property investors. At the time, there was a general lack of understanding of property investors from the lending industry.  We saw this as a great opportunity and created Investors Direct to fill the gap.

We saw a real need for this specialised service as we had found that the traditional mortgage professionals think more like a bank or a lender, rather than as a property investor because their main focus is on saving money rather than making money and creating wealth.  We realised that there weren't any mortgage companies specialising in servicing property investors. 

We now have offices in Melbourne, Sydney, Brisbane and Perth, and over 10,000 investor clients. In 2006 we started distributing investor specific mortgage products, and there will be more of these in the future.

Q. How do you think the current credit contraction will affect property investors?

A. Credit contraction will affect property investors in at least two ways:
• Cost of finance will increase.  This is the rule of supply and demand. Where there is more demand for money than supply, money will become more expensive.  This can in turn affect investment decisions as it can lower the return of your investment.
• Property prices will soften.  One of the main reasons why property prices have been able to go up consistently over the last few decades is the ease of obtaining finance (credit expansion).  If this stops, property prices will fall back to match the lower level of finance available to property purchasers.

The current credit contraction is something we haven't seen since World War II.  I believe this has been caused by factors such as advancement in computer technology, a highly leveraged finance market, and other structural declines such as aging baby boomers going into retirement.  It is possible that we could see a severe downturn in the property market if we fail to bring the credit crisis under control.

Q. What do you think investors should do to manage their finances in an uncertain time?

A. While the property market performed really well in 2007, and may continue to do so in 2008 (although it is likely to be to a lesser degree) the credit contraction means that I would be cautious in expanding my property portfolio in such an uncertain time.

There are different priorities at different times for an investor.  When facing a potential unprecedented financial crisis, safety is of a higher priority than making massive profit. While the property market is going up, it is time to be conservative.  When it is going down, it's time to be aggressive.  In my opinion, now is the time to be conservative.

Property investors may consider lowering their gearing and consolidating their cash to create a reserve.  This will ensure that you don't run out of cash to cover your interest repayments. If you are in a comfortable financial position to purchase more properties, do not over leverage and make sure you go for properties that are still in demand during a downturn in the market.
Do not rely on refinancing your properties to withdraw equity as you may not be able to do so during a severe credit contraction period. Diversify your debt with different lenders to keep your single debt exposure low with each lender.  This is to protect you from being monitored by lenders during bad times.

Do a worst case scenario calculation on your current property portfolio.  For example, if there was a 3% interest rate increase over a 3 year period, and a 30% drop in property prices, what would you need to do to prepare yourself for such a situation? We should always expect the best, but always be prepared for the worst.

Q. You believe there is often a lack of understanding of the needs of property investors among finance professionals. Why do you think this is?

A. Most finance professionals are not property investors themselves.  It can be hard to understand where people are coming from unless you have been through it yourself.

Investors are normally the most aggressive borrowers compared to average home owners.  They not only want to borrow more, but also want to delay paying lenders back for the longest time possible.

Most lenders, especially banks want borrowers to pay back the principal of a loan so that they can lend it to someone else to make more profit.  Investors want to hang on to the lender's money and pay them back as late as possible because it's always cheaper to pay back later due to inflation.

Interest rates play a much bigger role if you are a home owner as your main focus is to pay off your mortgage as soon as possible.  Whereas flexibility and risk management could play a bigger role if you are a property investor, as your main focus could be building a larger portfolio quicker with minimum risk.
Paying off your debt is not necessarily a high priority for some investors while they are building their portfolio, but having access to more debt is.
Using debt to create wealth through property takes a lot of courage and experience.  Having an experienced mortgage broker who has risk management skills required is critical for the success of a property investor.

Q.So is being a mortgage broker for investors quite different to being a mortgage broker for someone just buying a family house? If so, how?

A. A home owner's mortgage broker focuses on saving money and helping the borrower to get into their home with the lowest cost possible. An investor's mortgage broker focuses on creating wealth instead of just saving money.  They help investors to maximize the return on their money with the lowest risk.

An investor's mortgage broker needs to be more sophisticated in many areas to be able to meet their clients' needs.  For example, a property investor needs to have a thorough understanding of property selection, property strategies, risk management, asset protection, property taxation, exit strategies, etc.  A home owner just needs to fall in love with their home, everything else becomes less important.

Q. How can property investors identify which mortgage broker would be beneficial to them?

A. A mortgage broker who is also a serious property investor is definitely a good start. Alternatively, a mortgage company which has multiple mortgage brokers who are property investors can be even better as you aren't relying on just one person.

Another good indication of a good mortgage company for investors is to see if they have a large property investor client base.  If the mortgage company is no good at serving investors, investors don't hang around for long, so having a large number of clients shows that they must be doing something right.

Most mortgage companies in the market place don't have a special focus, they think lending money is their job, hence they take on any client and become a generalist rather than a specialist. An investor focused mortgage company should know that they are in the wealth creation business for their clients.  Their brokers should be familiar with investment related subjects to add value to their clients.

Q. What sort of services should an investor focused mortgage broker be able to provide?

A. All mortgage brokers should provide at least the following services: work out how much you can borrow, select the right product from the right lender for you, lodge the application for approval, and help you to settle the mortgage. An investor mortgage broker can help you with the following areas:
• define your finance strategy for your portfolio
• work out your future potential capacity
• manage lender's risk so that you can avoid loans being recalled during bad times
• select the right order of lenders for your growth
• set up your finance for taxation and asset protection purposes
• provide you lending criteria to help select better quality properties
• inform you of lending potentials on each property you want to purchase
• update you on the lender's attitude towards the property you want to purchase
• update you regularly on what is new in the finance market to help you grow your portfolio
• point you in the right direction for help in areas of investment taxation and asset protection
• assist you with knowledge and experience in property related areas such as property selection, renovation and development
• be an unemotional reference for your investment decision
• observe the investor's money management pattern and help you with better financial management systems.

Q. What sort of questions should a property investor be asking when employing the services of a mortgage broker to ensure they employ someone who is going to look after their needs?

A. The broker-investor relationship is a partnership.  It's technically no different to a business or personal relationship.

What sort of questions should a girl ask a guy to ensure that he is going to look after her needs? Can his words be trusted? What if the girl treats the guy badly.  Would the guy still keep his original promise?  It takes two to make a relationship work. You get out what you put in.

I personally wouldn't rely on people's words entirely, I look at what they do not just what they say they will do. If a mortgage company has got a great reputation in the investors' market, and have a lot of happy investor clients, you know they're probably workable for you.  Then it's up to both parties to work on the relationship for mutual benefit.

If we must ask them questions, here are a few I can think of:
o How many clients do you have? And what percentage of them are property investors?
o Are you a property investor yourself?
o How can you help me specifically as a property investor compared to a home buyer?

Q. Many property investors become frustrated with banks when they start to refuse to lend them any more money. How can a mortgage broker help overcome that?

A. Mortgage brokers have more options than banks. Technically their job is to find you the money from whoever wants to lend. Banks usually have tighter lending criteria than other mortgage lenders.  In fact, its good that they are more conservative, because our cash savings are held with them.

Investors are often declined by banks due to insufficient income to service debt.  Most investors understand that it is their responsibility to come up with equity, not the lenders. If you can come up with sufficient capital (or equity), you can get finance from lenders that don't lend against your income, but lend only against your equity.  We call these 'equity based lenders', (i.e. no-doc type finance).  A good mortgage broker can help you with these types of loans.

Q. Are there ever occasions when you can't help investors find finance, could you give us an example of why this might be?

A. The investors' income generally has a limit, when it reaches that limit, many lenders won't lend them any more money. When your income runs out, you need to rely solely on equity.  If you used up your equity, then you will find it hard to obtain finance from anyone, but if you learn a way to create sufficient equity along the way, your finance can still go a long way.

If you run out of both income and equity, then the remaining option is to use other people's income and equity.  This way, you can have a certain amount of control of the assets but not necessarily own them.  This way your finance is only limited to how much time you have to put those deals together.

Q.How important do you think it is for property investors to have clear goals about what they want to achieve right from the outset?

A. It can be important for some, but not so important for others. Having set goals is a double edged sword. It gives you a sense of direction, but can also eliminate great opportunities that could be beyond your logical reasoning.

Many clients don't have a clear goal initially due to the lack of knowledge of what is possible. Once they find out what's possible, then they can set meaningful goals.We assist clients by providing them with options . They still need to make the final decision.

Q. So just in closing Bill what would be your key words of wisdom to all those property investors out there?

A. Make fewer promises, and keep them.

For those who want to find out a bit more about Investors Direct, visit their website

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