First published 01/08/2012
Never sell in a down market: it’s an investor golden rule, but it could cost you big time if your property is underperforming. We enlist the help of investment experts to help you find out if it is indeed time to unload a dog investment
Weary investors across Australia have been throwing their hands up in disbelief during the rollercoaster ride the markets have taken the past few years. The mantra “safe as houses” has been heard across the land, though recent months have made the chants significantly less confident.
The housing market across most of Australia is ‘soft’, ‘flat’, ‘down’, or ‘ominous’, depending on which commentator you listen to. With those adjectives ruling the day, an investor’s first impulse, understandably is to head for the hills. Sell. Get out of Dodge.
But like most first impulses, following it might just get you into big trouble.
“The problem in this kind of market, and it’s the same in the share market and the managed fund market, is that now is not the time to be selling,” says Philippa Sheehan, Managing Director of My Advisor, an independent network of financial planners. “You’ve got to hold on if that property is part of your long term strategy to achieve income and asset positions.”
But she says it always boils down to the individuals’ situation – do they need the money quickly? Are they close to retirement? Have the rents tanked in the area and wiped out a needed source of cash flow? Would another asset class, or property investment, get an investor better returns? Sheehan says these all may constitute reasons to break the golden rule and sell on the downside.
Value investors of the school of Warren Buffett (who once said his optimal holding period on an investment was ‘forever’) are perhaps the most loathe to sell on the downside, but even they will admit there are times when you have to bite the bullet. “Any investor would probably be at a position to sell even at a loss, which is admittedly tough on the head, but you perhaps ought to liquidate at a loss if in fact that investment no longer meets your goals,” says economist and value investing scholar Donald Ross of Australian Catholic University in Sydney.
Don’t get spooked
Ross does warn investors against getting too spooked, and to really do their homework before deciding whether to sell. He says that property, even more than shares and other asset classes, tends to have much higher transaction costs, so investors need to be especially wary of being too hasty about dumping a property, because dumping tends to be expensive.
But Ross says sometimes that expense might be worth paying if it saves, or earns, you more money in the long run. But he says the problem is that many investors do not like to know that they were wrong, and many times avoiding that can cause them to hold onto an asset for far too long. Ross says this is especially the case in real estate where there is no ‘ticker’ to tell you the current price of the asset. He says the property market is more opaque, therefore allowing investors to fool themselves into believing that things are not really that bad.
But selling would kill the fantasy, Ross says, “because they may have said to themselves that I bought it for $500,000, it’s still worth $500,000, even if they know full well that they couldn’t get half a million for it today.”
The key, say scholars and advisors, is being objective about your property investment and treat it just like any other investment, and to subject it to the same kind of scrutiny and performance expectations.
With that in mind, there are two clear scenarios where advisors agree that dumping an investment in a soft market could make a lot of sense: in order to stop the bleeding, or when your returns just are not what they should be.
The first case is generally a lot easier to spot than the second. Think of it like spotting a metre-wide hole in your roof versus a slow leak. The hole is a lot easier to spot, but either way you have a problem.
When you need to stop the bleeding
If you got caught up in the hype and bought at the top of the market and were looking to make a short term flip, then chances are you may be faced with no choice but to sell. This scenario is the equivalent of having that metre wide hole in your roof.
“The first challenge is to admit that you made a mistake and you’ve bought a property that hasn’t performed how you expected it to,” says Stuart Wemyss, Director of Melbourne-based wealth advisory firm ProSolution Private Clients.
If you were expecting big capital growth through a negatively geared investment, you may be looking at just digging yourself a bigger hole if your local market does not look like it’s going to recover quickly.
In this case it really breaks down to running a pretty simple set of numbers. If you’re not going to be able to afford making those payments every month, then sell and sell quick, Wemyss says. Having a cash flow problem now could turn much worse down the line if interest rates creep back up or if you have trouble renting the place. What is a slow drain now, could turn into a deluge later on.
Projecting cash flows
How to tell if you’re at risk of having your cash leak turn into a flood in the near future? Run a couple of different scenarios in order to see how different events might affect what you’re going to need to shell out in order to keep the status quo. You may find it’s actually not worth holding on.
If you have a fixed loan and solid tenants on a long-term lease, then your future cash flows are easy to plot out as long as you are not looking at any serious repairs. The key thing to consider here is how long you intend to hold it in order to wait for those capital gains you were looking for, and figure out whether you can afford the holding costs it will take to get there.
Analysts warn that you should be conservative about the capital growth you may expect in the coming years especially considering the current slowdown.
Real estate researcher and advisor Michael Blight says he typically puts together models that incorporate key variables like income levels, CPI, population growth, and local investment in order to project the short to mid-term growth prospects for a region. But he says we shouldn’t be too scared off by all that, because in most cases, we can find someone else who has already done much of the work.
Several of the major property data and research firms produce their own growth projections even down to the suburb level. For example, he says Residex offers predictions for any suburb in Australia. Though Blight cautions that these predictions should be used very conservatively, he says they can serve as a good guide.
When not bad isn’t good enough
But Wemyss says even investors who are not in such dire straits may find that it is time to move on from an asset that isn’t performing as well as the alternatives. A lot of investors, he says, underestimate the returns they should be getting.
“So a client might say, ‘I bought a property for $200,000 10 years ago and now it’s worth $300,000 so I made $100,000. I’m feeling pretty good.’
“Well, I would say to that client had you made a better decision 10 years ago your property should probably be worth more like $500,000 so in actual fact you’ve lost $200,000.”