How do you know when it’s time to sell? Jeremy Sheppard examines the factors you need to consider before cashing in on your property.
Most investors only think about using the law of supply and demand when looking to buy their next investment property. But supply and demand are also crucial when considering whether to hold or whether to sell and when to do so.
It is well understood that prices for any commodity or service will go up if demand exceeds supply and go down if supply exceeds demand.
To quickly gauge the imbalance in demand and supply for Australian residential property markets I use the demand to supply ratio (DSR score) that is published in the back of this magazine. If you haven’t seen it before, flick to page 102 to see what I’m talking about.
The DSR score takes some of the better known statistics such as vacancy rates, auction clearance rates, yield, stock on market, days on market, etc and “munges” them all into a single figure called the DSR score. The higher the score, the better the potential for price growth to occur.
Buying a $300,000 property that experiences 5% growth per annum over the next two years instead of buying one that experiences 10% growth per annum will cost you $30,000 in lost opportunity (10% - 5% x 2 x 300,000). This loss is what most investors focus on. But the loss of hanging on to a property in a dud market can be almost as expensive.
Holding onto a $300,000 property for two years in a flat market when you could have invested the money in a market experiencing 5% growth is not actually a $30,000 loss over two years.
By hanging on to the property you avoid paying the costs associated with recycling equity. For this reason many property advisors recommend investors “buy and never sell”. The “buy and never sell” recommendation has one big flaw. That flaw is the word “never”. Almost as soon as you say it, exceptional circumstances start occurring to prove you wrong. I have sold properties I bought with a plan to never sell. But when I did sell, it made perfect sense. It all came down to the numbers.
If supply is exceeding demand, a decline in prices might only be slight – like a 5% drop. But it is usually the time it takes for the market to recover and start growing again that is the killer. Most markets spend more time flat than they do falling. It’s the time you have your money invested in a poor market while others are booming that hurts – it’s the opportunity cost.
Time in vs timing the market
I admit, the more time you have money invested in the property market, the more wealth you will create because of the basic nature of compound growth. But that compound growth is not constant, it usually happens in short surges and is followed by long flat periods. You can accelerate your wealth creation if you know when the right time is to enter and exit the market.
Passive buy and hold investors who plan to never sell actually put themselves at risk if they don’t keep an eye on their markets. On the other hand, the investor who wants to occasionally sell will need to be more observant, they will have to keep their finger on the pulse of every market they own property in.
I’ve noticed a lot of interest recently among investors in buying property
in their super fund. A lot of rules have been changing with respect to this. Investors who follow this path will need to alter their attitude about super funds. Fund managers keep an eye on their clients’ investments. But we, the beneficiaries, usually have a rather passive attitude.
Once you own property in your super, you will need to change your attitude and be more vigilant, giving not be the “set and forget” investment you thought it was.
When to sell – calculating costs
Whether to sell or hold is both simple and complicated. The simple bit is, if the opportunity cost exceeds the recycling cost, then you sell. The complicated bit is calculating all these costs accurately. You’ll often find estimating the future capital growth is the most inaccurate part of your estimating. And remember you need to estimate the future capital growth of both the property you own and the one you intend to replace it with.
The DSR score can’t accurately estimate a capital growth figure. But it can be used as a very rough guide. The average DSR score for most of this year has hovered around 22 out of a maximum of 48. And the long term national capital growth rate is around 6%. So, in a “normal” market, you can assume a benchmark of 6% growth and adjust that up or down a few percentage points depending on where your market’s DSR score lies, where interest rates are and the general confidence in the economy. That will give you a ballpark figure.
When to sell – examining the market
If the DSR score for your market has been dropping consistently over the last year this should trigger alarm bells. Similarly, if the DSR score has edged into the “very poor” category, you should be on your guard. Do some research and find out if anything is hampering demand like a council plan to have the region’s rubbish dump moved to your suburb. Also, see if the problem has been an increase in supply. Check the council website to see what development applications have been approved that may bring even more supply to the area.
To maximise the number of potential buyers for your property, it is preferable to have it empty. Having a tenant may be a bonus for an investor, but an owner-occupier will usually want vacant position.
It is important to perform your research early before the market really starts to slide – assuming it is going to. Remember, if you have a long period outstanding on the lease, you can’t just kick your tenant out. Even if the lease is “periodical”, you will still need to give your tenant about two months notice.
Check with your property manager what obligations you have to determine how soon you can exit. Remember that each state has different tenancy laws and each lease may have specific conditions. Here’s a hot tip that could save you tens of thousands of dollars. Ask your property manager to remind you three months prior to a lease expiring. When you get the reminder, spend no more than one month checking the health of the market and make a decision whether to sell or not. This will be two months before the end of the lease, which gives your tenant plenty of notice.
Also, remember that once your tenant vacates, you may need to perform a few touch-ups to the property before allowing inspections from potential buyers.
As a minimum, expect at least four months to pass from the time you start checking the health of the market to the time you get your first offer from a buyer. This highlights the need to not only act fast but to also understand the future movement of the market ahead of the pack.
If the market was not in a good position to begin with and it starts to slide quickly, it may be better to put the property on the market with a tenant pre-packaged for the next owner. Waiting for the tenant to clear out may actually cost you valuable time in a falling market.
Demand may be dropping with respect to supply, which is affected by owner and buyers. But so long as both vacancy rates and yields are maintained, there should be no panic to sell for the cash-flow focused investor. Of course, if something fundamental to the nature of the local economy is the cause of dropping demand to supply, then even positively geared properties are at risk.
If you find your market’s DSR score is dropping, have a look at which statistics are causing this. Is it vendor discounting and days on market that are increasing? Or is it vacancy rates and yield?
Note that some strong price growth without accompanying rental growth will cause yields to drop. This is nothing to complain about though. If you own property in this kind of market, you’ve probably already received some capital growth. Yields may increase because prices are falling. You want yields to increase because of rising rents, not falling prices.
Check the charts of recent prices to see what the cause is.
Case in Point
Figure 1 shows a chart of the DSR score from January 2010 to October 2013 of the housing market in Coombaba QLD. There is a noticeable slide in DSR values to a bottom in July 2011 and then some recovery.