Revealed: the greatest threat to property profits

By Luke J. Graham | 20 May 2020

For the vast majority of Australians, their home or investment property will be their single largest investment. As a result, there are few places on earth where the love for real estate is greater than here in the Great Southern Land.

Real estate is a more intuitive asset class than the likes of shares, derivatives, bonds, currency and cryptocurrency. If you’re so inclined, you can reach out and touch a real estate asset. Demand for it makes sense because shelter is a basic human need and if our population is growing, so too is the demand for housing.

The problem with the tangibility of real estate is that many people underestimate it. In essence, if we can touch it, it doesn’t appear to be so complex.

Inspired by tales of multimillionaire property developers in their thirties, relatives whose home values quadrupled in a generation and bidding wars on television, many of us reach a conclusion that the key to property investment is to simply to get into the market.

This has inspired the emergence of what we refer to as the backyard property guru. You know the type: somebody with limited property investment experience (if any) who has firm opinions on the viability of your investment strategy without regard for its complexity.

Another challenge we face as human beings is what is known as short-termism. Consider the notion of time value of money, which tells us that money becomes less valuable to us the longer we have to wait for it. Psychological studies of children playfully replicate this with treats: you can have one now or two later. If you’re less of a finance or psychology geek, perhaps you’re familiar with Queen’s 1989 hit song… “I want it all, I want it all, I want it all, and I want it now!”

The short-term paradox

Excessive short-termism is the cause of major global socio-economic challenges. CEOs have admitted neglecting long-sighted innovations in favour of investments that would boost next quarter’s earnings. Politicians are incentivised to create short-term prosperity in order to maintain their popularity – the mess they leave behind is the next chump’s problem.

The Global Financial Crisis was also blamed on rampant short-termism. Since then, concepts such as the triple bottom line and quadruple bottom line implore leaders to consider outcomes beyond the next quarter.

As Australians, we are not just subject to the very human inclination to expedite gratification, but also unique cultural factors that make us more inclined than others. In a 2010 book by acclaimed organisational anthropologist Geert Hofstede and co-authors, data analysed from the World Values Survey lists Australia as 77th of 100 countries on long-term orientation. With an index score of 21, our short-termism is among the likes of Nigeria (13), Rwanda (18), El Salvador (20) and Mexico (24). Not only are humans inclined to prefer something now rather than later, but we Australians are among the worst offenders.

It may come as no surprise that our short-termism and obsession with real estate leads to unfavourable outcomes.

Consider the inclination for the largest chunk of property transactions to occur during a boom, which then serves to further fuel the boom. Short-termism comes in via the lure of owning an asset on an upward price trajectory.

Eventually, however, changing demand-side factors such as affordability, employment or access to credit will stall this boom. You had better hope you didn’t buy at the peak alongside many of the others!

Another example of short-termism in the property market are those who dispose of their asset within a few short years. Following an unflattering bank valuation, market appraisal or news headline, these individuals fear the future will resemble the present. Then the regrettable choice to cut their losses and sell will typically follow.

Pain and gain in property markets

CoreLogic’s quarterly Pain and Gain report offers documentary insight into the prevalence of short-termism in the property market. According to a 2019 release, resales at a loss in Australian capitals were held as little as half the length of time profit-making resales were.

Adding to the complexity of a property investment strategy is that price growth is not linear. Various factors can contribute to the value of a property increasing and decreasing over time.

For a property investor, the goal should be to maximise the gap between the date they buy and date they sell. Other factors invariably come into play to facilitate this, including rental yields, available tax offsets, buyer’s income, risk profile, etc.

If a property investor steps into the market with expectations of linear or straightforward price growth and quick passive returns, they are likely setting themselves up for failure.

A long-term holding strategy, which evidence indicates is the most effective approach to property investment, will undoubtedly involve periods of price downturn, oversupply, softened rental yields, defects and others. Being prepared for these contingencies is what the word ‘strategy’ is all about. 

Luke J. Graham is an organisational behaviour and property market analyst. He is currently completing postgraduate studies at the University of Oxford.

Top Suburbs : bligh park , artarmon , new farm , lockridge , mayfield

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