There’s no Such Thing As a Property Cycle by Graeme Fowler
Oct 10, 2019
Disclaimer: Nothing is this article is meant to constitute financial advice of any kind, and is the opinion of the author only. Seek professional advice before making any financial decision.
Booms, busts, bottoms of a property cycle, tops of a property cycle, peaks, troughs, recoveries, property clocks, you’ve no doubt heard them all before.
Are they important to know?
Do you need to understand what they mean?
Will they help you make a decision if you want to buy, or sell a property?
Where in the property cycle should I buy?
Where in the property cycle should I sell?
How do I know what the ‘time’ is on the property clock?
Why are people so obsessed with all this jargon; needing to understanding it and always trying so hard to work out where in this hypothetical ‘cycle’ we are?
I think a lot of it comes from fear. Fear of the unknown, fear of making a mistake and fear of being wrong and looking stupid to friends and family. They try to understand something which isn’t logical, reliable or even able to be 100% understood. Investors will use some or all of these jargon terms to justify why, and more often why not they aren’t buying any property. How many times have you heard investors say ‘I’m not buying right now because we are at the top of this cycle’, or I’m waiting for the bottom of the cycle before I buy’, or ‘I’ll wait until the next cycle starts’, or ‘I think we’re at 2 o’clock on the property clock now and so I’m waiting until 7 o’clock on the cycle to buy again’, or ‘I’m selling my properties now because we’re at the top of the cycle and I don’t want to start losing money now when prices go down. People are scared to act in case they guess the market wrong, they are afraid that they will buy a property and then the market prices will drop. A lot of these types of people will want all the variables totally in their favour with no exceptions and will use any excuse not to buy!
If you’re more of a buy and hold investor i.e. you buy a property and your intention is to hold it long term, does it really matter when you buy it, if it makes sense to buy it at the time? Is your intention to pay the debt off and live off the cash flow, or to speculate?
There are three main types of buy and hold investor and knowing which one you predominantly are is important. These are as follows:-
1) Buy, hold and have the mortgage(s) all paid off with no intention of selling at all, until at least this point, - if ever.
2) Buy, wait until market prices go up $20,000 - $100,000 and then sell.
3) Buy, wait until prices go up and then sell half of what you’ve got. For example, buy 10 properties, wait until they double in value, then sell off five properties and pay the mortgages off on the other five.
Investors who use strategy 2) and 3) are more likely to use interest only loans and are what I call ‘speculators’. They are also happy to buy properties with a 6% or less yield. Their strategy relies on something they have no control over at all, the market. It’s also why they are so intent on trying to understand the real estate market and what it’s doing. They have no influence over what happens, however their strategy relies on it; something that is totally outside of their control. It’s the same with the sharemarket or the Forex market, individual investors have no control over the market.
So, with the 2nd and 3rd strategies mentioned above, the investor is reliant on the market doing what they want it to do. If not, they will lose money.
If you are mainly using strategy 1 which is the strategy I’ve used for nearly 20 years, it’s not reliant at all on what market prices do. During this period I’ve been purchasing buy and holds, there have been times when market prices have stayed static for several years, times they have drifted downwards by 20 – 30% over several years and other times when prices have doubled within 2 – 3 years. At no time did I think ‘wow prices have gone up so much, I should sell my properties now in case they go down again?’ Also when they went down by 20 – 30% in value, at no time did I think I should sell them in case prices dropped further. The only thing I was interested in was ‘are the tenants still happy to pay the rent to live there, and are the mortgages still getting reduced each and every month?’ The answer was always yes, so it was of no interest to me at all what prices were doing.
When I was in a position to buy more rental properties either through building up new deposits out of cash-flow from my business or profits from trading properties; I would buy more rentals if it made sense to. That is, if I could get at least an 8% yield on any property I purchased to hold by buying really well, or creating a higher yield in some way (eg improving the property and increasing the rent etc).
In 2014, some of you may have read the book I wrote in late 2015 (20 Rental Properties in One Year) which is about the story of how I bought 20 properties with effectively no money (equity) by buying really well and refinancing them. Many of the properties were bought from investors whose strategy was using strategy 2) or 3). These investors were selling at a big loss in many cases because now they owed more on the mortgage than their property was worth. They bought with the assumption that ‘prices would increase’ and that’s how they would make their money. These are the same type of investors that try to pick what’s happening in the market, analysing what they think will happen and then acting on emotion, rather than applying a good safe strategy that will work no matter what happens in the market.
People look back now and say to me ‘you picked a good time to buy all those properties in 2014, did you know we were at the bottom of the cycle?’ I say ‘no I bought them because it made sense to buy them at the time, no other reason’. For all I knew, the prices could have kept going down even further from where they were, but that was of no concern to me at all if they did. My focus was only on ‘will the rent cover the mortgage and outgoings on a 20 year P & I loan over 20 years with 100% financing?’ In other words; as long as the rent covered all of my expenses i.e. the mortgage, rates, insurance and property management; that was all I needed to know. At the time if people had asked me what I thought was going to happen to prices from where they were then, I would have said ‘I have no idea, and I really don’t care’. It’s exactly the same today in 2017, I have no idea what will happen to prices (in any location in NZ) in five years, in three years, in one year, in six months or even next month, and nor do I really care.
The only time when market prices are a factor is when you are renovating and selling them on again. The reason why it’s more important is that if prices go down too much, you could potentially lose the profit you were going to make.
How do you know if prices may go up or down? You don’t.
This is about as technical as you need to get if you are trading properties (with buying and holding property using strategy 1, you don’t need to be concerned at all)
Find out - are there more buyers around, or more sellers? If there are more buyers (shortage of listings) and there’s lots of properties getting multiple offers on, that’s a good sign that it’s still okay for trading. If there are lots of properties for sale with properties sitting on the market for a long time before they sell, that’s generally not as good a time to be trading properties. You may still be able to make money, but it may take you longer to sell and if prices are going down, this makes it even more difficult for you to make a profit. When this is the case, you really want to buy extremely well (or add value in some creative way) from someone that really needs to sell and then renovate or tidy up as quickly as possible, and be willing to take smaller profits.
So to me, there is no such thing as a property cycle, a boom, a bust, a property time clock or any other mumbo jumbo words that people make up to try and make sense of what’s happening.
There are just too many variables that quickly have an effect on market prices and can alter the way things are right now. Right now is the only time that matters.
What can happen to change market conditions fairly quickly? Things such as a sharp increase or decrease in interest rates over a short time frame (12 months or so), changes in banking regulations, changes with the Reserve Bank or changes in law. Another big factor is the sheep factor (following the crowd) combined with fear and greed. Nothing shows this more clearly than the sharemarket charts and looking at the rising and falling of stocks.
In summary, stick to the basics of property.
What is your low risk idea and strategy for investing?
Look at the numbers, do they make sense?
Am I able to get a good yield?
If not, can I create one?
If not, are there other locations in NZ with cities of 100,000+ population where it does make more sense to invest?
If the answer is still no, can I put more deposit in to each property to make the numbers work and therefore give me a better cash-flow? At least then you will be still using some leverage and having the tenants pay down your mortgage for you over time.
Realise, when people think there is such thing as a property cycle, they try to fit what they know about cycles into a box that makes sense to them, and often it doesn't make sense.
It's easy to see that the changes in market prices over various periods of time in cities throughout NZ, is different. There is no logic to it, but people (especially economists) will usually tell you in their own opinion ‘Why’ something happened - after its already happened.
And it may be accurate, or not. If you only look at now, now, now and nothing else when making decisions on buying, that is what I'm wanting to get across. Forget about looking at current as well as past trends, graphs, historical figures etc. Only ask yourself – ‘does this make sense for me to buy right now?’
Now is the only time that matters when looking to buy a property to hold.