(03) 9020 2905Today, I’m the guy who holds a red rag to a bull.
I’m standing in front of a rampaging herd of investors, holding great piles of cash, stomping and crunching everything in their way, chasing the “next big thing”.
With the stampede rushing towards me, I have a simple message. I’m hoping to make a few of them think. Not all. Just a little doubt in some.
“What if the herd is wrong this time? Could you survive financially if you get this punt spectacularly wrong?”
Investors are always looking for the next big thing. They think they’ve found it now in residential property. (And it’s a strong argument. I’ll come back to that.)
Investors are piling in, some of them blindly. When it comes to property cycles, investors tend to get in first. Homebuyers come later. And that’s certainly been the case on this occasion.
Certainly, the alternatives for investment aren’t great.
Cash is all but dead with an official interest rate of 2.5 per cent. The Reserve Bank has indicated the folding stuff is in intensive care. It might get sicker before it gets better.
Fixed interest – the super-star asset class throughout the GFC – has run its race. It ran a marathon. But it’s spent.
Shares are less predictable. For the last 18 months, they have done what investors love – a quick sprint. They’ve stacked on more than 28 per cent since May 2012.
So attention has turned to residential property. And why wouldn’t it.
Interest rates are stupendously low. While that’s bad for those holding cash, it’s a boon for property purchasers. Most indicators suggest property prices bottomed earlier this year, after going backwards for two years. There still seems to be a housing shortage, which will take time to reverse.
The authorities are again worried about bank lending practices. They want to restrict how much banks can lend to first home buyers.
But my red rag for the property bulls?
Property is not guaranteed to boom. And even more certainly, not all property will benefit from any boom.
Rubbish property is still rubbish property. Rubbish property can go backwards, even when the sector is booming.
If you’re considering making your first big property investment, take a few extra precautions.
Investment property involves huge debt. Debts have to be serviced. No leeway. Banks don’t care about hard times. Make your monthly repayments, or your new investment property gets sold from under you.
And your home could go also.
How? You buy a property for $500,000 and borrow another $25,000 to cover your stamp duty (which is how property is generally bought when the investor has equity in their home).
Then you lose your job. And you struggle to find another one (unemployment is rising). Within three months, the bank will move to sell your investment property.
But the property is now only worth $450,000 – because you overpaid, or there’s a flood of property on the market – so you have a problem.
You still owe the bank $75,000 (more, actually, with selling costs).
If you can’t put that debt against your home, it will be sold also.
Don’t get me wrong, I believe the property story at the moment – property is about to go for a canter. It could be a very profitable few years for those bold enough to dive in.
But investment property – unlike any other asset class – takes risk to a big new level, because of gearing.
What do you need to keep top of mind, if you’re thinking about it?
Do your research, or get someone to do it for you (not the property developer). Not all property is great. Some is truly awful and will always be truly awful.
Have a big cash buffer. Most people should hold three months’ salary in liquid assets. But geared property requires more, particularly if you’re in a shaky industry (retail and resources, as examples).
Don’t just hear “negative gearing” and fall in love. Negative gearing is a great tax strategy. Sometimes. But it also means that you’re losing money.
If there’s a boom coming, make sure you don’t just jump like a lemming. Geared property IS different. Borrowing money raises the risks, sometimes dramatically.
Anyway, I’ve raised my red rag. Good chance I’ll get trampled to death.
Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au), a licensed financial adviser and mortgage broker. bruce@debtman.com.au.