The Psychology of Declining Markets....

Good on you for looking outside the square

 

I guess one scenario I can think of would be those that are looking to refinance.

Say your 5 year IO period was coming to an end, and you wouldn't be able to afford P&I repayments, you would want to refinance. That might not be possible without a massive cash injection if the values are down.

But you're right. If you've crunched the numbers and you can survive on P&I, have a buffer, and won't need to access equity, it's a matter of keeping afloat. But sometimes it's not that simple I guess.

 

Dan you won't go suddenly bankrupt...but you do not need stress test your portfolio and anticipate the pitfalls. As I said if you have lets say 10 places and 5 become vacant...will you have enought to cover the next mortgage payment.

The real killer ...I get that you are covering mortage payments. But lets say you have $3m in loans and interest rates rise 2%...do you realise that is $60k pa in repayments or 5k per month. Have you got that in savings or offset? Fine to cover mortgage payment but each property will cost $5-6k minimum for council, water, insurance, and mgmt fees. If you have 10 places that is another 60k. Understanding the cash flow hurt is also important...

 

More than doubled in 3 years. Amazing result. Awesome timing, and welcome to the forum.

 

Spot on...this is an interesting point you raise about PI...based on recent bank changes...most now will not offer 15 yrs IO. A lot now require additional verification and approval to continue extension of IO past 5 years.

Lets say an investor holds a large portfolio and $3m in loans. If for some reason if 2/3 of his portfolio converts to PI....that would add another 8k in extra costs via a PI loan...on 3m that would be 15k.

 

Thanks mate - I only mentioned it because someone was asking about Kingswood specifically. I have others that are underperforming. e.g. I have a house in Mackay that I built a few years ago, say no more.

 

It's more risky for the investors who buy multiple negatively geared IO properties. Their strategy is to catch rising markets and then sell a couple off to pay down the remaining ones. The ultimate goal of investing is obviously cash flow providing enough for youto choose not to work etc. But if the market dips the properties may no longer be worth what was paid for them. This may mean you can't sell and have to hold them longer term. Meanwhile, no principle is being paid off ( which would at least be something) so as opposed to having financial freedom, the investor is working to keep payments going. Add in rising interest rates, a drop in rents or just the fact that having to maintain the properties in this way for a number of years increases the risk that some other issuewill crop up that tips finances over the edge. The awesome 'flexibility' of IO mortgages may mean they have no real financial buffer as it was spent on deposits for further IPs.

That's why I prefer to get my portfolio earning steady cash flow before I buy too many more. Then I have rental cash flow, but if needed I can also use income. Property investing gets very addictive and there's a risk of getting caught up in hype and fear of missing out, which can lead investors to pay too much for property. Only takes a dip in values across a few properties to cause serious financial havoc.

 

Yep...some newbies from Sydney are about realise this lesson from the Sydney market shortly....

 

Unfortunately some investors don't have properties that cover their mortgages, and as I/O rates have nudged up and rental yields have topped out or fallen in some areas, it can be problematic if they dont have income streams high enough to cover the gap. But yes, if you have sufficient cash flow to see off the dips and troughs, you should be OK

 

Some of you mentioned prices in Blacktown coming down (for houses admittedly).

It doesn't seem to be having an effect on unit prices which still seem very high given the area

$510k for this one... 53/8 Wallace Street Blacktown NSW 2148 - Unit for Sale #121763514 - realestate.com.au

$480k for this one... 11/14-18 Fourth Avenue Blacktown NSW 2148 - Unit for Sale #121268226 - realestate.com.au

I remember looking (and not going ahead) with buying in the area around May 2012 for around $300k for similar. Missed the boat back then but if prices are dropping for houses, would you expect unit prices to drop back to the $3's?

 

That's me (together with my investment partner)

Not at all in our case. We bought potential development sites with a view of developing 3 or 4 townhouses on each site and turning them around from negative cash flow to positive cash flow. We hit a servicability wall after 2 of these sites but even if we could have bought a third, we would have had no capacity to develop any of them. This is where cashflow is critical. Negative cashflow severly limits borrowing capacity. Incidentally, these properties were purchased pre-boom, so a severe price correction would not have affected us. Still, it's not viable for people in our position to hold negative cashflow properties in the long term, so we sold one down at the end of last year.

There is already a loan in place to develop the other site to send it cashflow positive. That will leave borrowing capacity for more investments when the market in Perth bottoms out.

Our psychology for a falling market is to sell down an asset to free up cash and capcity to invest at a much low price point as the market corrects. Our strategy is to actively watch the market for the next few months with a view to buy in the next 6 to 12 months depending on market conditions.

 

Hey PG
I love your story. I thought I was answering a post about what could go wrong though? Of course it may go very well,, and often does. That is my goal as well as everyone else's, but wouldn't you at least want some small note of the potential risks to help some one avoid them? I think there are some relative newbies here whose only real experience of buying is in a (recently) rapidly rising market, so their advice reflects that. They have strong personalities and will be influential. I'm not an expert myself but wouldn't it be better to be a bit more open? Doesn't affect me as I'm not in the relevant markets but saddened by the wall to wall optimism with no balance to it.

 

Thanks guys,

I guess I was just looking from point of view where I'm cashflow neutral after all
costs and was wondering why a decline in values would matter (other than the obvious that is). I guess it is worth considering when the interest only periods are up but I've always just refinanced in the past.
Cheers

 

I look forward to many more contributions fit wealth

Businesses are not easy so well done.
What is network distribution?

 

I agree your proposition is an example of what can go wrong, my story is a different kind of what can go wrong!

The part of your post I was specifically responding to is this: "It's more risky for the investors who buy multiple negatively geared IO properties. Their strategy is to catch rising markets and then sell a couple off to pay down the remaining ones."

...because myself bought multiple negatively geared IO properties... but not to catch rising markets and sell, we bought ours to develop. However, we didn't develop one of them and it is not feasible (at least for us) to hold a negatively geared property.

My warning is for people who buy negatively geared properties with a view to develop and then don't develop them... they are going to run into a serviceability wall.

Different scenario to us, but what if they bought these sites near to top of a rising market and then prices fell? They then run into the same kinds of cashflow problems you mentioned in your scenario and may not have the servicing capacity to develop the first site to turn it cashflow positive. I see that as an issue/risk too.

Not disagreeing with you at all. I am agreeing with your post and also expanding it to cover another risky scenario.

 

None of my IPs has ever gone P&I, only IO. So I guess the warning is for people like us who have always refinanced at the end of interest only periods. Since the APRA changes, it is not business as usual and we might not be able to simply refinance to another IO loan as easily as we did in the past. Something for both of us to consider I guess. I have not run the numbers on our loans if we were forced to go P&I because it is not something that has affected us in the past. However, prior any future purchase, I will be including this in my routine scenario planning.

 

I add 2% to stress test. I'm at accumulation phase so that's important and appropriate insurance. I'm more concerned with buying well.

 

Thanks PG. Apologies, I'm on my second large glass of red wine with the cricket on in the background, so even less sharp than my usual Really glad you didn't get caught out I decided I can earn more easy money myself just working in health than taking on developments, thats guvvy jobs for you, so big kudos to you!

 

No worries. Not sure how well we did on the Melbourne property yet. Being negatively geared over 8 years, we certainly lost a packet on it. I would estimate it cost us between $160k and $200k to hold. This means after selling costs and tax, we might only just break even. I have been meaning to start a thread on this very topic --- the actual costs of holding a negatively geared development site.

If we had bought it a bit later and sold it a bit later, we would have definitely made a loss as opposed to nominally breaking even. I am looking forward to turning my first development site to cash flow positive. I have never had a cf+ IP!

 

I'm from Europe and we were never allowed to just take IO loans, they had to be backed by an investment policy that would pay off the loan at the end of the mortgage term. Anyways, astonishingly it turned out that many of the investments were not covering the loan at the end of the mortgage term (30yrs). People were finding themselves unable to pay out their ppor mortgage in retirement let alone any anticipated profits. This was in the UK, not some one horse town. The government then put restrictions in place around IO mortgages in response. It was a good thing in some ways, but punished people who used them well. Anyway, there are a lot of benefits in Australia being 'newer' in terms of some policies but these opportunites can easily disappear, so best to be prepared.