How to get your head around the ups and downs of the property market
The property market is hot. The worst thing you can do is sit on the sideline and do nothing. The second worst thing is to buy the wrong property and spend the next 10 years regretting your decision.
The best thing to do is relax, research, prepare and build a rock-solid plan that allows you to live the life you want while growing your investment portfolio.
Millennials are leading the way with rentvesting, and there are other ways today's investors are thinking about property compared with their parents or grandparents.
But before that, it's important to understand the cyclical nature of the market. It is imperative to think of investing in terms of cycles. It is an important framework that will save you from making mistakes at the top or bottom.
Even with all the available strategies and tools, if you don't think in cycles, you'll be consumed by emotions and eventually succumb to peer pressure, often leading to mistakes.
A time for everything
The world moves in cycles. We have cycles of time - days, weeks, months, years. We have different seasons - a nitrogen cycle, carbon cycle, photosynthesis and the water cycle.
Around 2500 years ago, according to rabbinic tradition, King Solomon wrote "... there is a time for everything, and a season for every activity under the heavens..." (Ecclesiastes 3).
As many of the proverbs borrow from Persian and Greek writing styles, so scholars believe the work could be dated even further back in history.
I'm a big believer in investments also following this natural occurrence and moving in cycles because, at the end of the day, markets are driven by human beings and our natural habitat. I view every investment decision I make in the context of a cycle.
The hard part is picking cycles. It's very difficult to predict where we are.
For example, the residential real estate cycle in Sydney has generally fluctuated between seven and 10 years, when you have a boom at the top and pullback at the bottom.
Timing is difficult because booms or pullbacks may last longer or shorter than expected. The same can be said for stockmarkets and movements in the price of gold, silver and other metals.
Some investors like predicting cycles, using technical measurements like charts and data. I'm not completely sold.
As an investor, I like to keep things simple. I'm not too worried about being precise; I'm more focused on understanding where my competitors are and what type of market sentiment is prevalent in the current cycle.
So where are we now?
I recently came across a great note from an experienced investor who pointed out that post-war commercial real estate returns have averaged around 8%, so any asset that has grown by more than 8% in the past decade will probably see a sub-8% compound rate of growth in the next decade as markets revert back to their historical average.
A smart guy, he runs a multibillion-dollar fund. Big investors trust him and his team with their money. So this is really important.
The law of large numbers in statistics stipulates that as you add more numbers to a certain sequence, eventually the trends will revert to the average.
If we look at real estate prices over many years, you will see that eventually we move to a certain average when predicting the future. Same with stocks.
The situation is a bit harder with crypto because we don't have a long time series to measure.
It's a new technology and what we know from history is that new technologies can usually generate exponential returns in their early years before things settle down and trend towards the rest of the world. We saw this when the internet first emerged.
What booms next?
So, if you're young and entering the market, you need to take a step back and understand where the cycle is for the type of property you want to buy. Sydney and Melbourne are booming; Brisbane is slowly catching up; Perth is starting to rise but at a different pace and for different reasons.
If you're looking at an area like Bondi and the market has risen by 15% over the past year, it's probably a good bet that growth will moderate in the coming years. It's not to say that the market will fall, but the rate of growth will slow.
If Bondi has averaged 8% growth in the past few decades and it grew by 15% last year, simple maths tells you that the next few years might see growth below 8%.
On the other hand, you could look at a market like Parramatta, which has been plagued by apartment oversupply in the past few years.
All your friends and uncles at a family barbecue might tell you that apartments aren't the best investments, yet markets that haven't risen or have grown below their long-term average are probably more likely to exceed their average in the coming years, as long as you do your homework and have all the checks and balances in place.
Land has been hot and will continue to be so in the next few years. But don't expect last year's growth next week. You need to think outside the box and understand that your time frame is different from mine or the next person's.
Here's a little side story to further emphasis the point. I joined F45 fitness a few months ago to start training again and get back into shape. I almost collapsed on the first day.
But I left the gym happy. I didn't care about the other 30 people doing their high-intensity training and barely raising a sweat. I wasn't comparing myself to others. I was comparing my day 1 to my day 0. I'm now three months into my training and looking back at where I started with a great sense of accomplishment.
My physical training cycle is different from that of the guy or girl who has been training for two years non-stop.
Therefore my investment cycle, market cycle and property cycle expectations also need to be different if I'm entering the market for the first time. I shouldn't take advice from my parents or family if they have been in the market for 30 years and don't have the same pressures and realities that I do.
I don't know what will happen, but I do know that something will, so I make sure my portfolio is open to different possibilities. I want to make sure I have enough diversification and insurance to benefit from something breaking out and booming.
Focus is important
Having too many investments can be a distraction. But having too few investments and limited diversification means you can, and probably will, miss the next exponential growth opportunities.
It's better to have 1% in 100 things, across different asset classes, than 50% in two single exposures unless you are certain that you're making the right investment decision.
I've seen too many friends enter the crypto market by making large bets on single exposures. The rationale goes something like this: Bitcoin has already boomed, so they feel like they need to find the next boom. This line of reasoning isn't bad. It's the execution that lets them down.
Rentvesting is a game-changer
Okay, now it's time to focus on property opportunities. Young investors want two things: firstly, they want to grow their wealth and feel like they are contributing to their future; however, secondly, they value their lifestyle and don't want to necessarily slog it out in the suburbs with a 30-year mortgage that limits their experiences and ability to travel or move around.
Thankfully, there is a solution: rentvesting.
Basically, it involves renting your primary place of residence in a place you want to live while buying an investment property where you can better afford it and renting it to someone else. Rather than buying a place and living in it, buying a place and renting it out to someone else is a lot more tax effective.
Your mortgage, rates, bills, depreciation and other costs are tax-deductible and could see you potentially receiving a refund at the end of the year depending on your situation.
It's one of the best advantages of the tax system. The government doesn't give you many free passes, but this is one of them and more than 2 million Australians own an investment property utilising this set-up.
The other part of this strategy is renting your primary residence. I have many friends and colleagues who own multiple properties in areas that give them 4%-5% rental return a year while they chose to rent in places where they couldn't afford to buy, like Coogee and Bondi in Sydney's east, effectively paying 1%-2% of what the property is worth.
When they get sick of the property, they call the removalists and find somewhere else. If they want to work or travel overseas, no problem.
They don't have an owner-occupied mortgage tied around their necks. Their investment properties are rented out and their rental managers make sure to collect the rent each month.
Think big, start small
This is how we think about real estate, as an investment. We're constantly assessing different market cycles, picking high-quality stock and putting together different cash-flow scenarios so investors can actually simulate what their life and cash flows look like under different circumstances.
We live in a new world where the internet makes many more things possible. Our parents or their parents didn't have these luxuries, so they made the best of what was normal back then. But the normal way of investing in property in 1970 shouldn't be the normal way of doing things in 2021.
My parents grew up in an environment where interest rates were going through the roof. My dad was paying 19% interest on his loans when I was a child.
Yet since I started working and investing, interest rates have been collapsing and I'm now paying 1.9% on my loans.
My reality is different from my parents'. We're living in different cycles, so it makes sense to use debt in different ways, use different strategies like rentvesting and not compare our growth point to that of others.
If you're a young investor, you need to think big, start small and keep growing your education, mindset and investment knowledge. Surround yourself with great people who will open your mind to new possibilities.
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