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We are moving into the next stage of the property cycle.
After just over a year of very strong property price growth, where the value of many properties around Australia increased by more than 20%, our real estate markets are now facing some headwinds.
Affordability is starting to price some buyers out of the market due to soaring house prices at a time when, even though the official cash rate hasn’t increased, banks are increasing their long-term fixed rates making owning property a little more expensive.
And there’s plenty of talk about further interest hikes now that inflation is creeping up both overseas and here.
Then let’s not forget APRA’s intention to slow down our housing market by increasing the serviceability buffers required by the bank before they lend you more money.
While I’m not suggesting we’re anywhere near the end of this property cycle, I believe moving forward house price growth will slow, and then eventually, like in every other cycle, we will reach a temporary peak and the value of some properties will plateau while the value of other properties will fall.
That’s just how the property cycle works.
So, are you prepared for the next stage of the property cycle and the one after that?
Don’t get me wrong, I’m very optimistic about the long-term future of well-located residential real estate in our capital cities, but I’m a realist and that’s why I hope for the best, yet I’m prepared for the worst.
While I know that the long-term trend for well-located properties is strongly rising prices, I also now understand that, at times, property values fall.
If, like me, you plan to be in the property market for a long time, here are five questions you should ask yourself to make sure you’re prepared to ride the ups and downs of the cycle.
1. What if interest rates rise?
It’s really not so much a case of ‘if’ as ‘when’ will interest rates rise.
The Reserve Bank uses interest rates as a tool to either stimulate our economy or to slow it down, and the current historically low levels of interest rates are stimulatory.
However, once our economy picks up and inflation remains within a band of 2 to 3% and wages rise strongly, that’s when the RBA will raise rates.
No one really knows, but it is said a neutral interest rate would be an RBA cash rate of around 1.25% to 1.5%.
In other words, the cost of your mortgage may rise an extra 1 to 1.5% as the cost of funds for the banks increases.
When that time comes, will you be prepared?
While many homeowners and property investors have significant equity in their properties, no doubt there will be some who have recently entered the market and bitten off a little more than they can chew.
Hopefully by the time interest rates rise their wages will have gone up and their investment rental income will have increased making their repayments a little easier, however, some will feel the pinch when rates rise.
Others will protect themselves by locking in some or all of their loans to fixed interest rates; not to beat the banks, but to give themselves certainty over their cash flow.
2. What if the property market crashes?
As I explained, at some stage we will experience a cyclical property market correction, but there is no need to worry about a house price “collapse” like some property pessimists are suggesting.
House prices “collapse” when people are forced to sell their homes and there is no one willing to buy them.
I accept that properties are expensive at present– but that doesn’t mean property values will crash, especially in our capital cities.
In fact, they’ve never crashed since housing market data has been collected in Australia.
Instead, what tends to happen is an orderly correction, with prices only falling slightly, because homeowners choose to simply remain in their home and ride things out, while most property investors also try and hold on rather than realising their capital loss.
On the other hand, a true collapse in house prices would require a significant external shock such as:
- Unemployment is high enough to trigger a waiver forced home sales, and that’s not going to happen.
- Interest rates rise so high that they would cause a raft of homeowners to default on the mortgage (the Reserve Bank wants this about as much as it wants another strain of coronavirus).
- A credit squeeze – APRA is currently making it a little bit more difficult to borrow money, but they don’t want to crash our property market either.
- A severe recession that would increase unemployment and cause homeowners to default – that’s not on the cards.
- A severe oversupply of property – currently we have an undersupply of the right type of properties that most homeowners want.
So while a crash is not on the cards, a correction will occur one day and at that time some properties will hold the value better than others.
Obviously, that’s the type of property you should own – A-grade homes or investment-grade properties in established suburbs and lifestyle locations
3. What if my financial circumstances change?
Life is a way of throwing unpredictable events at us, doesn’t it?
You could lose your job, you could become ill, or suffer other financial difficulties.
Strategic property investors prepare for these uncertainties by having a “rainy day” cash buffer, often sitting in an offset account, available to see them through these events.
4. What if my rental income stops coming in?
Over the last year, rental incomes in most parts of Australia have been rising and they are likely to continue growing as there is a shortage of good properties available.
This means vacancy rates are low and rental returns are strong, but the unexpected can happen including prolonged vacancies or unexpected repairs.
Again, strategic investors prepare themselves by not borrowing to the max and having cash flow buffers available.
5. How should I structure my purchase?
This is a critical consideration that must be determined before you buy a property – it’s too expensive to change ownership structures later.
Ownership structures are just part of the Strategic Property Plan that all investors should have before they even start looking for a property.
Other parts of this plan include a finance plan and a risk management plan to identify risks you hadn’t thought of.
And the real benefit is you’ll be able to grow your wealth through your property portfolio faster and more safely than the average investor.
Be optimistic about the future of our property markets but prepare and plan for the worst.
Strategic property investors don’t think things will go wrong; they know they will.
They know their journey to success will be riddled with challenges, failures, and mistakes.
However, they know that if they expect failure and prepare for the worst, they will be ready for the bumps in the road, obstacles, and interruptions to their property journey.