Balancing risks and rewards

Some experts are saying the investing in property now is less risky that during the boom. Is this right? If so, why? What are the risks investors face and how could they get around them?

The world is in economic meltdown and British analysts are suggesting that property is about to face its biggest challenge in 50 years, with predicted losses of around 40%. The other half are claiming that our housing shortage and prudent lending practices will protect us from a US-style property crash and that we have already hit the bottom of the market. Well, 50% of them will be right, but on which side?
It has been claimed that a country’s economy will grow comfortable when household debt levels are 2.8 times the median household income. That means that when median household income is, say, £30,000, debt levels should sit at around £85,000 per household.

In the US, debt levels are round 3.6 times the median household income, which seems to account for their present slide into recession. In Australia, their debt levels are over seven times the median household income. This is causing analysts to grab their calculators and attempt to predict just how quickly they will fall into the second Great Depression – and how hard.

There is no doubt that we are yet to see the true fallout of the unique economic circumstance in which we find ourselves, and I challenge any analyst to be able to use historical data to predict the next phase. There are simply no numbers that can possible forecast the future for us, because our present reality is different from anything we’ve ever seen – this particular set of circumstances has never existed before.

There’s always been, and still is a risk associated with investing in property. All investing carries risk and property is no different. There’s the market risk that the property chosen will not do as well as the other properties; and, of course, the pure risk, that investing anywhere is not as good as keeping your money in a jar in the kitchen!

Is now a less risky time than any other? I personally don’t think so. However, I also think that now is a great time to buy property for anyone who is prepared to understand the risks and learn how to manage them well.

Risk #1: Will property fall in value?

If we considered the property market in UK as a single market, I would have to answer the question with a yes. If we combined the value of all property in Britain today, the sum total would be lower than a year ago, and it’s likely to be lower again in another 12 months. This is because we have come through a 10-year period of wage increases, enthusiastic spending and low inflation. People have had access to money and have enjoyed spending it. This enthusiasm spread to property, when people who found themselves more financially stable than ever before bought real estate in areas they were previously unable to afford. The result was pressure on prices everywhere, with the greatest increases occurring at the top end of the market.

Just as the highest rung is the greatest height from which to fall off a ladder, so it goes that properties at the higher end of the market drop the most in value. Those who purchased these properties are the ones hardest hit by the downturn, probably because they overcommitted when they did so.

The rapid fall in premium property prices has had a significant impact on overall ‘average’ statistic. These properties, in fact, skew the results. Since we have a several undersupply of housing, and more people pouring into the rental markets that we have had for many years, property in the lower price ranges, which attracts the greatest number of tenants, is at far less risk of losing value. If it does, the impact with be minor. While I expect very small upward movements, if any, properties in the lower price ranges are much more likely to remain stable throughout out this current crisis.

The important task for investor is to be sure they can afford a small shortfall between income and dispensed, not to gear too highly (capping at 75% to provide a margin) and not to over commit themselves. In addition, investing for growth needs to be put aside temporarily in favor of finding those properties most likely to attract the best yields.

Risk #2: Will properly perform less well than other assets?

The debate has long raged about which has the better long-term outcome – shares or property. At the risk of being bombarded with e-mail, I would respectfully like to suggest that the recent stock market turmoil will severely affect the long-term growth reading of shares for many, many years to come.

I don’t know which one is going to perform better over the long term but I do know that over the past three months I have had no fewer five margin calls on my share lending, but the bank has not once suggested that I think about some additional repayments of the debt I hold on my investment properties.

A good friend suggested to me that the reason my property values seemed not to have been affected was because of their illiquidity – try selling them for cash in three days and see what you get, he said. The point is that I don’t have to sell them that quickly because I am not being asked to pay back my debt. I can ride out this storm and wait until a better time. Even if the properties do lose value in the next few years, they are all in areas of highest rental demand and I can still afford to hold them because they are rented consistently.

Risk #3: Is it better not to invest anywhere, including property?

Investing does carry risk, but don’t think that if you avoid all investing, you are avoiding risk. There is my opinion, just as big a risk in doing nothing as there is in taking the chance and investing carefully.

Which analysts are right?

I think that they are all a little wrong. While there will be property that most definitely loses value, I cannot see property in areas of high rental demand suffering too much. I have always encouraged investors to invest with their brains, not their hearts, and this will now become the most crucial skill you can possess. Ignore the experts making money from their endless theories about sea change, city centre properties and location, and accept that the best way to buy property in the current climate to buy bread-and–butter property that tenants will want to rent from you. Then, understand that the next five years probably won’t bring you stunning growth, if any at all. For some, you might even see a small decrease in value. But that doesn’t matter a lot, as long as your yields are paying for all – or most – of your expenses and you don’t have to sell to fund a retirement in the next few years. In many areas, we are close to the bottom of the market and, as soon as more investors realize that, the choices will become less abundant and you will be forced to take whatever is left. The key to successful investing has always been ‘time in the market’. For property investment, you should always take the long-term view. This way, you can ride the peaks and the troughs.

Since now seems to be a great time to buy, it could be one of those rare moments in history when market timing and time in the market work together to produce results.

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