Why It's Easy To Have Lemons In Your Property Portfolio And Hard To Sell Them
There’s a lot of negative sentiment around about the property market and it’s got many investors worried about their future. We’re contending with fears of falling prices, expiration of interest only periods on our loans and the prospect of losing negative gearing. To make things worse, when investors decide to exit the market, they often choose the wrong property to sell, but more about that later...
It’s easy to buy lemons in a booming market.
The recent property boom was really only a boom in Sydney and Melbourne. Over the past 10 years, a large proportion of property in these two cities doubled in value (some even doubled in five years).
In a boom, everything gets competitive and the fear of missing out (FOMO) drives prices upwards. Sub-standard properties sell for crazy prices. People fight over them because they see them as their opportunity to get into a market that they can't otherwise afford. When the market slows, these are the first to fall in value.
This frenzied growth also sent investors in pursuit of more affordable locations, which often haven’t performed. To illustrate the opportunity cost, over the last decade median house prices in Adelaide and Brisbane grew by only around 25%. Poor Perth property owners suffered with a median house price increasing only by 5% over the decade.
Investors like lemons, owner-occupiers don’t.
One reason why investors often have lemons in their portfolios is that they buy “investor stock”, which essentially means that the style of property doesn’t appeal to owner-occupiers. Worse still, there are no owner-occupiers who desire the location or the locals can’t afford to buy.
The safest areas to invest in are within a 10 kilometre radius of Sydney and Melbourne. That’s not to say that you can't make money investing in other areas, but when I say safe, I'm talking about long-term sustainable growth. We discussed an illustration of this with data scientist Kent Lardner in episode 6 of The Elephant in the Room property podcast. He spoke about the median growth curve in beachside Coogee in Sydney’s Eastern Suburbs. He observed that when the property market dropped in the broader sense, Coogee’s prices levelled out and didn't fall.
This is the sort of subtlety and nuance that investors need to pay attention to. Robust locations are areas where owners are not forced to sell when things slow down. This reduces the likelihood of there being an oversupply of stock. The socio-economic composition of these areas means that even if investors exit, there are owner-occupiers who are prepared to buy and who can afford to buy.
If you’ve chosen a solid location, the way to really maximise your gain over time is to understand what type of property in that area will do better than others. The characteristics are different in every location and boil down fundamentally to what buyers want. What do buyers view as being scarce? What are they prepared to compete for? Does the property you own appeal to a wide base of local buyers?
It’s hard to sell lemons.
Let’s face it, it’s never easy to admit to making a mistake. It’s uncomfortable to think that you've got your money and your borrowing capacity tied up in a dud asset. We human beings are good at coming up with all sorts of reasons to justify the things we do and avoid tough decisions.
In episode 1, behavioural scientist Simon Russell explained the disposition effect, where we are inclined to avoid selling poor assets. He talked about studies on share market investors that show a propensity to sell good assets and keep lemons because it feels better to realize a profit than it does to realize a loss. Property investors do this too, especially when they say, “I’ll just wait until the market comes back before I sell.” Failing to account for opportunity cost plays havoc with our financial future.
Most people decide to invest in property because they want to accumulate wealth and ultimately experience financial freedom. Yet this dream won't eventuate if they hold a property that doesn't perform. Capital growth is a major concern, and now that APRA and the Royal Commission have impacted the lending practices of major banks, it's becoming even more critical that borrowing capacity is not tied up in poor-performing assets. It takes some discipline, but it is important that property investors consider the quality of their assets carefully before deciding which ones if any, they should sell.