How long should property investors hold on in the downturn? – Nadine Higgins
Like most financial decisions, psychology has as much to do with it as the numbers.
Your brain focuses on what you paid for it, sunk costs and loss aversion. I’ve spent so much already! I don’t want to lose money! I just need to sit tight and wait until prices recover!
But will property prices recover?
Eventually, probably. But when? How enthusiastically? And what will holding in the meantime cost you?
If you’re continuing to tip money into simply servicing the debt, then the goalposts – the capital gain you require it to deliver – keep shifting.
Let’s see if I can bring that to life with some numbers.
Say you bought a property pre-Covid in 2019 for $900,000. I’ve assumed an interest-only mortgage because I want to isolate the cost of holding the investment, rather than repaying the debt.
The rent covers most of the costs, depending on the interest rate – but not all. Averaged over the six years, let’s say you’ve needed to contribute about $200 a week to pay the property’s costs. That’s not an unusual amount for a fully leveraged property in Auckland, but over that time it’s a not-insignificant $62,400 you’ve chipped in.
Today the property might sell for $1 million, so a headline capital gain of $100,000.
But you still need to pay the real estate agent, marketing costs and legal fees – let’s say 3.3% or $33,000. Plus we need to subtract the $62,400 you chipped in to keep it afloat.
Suddenly, that original $100,000 gain has been eaten up by the cost of getting there – and that’s before you factor in inflation, and the opportunity cost – ie what else could you have done with your $200 a week?
You might well say “just don’t sell it, then – duh!” Property is a long-term investment and holding for 10 years is the golden rule, right?
If you hold for another five years, topping up again at around $200 a week (you could argue this could fall as rents rise – but the rental market is weak, interest rates are on the way up, and rates and insurance are only heading in one direction – so I’d argue it’s conservative). That’s another $52,000 you’ve put in simply to own the property, and selling costs will arguably be higher as its sale price rises.
So, the hurdle the investment needs to clear keeps getting higher. The longer you wait, the stronger the capital growth required to justify continuing to hold it.
Will strong capital growth return? Maybe.
Independent economist Cameron Bagrie is firmly of the view that gains made in past property cycles are over.
“Houses used to average 6-7% a year while income growth was about 3-4% – that model was always going to blow up. You’re probably talking something around 3% in future,” he says.
Opes Partners resident economist Ed McKnight says prices are already rising in some regions like Christchurch and Invercargill, while Auckland and Wellington remain weak.
“My standard long-term assumption is that property prices would rise by 5% per year (on average) outside of Auckland, and 6% in Auckland.”
However, McKnight also points out that long-term forecasts from Treasury and Westpac “both have the property market going up by around 4.1% per year once we get 4-5 years in the future”. That suggests there could be several years of bumping along the bottom to come yet.
That, incidentally, is a problem for Labour, because it’s difficult to fund policies from a capital gains tax if there are no capital gains to tax.
But that aside, how do those forecasts bode for our example?
If property prices are flat for another two years, then grow 4% a year, as per Treasury’s forecasts, it would be worth about $1.125m in five years’ time. If it instead grows at the 6% McKnight factors in for Auckland, after two flat years, it might be worth closer to $1.191m. Do the same using Bagrie’s 3%, and we’re at about $1.093m.
So a headline gain of anywhere from $193,000-$290,000. But after subtracting circa $150,000 of holding and selling costs, has it rewarded you particularly well for the risk you’ve taken, the time – 11 years – and the pressure you’ve put on your household’s cashflow? That’s the question you need to answer for yourself, with your own numbers (and perhaps a bit of professional advice).
Of course, not all property investors invest this way – the Property Investors’ Federation’s Matt Ball points out that investors are not a monolithic group. But he says the rules have definitely changed, and he believes simply waiting for the market to deliver no longer works.
“Assume windfall capital gains are a thing of the past. Buy and hope is no longer a strategy. Buy based on cashflow and potential, run a good business, add value, and you’ll do well.”
I don’t think the question is whether the property market is dead or alive, or whether property prices will eventually recover. They probably will – eventually.
The question is, will they recover enough, fast enough to justify the extra dollars you have to contribute while you’re waiting?
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