When people contact me about property investing, it's usually one of two questions.
1) "Can you help me get into property investing?"
2) "Can you help me get out of property investing?"
On the first question, my answer is always no.
Reasons: The lack of diversification. The need to use quite extreme leverage. The hope that capital gains will wash away any losses on income. The maintenance costs with older properties. Uncertainty on locations and rental returns, even within a booming city.
All the above things don't sit within an evidence-based investment strategy. The level of risk is significantly higher than most investors can conceive. But how would they know? Most of us are fed with a one size fits all property boom—something perpetually peddled by some media houses with not so small ad revenue from real estate companies.
On the second question, my response is, "what went wrong?" What I hear should be the lesson to those wanting to get in.
Inevitably, the lack of diversification, the extreme leverage, the fees on a new property, the maintenance on an old one, poor rental returns or buying in a location that turned ugly, difficult and unruly tenants, have conspired in some way to deliver a poor outcome.
Recently, a story popped up on the landlord section of an online property investment forum. The story is an extreme version of what we view as the risks associated with property investing. It was exacerbated due to Covid-19, but it's illustrative, nonetheless.
The background: Two brothers decide to invest in a Christchurch property in 2018. Brother 1 earns $100k pa, and brother 2 earns $80k pa. They bought a three-bedroom rental property at a high of $400k range. Their deposit was $140k. The house comes with tenants; a couple with two kids. Weekly rent was not mentioned in the forum.
The problem: Pre-Covid they spent $12k in maintenance; plumbing damages from trees and decided to increase the rent in April 2020. Covid hits and on 23 March 2020, the Government announced a freeze of rent increases for six months and landlords would not be able to end tenancies until 25 June 2020, regardless of when the notice was provided.
The brothers hear the male tenant lost his job and is on an income relief payment. Although he secured a temporary job at a local shop, the brothers think the current tenants might give notice soon to end the tenancy, and they are not feeling too hopeful about securing reliable tenants as current economic situations remain uncertain.
Work issues arise: Brother 1 has his income cut 30%. Brother 2 is put on wage subsidy and told he would not be kept on when the second wage subsidy programme ends in September. They applied for a six-month mortgage holiday on the rental property from their bank.
The reality: They consult with some unstated 'professionals', their bank, and discuss with friends and family. Many said sell now rather than later. Bank said no further mortgage holiday beyond six months. They conclude it's best to sell.
The admission from Brother 1: "This whole thing made me realise I don't think I am cut out for the responsibility of being a landlord."
The brothers may have had defined income goals, but they were never mentioned in the forum. We would guess they decided on the investment without defining their financial goals and circumstances.
Liquidity: Many property investments lose money on a cash flow basis in the hope of a big pay off at the end. Holding the investment generally requires both the investor and the tenant have cash flow. The investor is also at the mercy of someone else's liquidity.
Luckily the brothers were in unison on the exit. But had the brothers invested in separate diversified investment portfolios, they will have options when there is an income downgrade or even job loss. They can sell a portion of the portfolio, the transaction fees are minimal, and the money in their bank account in 2-3 business days. But with a property, you can't sell a bedroom.
It's all very well to say, "well they should have held on, the property eventually goes up". But that requires preparedness for the worst. An investor in distress generally doesn't have a plan, nor a handle on the risks. The moment the storm rolls in, their boat is taking on water.
Price movements: A lot of the focus on property prices in New Zealand revolves around valuations. There is always discussion about overvaluation and the potential for crashes. And we think there is too much obsession with momentous events instead of more tangible risks like cash flow issues and liquidity.
We admit to having no idea where any market will go, the property market included. Property is a necessity because we all need to put a roof over our head. But trying to get rich putting a roof over someone else's head? That's not for everyone. It's best to weigh the downside risks first before buying into the hype and excitement that fills our property obsessed nation.
Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
The article is prepared in association with Mancell Financial Group, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
