The property market is heating up (see auction clearance stats [1] for the weekend), and as an avid property investor, I should be excited – but, I’m not. The reason for this is because a hot property market has a strange effect on usually intelligent people – it makes them lose all of their common sense and make huge mistakes.
Keep your guard up
At this time, many property markets are typified by buyer frenzy, and this is a highly dangerous situation in which to find yourself. It’s a normal function of the property cycle, however that doesn’t mean you should not be on your guard.
When buyer confidence returns to a market, often brought on by a lowering of interest rates and a collective sigh, as the forecast property bubble and bust didn’t materialise after all, investors feature heavily among those buyers.
Having remained aloof and somewhat afraid of huge losses when the stories of property gloom were being touted, the urgency with which they suddenly feel the need to enter the market descends upon them with a vengeance. They rush out to ‘home opens’, attend auctions and scour the internet looking for the next hotspot. Their search is influenced by the literally dozens of articles written by experts predicting the double-digit growth in all manner of areas, and collectively they descend upon these favoured areas, scrambling to acquire the available stock.
A seller’s market
It’s a picnic for sellers – they stop naming their price and move to price ranges, often holding out as bidding wars push their achievable price higher and higher. I’ve seen buyers pay well over what the seller actually wants, eager to outbid their opponent and become the owner of their next investment property.
I marvel at how, when things are quiet and more normal, these same people won’t buy as they are nervous and unsure – yet the moment everyone else wants to buy, they are part of that stampede, taking far greater risks than they would if they instead chose to buy in subdued markets.
The risks
Buyer frenzy is risky for many reasons, not the least of which is that you most likely will pay more than the intrinsic value of the property. When this happens, you are exposed in a number of ways:
- If you are borrowing, your holding costs are higher, making net yields lower;
- It’s unlikely you will get more rent return – paying a higher price does not translate into improved rental yields;
- You may not be able to borrow enough to complete, in the event that the valuer does not agree with the increased price you have paid; and
- Most importantly, when the buyer frenzy ceases, you are likely to end up owning an asset worth less than you paid and it could be many months, or even years, before it catches up. At best, this results in a reduction in your net worth – at worst, it may completely halt further acquisition of more properties and hamper your retirement strategy, as your equity shrinks and you are unable to borrow again.
If the area you are looking to buy in has true hotspot characteristics, then get out of the buyer frenzy and wait until it calms down. Growth drivers aren’t a five-minute thing – they will still be there after the short-term demand is over, and you’ll be able to get hold of a property at a more reasonable market value.
If, on the other hand, underlying growth drivers don’t exist, and the present boost in values is being driven purely by short-term buyer demand, then you shouldn’t be buying there anyway. You’ll just end up with a property with ongoing lacklustre performance, and you’ll pay too much to get it.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: The great market seesaw [2]
- Paul Rickard: Road test – hedge funds [3]
- James Dunn: Dividends the sub-plot to reporting season drama [4]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [5]
- Penny Pryor: Is a property bubble forming? [1]