I’ve recently seen on social media a story of a young couple crowned “Property Investors of the Year – 2012” have announced that they are virtually bankrupt, owing the banks more than $3m more than the value of their properties.
While I am not one to cut down tall poppies, it is a cautionary tale of, potentially, confusing the fact that you are lucky with the fact that you have extraordinary skill.
In the awards announcement, the property magazine touted them as ‘having a knack for property making a killing in property’ and having ‘awe-inspiring ability’.
By using the rising equity in one property to finance others, they turned a relatively modest deposit into a vast portfolio. They also turned their hand to property development – building units and duplexes to meet rental demand.
In 2012 this young couple had amassed an $8m fortune in property in less than four years. They had invested heavily in regional mining towns, which coincidentally was in the midst of an unprecedented property boom.
Unfortunately their strategy has not ultimately been successful, as despite ‘owning’ $8m of property, they barely owned anything at all. It seems that the $8m in property was financed by over $7m in debt, leaving them with only around $900,000 in equity.
Their ‘awe-inspiring ability’ was not so much skill, but being in the right place at the right time and using an awful lot of debt to finance the purchase of assets.
In order to learn from their mistakes, below is a quick summary of what went wrong.
They confused luck or good timing with skill and ability
The fact that this couple started investing during a property boom does not makes them property gurus.
Their main advantage was being the in the right place (central QLD) at the right time (during a property boom) and having incomes sufficient to support their debts.
True skill or ability would entail making this venture successful in all market conditions, not just when prices were going up.
They took on too much debt
Having just $900,000 equity in an $8m property portfolio is a scary position to be in. The more leverage you have, the higher the potential rewards BUT you also face increasingly large risks, most of which are out of your control.
In general practice, financial advisers would never recommend investment leverage of over 50% for anyone. That means an asset financed with 50% of your own equity and 50% debt. This young couple found themselves with leverage of around 90%.
From a strategy perspective, having 90% leverage means that just a 10% drop in property prices would completely wipe out that equity. A drop of more than 10% means that you’ll end up owing more than the assets are worth (which is what happened here).
That is a scary proposition if you know anything about asset and property cycles.
Unfortunately what we have seen since 2012 is much worse than a 10% drop in these regional areas. Prices on average have fallen more than 50% in the last 3 years. Rental incomes have also dropped dramatically, leading to a situation where you own an asset that is worth less than what you have borrowed from the bank, and is barely producing any income.
They forgot that asset prices move in cycles
Just like any appreciating asset, property moves in cycles.
A basic knowledge of economics and the business cycle suggests that things don’t only go up. It is bad practice to assume the often quoted property mantra ‘prices only go up’.
To be successful in investing, you need to know how asset prices move over time and to plan for the time when things don’t go to plan.
Smart investors also look to take advantage of these cycles – selling when things are hot and buying when no-one else is interested.
They didn’t diversify
Looking at this couples’ portfolio, they invested only in property and only in regional areas. As the mining boom wound down, demand for regional properties dropped. Being exposed to only one area, they’ve felt the full force of the property cycle.
Savvy investors look to diversify their investments:
- Across assets – property, shares, bonds, cash
- Across geographies – regional Australia, capital cities, overseas
- Across sectors – commercial, industrial, finance, technology, consumer staples
Only by diversifying can you try to smooth out the risks inherent in investing.
They got greedy
Combine the above factors and you can easily come to the conclusion that they simply become too greedy. Confusing luck with intelligence they simply repeated what they had done in the past and expected a similar outcome. Unfortunately, their luck ran out.
How can you avoid this?
Getting advice is a crucial part of investing and (more importantly) protecting wealth.
With guidance from a qualified adviser you can take a step back and ask some important questions:
- Is this the right strategy for us?
- Rather than just focusing on the potential rewards, what can go wrong?
- How do we protect ourselves from these risks?
- How much is enough?
While an adviser can’t predict the future, they can help you better understand the risks and rewards of any potential strategy.
If you’d like to know more about how we can help you, simply contact our office to arrange a complimentary initial consultation on 07 5494 0650.