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Ryan Smuts: How to survive a market downturn

Thursday, February 08, 2018

CREDIT: FT.com

The key to surviving in a downward market is having a strategy and set of buying rules that you commit to regardless of circumstance. In this, and in any market, the team you have around you will be the key to your success. A good mortgage broker, solicitor, building inspector, insurance broker, real estate agent and property manager will give you the information and professional support you need to succeed.

Over and above that, there are specific and important issues you need to develop an understand of and tailor your individual circumstances to. They are: having a financial buffer, market cycle, portfolio longevity, and cash flow.

Financial Buffer

Having a financial buffer is key in this market. Your financial buffer must relate to how much you need to cover your personal expenses when things go wrong.

The general question is how many months you would like your reserves to last if you lose your income or get flooded with costs all at once. At this time in the market, it may be worth considering (or re-considering) your minimum cash reserve.

  • Loss of income can come in the form of loss of employed, or business income, debtors not paying on time, missed rent, etc.
  • Cost increases could be unexpected expenses – potentially property related maintenance, or even fluctuations in mortgage rates.

Another form of a financial buffer is the ability to access the capital in your property(ies) so that you can take advantage of opportunities when others may not be able to. This can either be in the form of offset account or revolving credit set-up with your lender to access the equity that’s locked up.

Depending on the amount of capital you have access to, it could put you in a position to be a cash buyer and allowing you to move promptly on good deals. This puts more bargaining power in your hands in a market already in favour of buyers as it is.

Be careful about the level of access you have to capital especially if you are not a disciplined saver. Having the ability to access your property equity in liquid form allows you to cover expenses that directly relate to your properties. If you develop spending habits outside of this purpose, you may find yourself moving backwards with no value-add to your current position.

Market cycle

Different parts of the market cycle warrant different tactics for investment success.

If you are buying for capital gains then be mindful that you may not be able to turn around properties as quickly as you otherwise would in a rising market. When the market slow and starts showing signs of trending downwards, you don't want to be acquiring a property that depreciates faster than you can add value to. This could mean holding onto a property for longer than you intend (e.g. 2-5 years) to give the market time to get itself back to a position where you can maximise your profits. 

At this point in the market, some sellers are facing the same financial issues, and often you find that some people are over-exposed and are ‘motivated’ to sell. Key indicators for this situation are:

  • The property has been listed for months;
  • The property itself is vacant, which means the vendor is living elsewhere and either need to cover two mortgages or rent and the mortgage from their own pocket; or
  • The price drops (several times). 

Asking the agent the right questions will let you know just how motivated your seller is, and whether or not you’re onto a bargain.

Downturn markets favour buyers, not vendors. Stick to your buying rules and be disciplined enough to walk away from bad deals to truly leverage your advantageous position. Too many people get emotionally involved and lose a great deal by entering into bidding wars. Particularly if the downturn is just beginning, it might take time for vendors to adjust to reality in the prices that they’re looking for. Additionally, as economics demands, the more inventory that enters the market, the further prices will head down – assuming constant (or declining) demand.

Portfolio longevity

Balancing your portfolio is important in all parts of the property cycle, but particularly in a downturn as you can’t rely on equity gain to build wealth as you once were able to. A common strategy is to have some equity focussed properties and other cash-flow positive properties, those which are negatively geared are countered by positively geared properties to level out the expenses that relate to each. This reduces cash-flow pressure and balances your portfolio to ensure it is not subject to market conditions.

Cash flow

Don't beat yourself up if you feel that your cash flow could have been managed better up to this point. There is never a bad time to address past failures and make a fresh start. 

Be very clear and realisitc about your income and expenses. Your income must always be greater than the expenses if you want a positive cash flow or accumulate any form of surplus. Most of us instinctually spend what we make (or, god forbid, more). Treat surplus as a mandatory expense. In fact, you may find that it is the most important expense of all.

Looking at income first, you want to ensure you have a real net cash position, i.e. remove the tax from your gross, remove superannuation payments and student loans if applicable, etc. If it is a business (including rental property businesses) you want to ensure all expenses are deducted first too – we are only concerned with the profit AFTER expenses and tax, not the revenue figure.

From here you have a real figure to begin with on your income statement. Further, if you find that this figure isn’t satisfactory, it is important to first look at easy ways to increase cash-flow which will help not only in reality in terms of making things easier financially, it will also assist in your borrowing capacity through banks which will allow you to be aggressive in this market - lenders are typically tighter in downturns, so the stronger you look on paper, the better.

Ideas to increase cash flow could be things such as: raising rents on investment properties, renting out rooms in your own home where you live, secondary jobs, if one spouse isn’t working, this may be an option too.

When looking at expenses, we must be accurate in the things we include. Categorise them into mandatory, and discretionary, and even extraordinary. The best way to do this exercise is to go through your bank statements and track your spending habits – 3 months history may be sufficient in some cases, in others, 12 months, the more data you have access to, the more accurate.

Lastly, allowing for unforeseen expenses is key to budgeting too. While your financial buffer might cover one-off unforeseen expenses, ongoing increased expenses might be a different story. An example of this is that while rates are low now, property should always be looked at from a long-term perspective, and historically interest rates are higher than what we are seeing. It might be worth considering the impact of rate fluctuations in your calculations that you make.

Understanding that wealth comes from the increasing gap between what we make and what we spend, if you are looking at achieving your wealth goal in the future, the bigger your ‘surplus’ is, and the quicker it grows, will determine how quickly you reach your financial goals or desired net worth.

Summary

In summary, there is money to be made in every stage of the property cycle, but it is worth understanding that the tactics themselves must be altered to ensure you’re more successful. At this stage, you can’t afford to be making foolish mistakes where the rising market would be forgiving of such. Warren Buffet says that “you only find out who is swimming naked when the tide goes out” – don’t let that be you!


ABOUT THE AUTHOR

Ryan Smuts 

Ryan is a Key Accounts Manager at Kris Pedersen Mortgages and Insurance. Ryan can be reached on 021 193 9333 or ryan@krispedersen.co.nz


 

 

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