How Property Investors Lose Money… Even When Their Property Goes Up
Did you know you can lose money through property even if your property goes up in value? Let me explain…
I want to talk to you about the opportunity cost that you end up paying when you buy a property, not necessarily in the wrong area, but at the wrong time.
Let’s look at for example someone who I spoke to recently. They bought a property in Sydney back in 2017.
Now you may know that the Sydney market hit its peak in about July 2017 and the prices have dropped since then and Melbourne hit its peak in about November 2017.
So they bought early 2017. They paid $1.26 Million for their property. They had an 80% loan so their loan was $960,000.
Now fast forward to 2019, when they first reached out to me and their property was now worth $1.05M. So it had dropped $150,000.
But the reason why they reached out to me was they thought they could still invest and buy property in a growing market to offset this loss because they thought they had equity in the property because their property is worth $1.05M despite the fact it dropped but their loan was only $960,000.
Yet when it comes to working out equity, what banks do is they take the value of your home, they multiply it by 80 percent and then they subtract what you owe. And unfortunately, in this person’s situation 80 percent of $1.05 Million is less than his loan which means he actually has zero equity available in his property.
So then he was like, well what what do we do now? And so what I want to do is walk you through his scenario because he’s not in a situation where he’s going to sell and realize a $150,000 loss.
So the property has dropped quite significantly from 2017 to 2019. Now thankfully in 2019 we have had some interest rate drops. That has stopped prices dropping as rapidly as they were over the last couple of years.
But the thing is then, it depends on which suburb you are looking to buy in now for future performance. In this particular person’s suburb, the best-case scenario, is that based on all the predictions out there, his suburb will rise in value by about 5 percent over the next 3 years.
So his property has dropped about 12%. Now let’s just say his property rises in value by 5% over the next 3 years so he’s up 5 per cent. Which means minus 12 plus five, just for the case of this exercise, means that he’s still negative seven per cent but he’s lost two years here and this is three years afterwards.
So we’re now into 2022 okay? Which means that over five years he’s still down 7 percent. Now let’s assume that then the property does eventually go back to the price that he paid for it. It’ll maybe take another 3 years which means he’s at now 2025.
So look at this. He’s bought in 2017. His property then, in this scenario won’t get back to the price that he paid for it in 2025. And then maybe by about 2027 he has made a capital gain.
So yes, property investing is a long-term game, but here’s a scenario, where for 8 years he wouldn’t have been able to really touch any equity in his investment property.
Really for 10 years until his property rose in value which meant that not only had he lost value then on that property but he paid a huge opportunity cost.
He couldn’t use any equity in order to buy somewhere else. And that was this person’s real dilemma. He bought this property with the aim of using the equity in this property to buy future investment properties and build up a portfolio so he could retire in 10 years.
Yet when we went through the projections he was stunned to see that really in 10 years time he might have only just go some equity gain on his property because of when he bought.
Now he bought in a good area, okay?
However, it’s just that he bought at the wrong time and this is one of the key things that we need to understand is that when you’re buying in an area, when you’re buying investment property, when you buy matters right?
For those people who bought in and around these areas in 2017, it is going to take them many years before they can tap into the equity and use it to build their portfolio right?
At the same time though he’s also seeing his rents dropping on his investment property as well which means it’s making it harder for him to cash flow but because the property has dropped in value, even though other lenders are giving him better interest rates he can’t refinance because the value is too low.
He’s in a real pickle.
Now, of course come 2025, 2027, his property would have risen in value.
Say he holds again until 2032. 15 years later his property is worth significantly more than he bought. He may look like a hero on paper. However, the journey has been so painful because he bought at the wrong time. He’s missed out on the opportunity to buy other properties. And mind you, his goal was to create wealth over the next 10 years and he would have failed to achieve that goal because he bought, not in a bad area, but he bought it in a good area but a bad time.
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November 13, 2020