Lemons to lemonade
Bad investment choices happen to almost all investors. The market changes, the area’s demographics shift and a once promising property turns out to be a flop.
While you cannot always control the outcome of your investment decisions, you can minimise the damage of a poor purchase on you and your portfolio.
Assess the situation
When a property performs badly, investors should avoid knee-jerk reactions.
“Sometimes you need to identify what’s happening so you're not jumping the gun and making a decision based on emotion rather than cold, hard facts,” director of Right Property Group Victor Kumar says.
In some cases, the investment may not have had time to perform to the owner’s expectations, he warns.
Buy Property Direct managing director David Brewster has seen owners panic when a property does not appreciate in value within a few months of purchase and cautions that “property is not an overnight thing”.
Owners in this situation need to look at the bigger picture. It may be that the market is currently stagnant, but major infrastructure projects could be in the works to create growth in the near future, he says. In this case, the owner’s best course of action may be to let the investment mature.
There are some properties though which consistently fail to deliver capital growth and sustainable rental incomes. If an investment is not panning out as expected, investors need to take control of the situation.
“You've got to realise that doing nothing is probably going to cost you a lot more than having another go,” We Find Houses managing director Paul Wilson says.
A number of strategies can help investors recoup their losses and continue improving and growing their portfolio.
Once problems arise where industries shut down and the rental market drops from under you, there's no way you can influence getting the property rented out.
Improve your property’s appeal
If an investor cannot attract a tenant in a market that is otherwise strong, the problem may lie with the property itself.
To avoid ending up in this scenario, Mr Kumar urges buyers to stick to fundamental investment principles.
“When you buy, it needs to tick all those boxes,” Mr Kumar says.
Mr Wilson says owners struggling with vacancies should consider how the property’s appeal could be improved.
“What is the market looking for? Where are the gaps in the market? What would make your property stand out and be unique?” he says.
One approach might be an internal modification. Mr Wilson says he recently converted a two-bedroom rental to a three-bedroom home in a bid to improve his cash flow.
“That increases the rentability, it increases the amount of rent I get for it and the amount of people attracted to it,” he says.
Even cosmetic renovations can make a difference, Mr Kumar says.
“If tenants are driving past and it doesn't appeal to them, it's not going to get rented out,” he says.
In Mr Brewster’s view, some people are hesitant to spend money on their investment property, despite minor improvements greatly increasing the property’s chances of being snapped up.
In some cases, an individual property may not be to blame. Instead, investors may find themselves trapped by a soft rental market.
To find a tenant in this environment, owners should consider offering extras, such as air conditioning or other appliances, Mr Brewster suggests.
Nonetheless, Mr Kumar warns that renovations and sweeteners may only help attract a tenant, not necessarily increase the weekly rent.
“It may not mean that you're going to get a higher rent because the rent that you're asking for might be at market rates, and your property is just very tired and jaded,” he says.
In this situation, putting $10,000 into a renovation may be more costly than dropping the rent by $5 or $10 a week, he suggests.
Mr Wilson believes in offering a few weeks rent-free if the property is at risk of standing empty.
“Even though you're letting go of some rent for a period, they're paying a better rent, so that underpins the value and the performance of the property once it's actually running,” he says.
These tactics may need to be taken to the extreme if the bottom drops out of the market. In regional towns that rely on a single major industry, such as mining or tourism, rents can fall dramatically when that industry faces a downturn.
“Once problems arise where industries shut down and the rental market drops from under you, there's no way you can influence getting the property rented out,” Mr Kumar says.
Investors facing this scenario may need to drop their rent by hundreds of dollars simply to secure any income from the investment.
“You need to sit down and do the sums to make that calculated decision,” Mr Kumar says.
Earning $100 a week instead of $300 is still better than having a property stand vacant for months at a time, he explains.
Ride it out or cut your losses?
If a property continues to underperform, investors are faced with a difficult decision: sell up or sit tight?
On one hand, a flat or depreciating market may eventually turn around.
“Odds are, as long as you can afford to hold it, you're always going to win on property,” Mr Brewster says.
Where a major industry or project has closed down, a secondary industry may eventually stimulate property values again, albeit at a slower rate, he says.
“Maybe they're not going to give you a big mining return but can you minimise the impact and get something out of the property?” he asks.
Mr Kumar reminds investors that even where values are dropping, a loss is not a loss until the property is sold.
“Quite often when people start to think about offloading the property, they haven't taken into account that if they do sell then they're crystallising their losses,” he says.
Nonetheless, Mr Kumar believes there are times when investors need to cut and run.
“Sometimes it's better to take a small loss now than a continual loss that leads to larger and larger losses,” he says.
In the example of a mining town, investors might be better off bailing out at the first rumour of the mine closing – even if it means losing $15,000 – than not being able to sell or rent out the property at all down the track, he says.
Mr Brewster says investors should start considering a sale when they see no hope for recovery in the near future.
“When you look forward and you can't see any hope for the next two, three or five years, then it's time to fold and try to minimise your loss,” he says.
In particular, Mr Brewster urges investors to consider the opportunities they may be missing by staying in a stagnant market.
“Not only is it costing you in the property, there is an opportunity cost in another piece of the marketplace,” Mr Brewster says.
“If you lost $10,000 on the way out of that investment, but you put that buying capacity into an area that's growing at five or 10 per cent, in five years’ time you'd soon forget about the potential $10,000 loss you made by getting out.”
Investors planning to sell at a loss need to fully understand the potential impact on their finances. Apart from the reduction in the sales price, selling will also cost you in the form of agent fees and marketing expenses.
“Look at what the real loss is going to be before working out what to do,” Mr Brewster says.
In addition, Mr Wilson reminds investors that losses can be balanced out by other properties in your portfolio – if you have them.
“If you do make a capital loss, that loss can offset future gains,” Mr Wilson says.
An investor with two properties, one which is going up in value and one which is falling, should sell the weaker property first, he urges. The loss incurred on that property can offset capital gains earned on the other at tax time.
However, Mr Wilson also reminds investors that they may not have a choice to sell after the market has crashed.
“If that's the case, you're probably going to struggle to find a buyer anyhow,” Mr Wilson says.
“Worst case scenario, when you're stuck and you just can't move, that's when you ride out the storm and hope that something over time changes,” he says.
Some investors might see their property fall into negative equity, meaning its value is less than the loan amount.
“If you’re getting into a negative equity situation for a significant amount, you have no other choice but to hang on and hope it recovers,” Mr Kumar says.
He gives the example of serviced apartments on the New South Wales central coast. While these once sold for up to $700,000, some are now worth less than $250,000.
“That’s $500,000 gone in equity. If you can’t afford to take that hit, you do have to just grin and bear it and hope the bank doesn’t call in the loan,” he says.
You need to identify what’s happening so you're not jumping the gun and making a decision based on emotion rather than cold, hard facts.
Getting back on the horse
A financial loss does not have to mean the end of your property investment journey.
“Start working with your property broker to see what you need to do to get out. Then start from scratch,” Mr Brewster says.
At this point, investors need to implement a savings program or search for other sources of equity, Mr Kumar says.
If possible, he advises building up equity in the rest of the portfolio to help balance out the loss. Alternatively, investors may be able to source equity in their family home.
The important thing is to adapt your strategy and learn from your previous mistakes, Mr Wilson says.
“It's really about developing a plan, making sure you've got the right level of advice and people supporting you and making sure you're buying the right property that suits you as an investor,” he says.
While recovering financially is difficult, recovering mentally and emotionally can be equally challenging.
Mr Wilson emphasises the value of becoming ‘market-ready’ again.
“Market-ready might be from a financial perspective or it might be from your own emotional perspective,” he says.
“It might be conceptually, so you understand what it is you've now got to be doing this time around, and strategically, so you know on a more micro level what steps you're going to be taking.”
Mr Brewster encourages investors to learn from their mistakes and try again.
“Get hard data on property investment and educate yourself,” he says.
“When you go through it next time, take the knowledge you've learned and go into your investment with confidence.”
No one is immune from having an investment go wrong. It is impossible to control all variables in the market or eliminate risk from property investment, Mr Wilson says.
“The more successful you are, the more mistakes you'll have under your belt,” he says.
While a poor investment can damage an investor’s confidence and bottom line, it can also teach invaluable lessons about the property market. These investors return wiser, more experienced and ready to take on a new challenge in a more promising market.
Strategies for bouncing back
Improve your property’s appearance
Drop the rent
Hold out for future gains
Sell up and move on
Learn from your mistakes
