What if property prices drop 40%?

[alexlee]

Thought that would get your attention. This is my analysis of what would happen to me if property prices drop 40% (not immediately, say over 3-5 years).

My overall LVR is approx 60%, -ve cashflow on the IPs about 1% of the gross value, plus the PPOR.

So, if property prices drop by 40%, my IP LVR goes to 100%, and my PPOR LVR goes above 100%. Is this a problem? As long as I still have my job and the same salary as I do now (so assume zero increases for 4 years), no. My savings rate is more than sufficient to make up the CF shortfall, interest rates will most likely go down (40% drop in property prices either causes or results from a recession), and rents will most likely rise (my properties are all below median: if people can’t afford to rent it, they’ll share).

Now, I still have the problem of a portfolio with negative equity and negative cashflow. So what do I do? Am I worse off than someone who is just starting in this market? Should I sell and wait?

I wouldn’t. I’ll just sit there, feeling sorry for the lost equity, sure, but I’m not going to sell. Why should I? After a 40% fall over a few years, we would be approaching the next boom point. Imagine this is the late 90s. Rates are coming down. Horrible memories of the property bust, so people aren’t buying property. Many of us started around that time and have managed to build up nice portfolios in the subsequent boom.

In the late 90s people bought positive cf properties, even in a depressed market because they figure if it costs them nothing to hold any gains are a bonus. Of course, that’s the environment when big gains may well be around the corner. However, if you start from scratch you won’t build as quickly.

In short, imagine if you’d survived the early 90s bust and entered the late 90s with a couple mil in gross property (but ZERO net, notice), and pretty much neutral cashflow. You’d be laughing your head off by the early noughties.

If property prices drop 40% from here on in, I'm going to budget tightly, and just hang on for the ride. By the next cycle I'll be even richer.
Alex

 

[alexlee]

What do you think might happen to rents in whatever conditions could send prices down by 40%?

GP

Depends on which segment of the market. I think high end will be hurt because demand dries up. But people still have to live somewhere (I'm not projecting a mass exodus from the country). So they trade down. My properties are all below median, so there is room for trade downs even as the amount of sharing increases.

A 40% drop in prices will kill IP supply even more, because no one is going to buy any IPs, but that will be partially offset by more sharing. I think rents will increase for the cheaper properties. I certainly don't expect a big drop in rents for median and below.
Alex

 

[Sunfish]

Contra arguments:

If a market can fall 40%, why can't it fall 50%?

If the banks called in their markers, you are wiped out.... Crashed and burned! Blows the oft repeated mantra that property can never fall to zero. While that is true, your equity can fall below that.

Under your scenario you would be working for 4-5 years for no income! (your wage goes entirely to meet your investment commitments) Why not sell down over a couple of years and take the opportunity to bum around the world?

You only have 30 prime years (max), How can you be so nonchalant about wasting so many of them?

Sorry, but that's a pretty crappy Plan B.

 

[evand]

Grab a cold beer and turn the cricket on mate
Don't stress about unlikely events.

 

[alexlee]

Contra arguments:
If a market can fall 40%, why can't it fall 50%?

If the banks called in their markers, you are wiped out.... Crashed and burned! Blows the oft repeated mantra that property can never fall to zero. While that is true, your equity can fall below that.

Yes, equity can certainly fall below zero. Property can fall 50%. Or 60. Or 70. Or 80. I'm betting that it won't fall that much. I don't even expect it to fall 40%. I'm also betting that the banks won't call in their loans if I keep making payments. If they do, I'm dead. I'll declare bankruptcy and start over in 7 years. I have that much time, at least.

You only have 30 prime years (max), How can you be so nonchalant about wasting so many of them?

Sorry, but that's a pretty crappy Plan B.

That's your opinion, and I have my own. Maybe I'm blase about it because I do have 30 years and I don't have your perspective. But if this was 30 years ago and you were in my position, would you rather take a few more chances? My opinion (and at least I'm putting my money where my mouth is) is that if I sell down and (gasp!) use it to bum around the world, I'm not going to have enough money to last me until I die.

I'm playing probabilities. I believe it's more likely that we'll have a recession, and in 5-10 years we'll have another boom. I believe it's unlikely that we'll have a 40%+ fall in prices, even over several years.

If I bet wrong? I'm toast. If I'm even sort of right, I have enough time for the market to make me very rich.
Alex

 

[GreatPig]

Alex,

Gee, you must be watching this forum like a hawk. That post of mine was only there for a minute at the most (I deleted it because on reading back through yours I noticed you'd already mentioned rent).

A 40% drop in prices will kill IP supply even more, because no one is going to buy any IPs, but that will be partially offset by more sharing. I think rents will increase for the cheaper properties.

Personally I think that depends on the economic circumstances that produce the 40% price drop. If it's just a correction in property prices due to overvaluation, then yes, rents mighn't be affected much. But if it's due to a wider economic slump, then that could also lead to corporate underperformance, cost-cutting causing layoffs, and, as mentioned in another thread recently, more people moving back in with family and sharing, causing a reduction in overall rental demand.

I rented for many, many years, and remember times like now when getting a place was next to impossible, but also times where places were so easy to get that landlords were offering incentives (typically rental discounts) to prospective tenants. In that latter scenario, I think you could potentially face having to reduce rent to secure tenants, even in cheaper properties.

Cheers,
GP

 

[GreatPig]

How can you be so nonchalant about wasting so many of them?

I think the concept of wasting years of your life is something you only start to think about when you realise there are now more behind you than ahead of you.

I'm approaching 50 now, and value my spare time much more than I used to. I hate to think now back to my mid-late 20s when I sometimes worked from 9am-1am five days (sometimes six days) a week trying to get work finished - and it wasn't even my own business! The ultimate result of all that effort: the company went broke (this was a very small company). The main positive was the experience I got, which set me in good stead for the next job - at the place I'm still working (part time now though).

Now I'm much more aware of that saying that goes: on their death bed, no one ever said they wished they'd spent more time at the office.

And that other one: on your death bed, the only things you'll regret are the things you never did.

When you're young, there's always time to do those things later. But one day you suddenly realise even later has been and gone for some things.

GP

 

[Sunfish]

Alex, I'm not trying to give investment advice. Wouldn't dare.

I was pointing to weaknesses in your logic, which is more fertile ground.

 

[alexlee]

Naturally, the logic is flawed, because I don't know what's going to happen in the next 30 years. I'm basically betting that we're not going to see the end of the financial world as we know it.

Yet, if you were in my position 30 years ago, Sunfish, and someone 30 years older than you said 'you know, I've seen the depression, and things can get REALLY bad', what would you have done?

I got to where I am now because I DIDN'T always listen to people older and more experienced than me. I wouldn't have done half the things I did if I'd always listened to people. I certainly wouldn't have the assets I have now.

If I bet wrong, I'll just have to be satisfied with retiring on a meager pension at 65. If I'm right, or even not too wrong........
Alex

 

[alexlee]

I rented for many, many years, and remember times like now when getting a place was next to impossible, but also times where places were so easy to get that landlords were offering incentives (typically rental discounts) to prospective tenants. In that latter scenario, I think you could potentially face having to reduce rent to secure tenants, even in cheaper properties.

I saw those in Sydney in 03. I think the best I saw was 6 weeks rent free. It's a fight between decreased demand from a recession, and whether that's bigger than the undersupply from underbuilding.
Alex

 

[pi2012]

Grab a cold beer and turn the cricket on mate
Don't stress about unlikely events.

Haha!! Good one Evand.

 

[marg4000]

I would be very surprised to see a 40% drop in house prices.

I've been investing in real estate, PPORs and IPs, since 1974, or 34 years.

Prices usually only drop when people are forced to sell because they can't keep up repayments, which is often associated with job loss. That, by the way, is the biggest worry with a recession rather than the interest rate rises.

On the most part, prices plateau as in the 1990s and you may not see capital growth for 5-6 years. People who will lose money if they sell do all they can to hang on and ride it out. Or they will use the opportunity to trade up, they lose money on the present property but save more on the new one.

Yes, there will be mortgagee and forced sales out there, as we are seeing publicised in the western suburbs of Sydney.

So long as you don't go out and buy several properties, 100% geared at the height of the boom you should be OK.

Yes, we bought two IPs in 1991 and 1992 (one each year) and probably did not see much capital growth for the first 4-5 years, and then only marginal until things hotted up in the early 2000s. But they were cash flow positive so we worked out that even though they weren't making us much, they weren't costing us much anyway so we simply looked at it as a forced saving and paid the loans down.

(Of course, in hindsight we should have gone out and bought more, but the SANF kicked in.)

Sold both last year for approx triple what we paid so that we could pursue other projects. Not looking forward to the CGT bill......
Marg

 

[redsquash]

How many times in the last 40 years has property dropped by 40%.

Lets leave out places like Julia Creek or one of examples and focus on typical markets?

 

[luce.rocks]

If property prices dropped by 40% I think I'd be more stressed about the state of the world than my IPs. Not that I wouldn't be stressed about my IPs, but how dire would the situation have to be for a drop like that to happen?

 

[redsquash]

I would be very surprised to see a 40% drop in house prices.

I've been investing in real estate, PPORs and IPs, since 1974, or 34 years.

Prices usually only drop when people are forced to sell because they can't keep up repayments, which is often associated with job loss. That, by the way, is the biggest worry with a recession rather than the interest rate rises.

On the most part, prices plateau as in the 1990s and you may not see capital growth for 5-6 years. People who will lose money if they sell do all they can to hang on and ride it out. Or they will use the opportunity to trade up, they lose money on the present property but save more on the new one.

Yes, there will be mortgagee and forced sales out there, as we are seeing publicised in the western suburbs of Sydney.

So long as you don't go out and buy several properties, 100% geared at the height of the boom you should be OK.

Yes, we bought two IPs in 1991 and 1992 (one each year) and probably did not see much capital growth for the first 4-5 years, and then only marginal until things hotted up in the early 2000s. But they were cash flow positive so we worked out that even though they weren't making us much, they weren't costing us much anyway so we simply looked at it as a forced saving and paid the loans down.

(Of course, in hindsight we should have gone out and bought more, but the SANF kicked in.)

Sold both last year for approx triple what we paid so that we could pursue other projects. Not looking forward to the CGT bill......
Marg

Capital growth of around 7% compound.

 

[Sunfish]

If property prices dropped by 40% I think I'd be more stressed about the state of the world than my IPs.

You would have every right to be stressed if it happened. The world would be a stressful place indeed.

But I feel an obligation to myself and my family to protect us from what, in reality, has a far higher probability than you seem to believe. I don't know either "what" or "when" but on a scale of 1 to 10 on desirability I suspect it will be 2 to 3. In years it may be about the same but knowing how bankers can delay the inevitable, it may be twice that.

Call me an old phart if you like, but don't call me a fool.

 

[chrispy]

When I went looking in Cairns in 2002 the prices had halved, property prices were almost exactly 50% of original price.

SARS, pilots strike, ansett closing had all caused the problem at that time

Prices drop by 40% yes and more

Chris

 

[evand]

Should have sold one just before end of financial year (June) and the other one just after (July).

Sold both last year for approx triple what we paid so that we could pursue other projects. Not looking forward to the CGT bill......
Marg

 

[trendsta]

Thought that would get your attention. This is my analysis of what would happen to me if property prices drop 40% (not immediately, say over 3-5 years).

My overall LVR is approx 60%, -ve cashflow on the IPs about 1% of the gross value, plus the PPOR.

So, if property prices drop by 40%, my IP LVR goes to 100%, and my PPOR LVR goes above 100%. Is this a problem? As long as I still have my job and the same salary as I do now (so assume zero increases for 4 years), no. My savings rate is more than sufficient to make up the CF shortfall, interest rates will most likely go down (40% drop in property prices either causes or results from a recession), and rents will most likely rise (my properties are all below median: if people can’t afford to rent it, they’ll share).

Now, I still have the problem of a portfolio with negative equity and negative cashflow. So what do I do? Am I worse off than someone who is just starting in this market? Should I sell and wait?

I wouldn’t. I’ll just sit there, feeling sorry for the lost equity, sure, but I’m not going to sell. Why should I? After a 40% fall over a few years, we would be approaching the next boom point. Imagine this is the late 90s. Rates are coming down. Horrible memories of the property bust, so people aren’t buying property. Many of us started around that time and have managed to build up nice portfolios in the subsequent boom.

In the late 90s people bought positive cf properties, even in a depressed market because they figure if it costs them nothing to hold any gains are a bonus. Of course, that’s the environment when big gains may well be around the corner. However, if you start from scratch you won’t build as quickly.

In short, imagine if you’d survived the early 90s bust and entered the late 90s with a couple mil in gross property (but ZERO net, notice), and pretty much neutral cashflow. You’d be laughing your head off by the early noughties.

If property prices drop 40% from here on in, I'm going to budget tightly, and just hang on for the ride. By the next cycle I'll be even richer.
Alex

Not sure what your point is there Alex.

If we do have a 40% across the board fall in property, that to me signals very bad times .. very high unemployment, weak economic growth, low profits, drop in consumer spending etc etc .. chances are you (and i) may not even have a job in such a economic climate..

to me the argument seems flawed..

 

[sash]

Alex

When did property prices fall 40% last?

I can't seem to recall anytime in history.

I went looking at properties in the St George area in Sydney..prices have been stagnant and will remain so till rates come down. But the rents for 2 br units have hit the roof....they are getting 320-360 pw for units priced at 240k-300K.

Scary...because I am hearing very little new stock in coming to the market....based on demand and supply at some point investors will step.

So my friend....I think this talk of 40% drops maybe premature. However, I can see the market flattening and the ability to pick bargains from distressed sellers.