Buying in a Falling Market?

September 05

Back in November last year, I wrote about the difficulty of predicting the future when it comes to property prices. Certainly, the much forecast Market Crash that was being trumpeted at the time has mysteriously not happened.

The article is still available here so I am not going to go back over the same ground.

However, I do want to respond to some of the questions that I have been asked since writing that article on the subject of investment strategy for different times in the market cycle.

The strategy that brought great paper wealth to many people in the late 90s was simple - Buy Leveraged Assets In A Rising Market.

This is not a new strategy, the great so-called merchant barons of the 19th Century United States did exactly this - borrowed money, invested in a fast rising market - and watched the value of their investment far outpace the interest they had to pay to their lenders.

I personally do not believe that we are in a fast rising property market in the UK at the moment, so the question becomes whether that strategy is still a certain path to riches. In my experience, it is not. In a falling market, high leverage translates to maginified LOSSES rather than magnified gains. In a static market, the question becomes one of cashflow and timing.

One of the most important investor controls is that of being in control of WHEN you dispose of an asset. One of my ongoing concerns about putting property into a pension fund, is that I would be seeking concrete assurance that on my 65th (or whatever) birthday, I would not suddenly be forced to sell up my portfolio to buy annuities (in the way that stock market pension plans force purchase of annunities under the current rules.) The danger is that a forced sale might come about at the same time as some 2035 crash. (If it is hard to predict whether the market will go up or down in 2006, think about how much harder to work out where in the cycle we will be in 2035.)

Apart from regulatory issues, what else might force a sale? The two easy answers are either a cash crunch, or a mortgage lender.

Property investment should only ever be part of a larger financial plan. A key part, in my view, of any such plan, involves having enough cash to live on for at least 6 months, and ideally 12, if my other income were to stop. In the case of the Property Investor who has only a few properties, then this cash buffer should contain enough to pay the investment interest if the property were to become empty at the same time - consider the case of the Rover employee who bought a property and let it to a colleague. In one foul swoop, he or she would have lost their job, and their tenant would have lost their ability to pay the rent.

For those with larger portfolios, then a cash buffer suitable for paying SOME of the rents, on the basis that it is most unlikely, with a diversified property portfolio, that all your tenants would hit problems at the same time.

The slightly more insidious problem is that, buried in the small print of many mortgages, is a clause that says that, were the market to crash, the lender could demand a partial repayment of the borrowing EVEN IF the mortgage were being paid reliably on time! Ouch. It is more likely that lenders would crack down on those borrowers who are over-extended in terms of Loan to Value, than those who have good equity in their portfolios and have not remortgaged once too often.

The focus, therefore, has to be on keeping up the mortgage payments, so that you never get into the situation where you have to sell because you need to raise cash in a hurry. This means buying for Cashflow, rather than in the hope of capital appreciation.

Do investments that will generate positive cashflow exist? Absolutely.

Do all properties advertised for sale stack up on a cashflow basis. No.

I have long maintained that property investment involved putting in effort. Ten years ago the time-consuming thing was finding finance. Buy to Let loans have made that much easier - now the time-consuming thing for the Property Investor is finding the deals that stack up.

After all, if a property is putting five hundred quid into your pocket each month, and putting that money into your pocket is the reason you bought it, because it meets your financial goals, does it really exactly what the market value would be if you sold it?

This is just the feature article from the September 05 newsletter. Subscribe for market comment, forthcoming events, and more.

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