Six tips to help you through the next market cycle unscathed: Gavin McPherson

There are a lot of conflicting views about this so-called ‘new’ property market cycle.

Has the 2013 budget made it worse? Will it turn a corner after the election? If buyers think this will be the last chance to get into the property market before it becomes totally unaffordable, don’t be fooled; it’s not.

For the major cities in Australia it’s true that the housing supply problem will always ensure that there will be ready and willing buyers. But are they able buyers? That is, are they able to stump up a deposit?

Being able to pay the mortgage at today’s rates isn’t really the challenge. It’s being able to keep up repayments when things return to normal.

For instance, let’s take the average Sydney home price at approximately $650,000. At more normal 7% interest rates, that’s $45,500 per annum (after tax) to pay just in interest on the mortgage. Not only is this huge, but it’s also about the point some years ago where new buyers said “that’s enough, I’m out!” In other words, those who can afford property still have their limits.

Now with rates at historic RBA lows, the (variable) rate is currently 5.4%. This takes repayments down to $35,100 – almost 23% less (after tax) for the same mortgage – even less if they want to lock it in for a few years.

So let’s say that those same buyers (who could afford 7% rates) bid the price of that average $650,000 up by 23% making it $799,500.

Is that really possible? You bet it is.

But this isn’t the problem; those lucky buyers getting into the market now (paying $650,000) with a great low interest rate will probably be the winners right now.

But what about the buyer who ends up paying $799,500 for that same property in, say, November 2014? How do they fare when rates return to normal again? Imagine $799,500 at 7%, with repayments of $55,965 - some $20,000 more than the lucky purchaser who locked in three-year rates in June 2013 at $660,000.

Keeping in mind the infamous phrase: “Confidence enters the room one person at a time. Fear exits the room all at once”. That sort of event usually leaves some double-digit price drops behind it.

And for those that don’t think that rates will return to normal? Check your history. They will.

For those looking to cash in on the current low interest rates, here are just a few tips to help you through the next market cycle unscathed.

1) Buy under market value by 5-10%: Always go into a deal buying the property some 5-10% under market valuation. I adopt this as my number one rule in every purchase I make; Warren Buffet dub’s this his ‘margin of safety’. In the property industry I find the first and easiest way to do this is to avoid buying at auctions. When bidding at auctions, you will usually bebidding against owner occupiers rather than investors, making the property a personal (and emotional) acquisition to them – and making it nearly impossible for you to get a good deal. I buy over $100m of property a year and I’d say less than 1% of it is at auction. So much so that an auction campaign rarely gets my attention at all!

2) Keep debt low: As tempting as it is, now is not necessarily a good time to commit to high debt for the long term. We still don't know how this market will play out, and if the recent federal budget is any indication, all signs are pointing to higher unemployment, anaemic growth and little in the way of surplus cash going forward.

3) Fundamentals are... well, fundamental: While a good investor will never ignore good property fundamentals, this is especially relevant now. Remembering that at times like this every property can increase in value, even if they have deficiencies such as poor land value, main road status or no natural light. When things normalise however, bad properties will be punished.

4) Go North: For investors I'd be looking at major cities that are undervalued like Brisbane and the Gold Coast. I believe Melbourne was in a prolonged state of plateau before the rate decrease, so I don't see a lot of movement except for some ‘topping up’ of that affordability threshold. Sydney has further room to grow organically but it is limited by a high threshold that pushes affordability up – as seen in my earlier example. In fact, most of my tips for above par growth will be north of the NSW border for the medium term (2-4 years).

5) Read and learn. The investor of the future understands that property is just one piece in a jigsaw. That jigsaw also includes factors such as the greenback, parity, quantitative easing, terms of trade and yes you guessed it, China. So while you don’t necessarily need an economics or geopolitics degree (although it is handy), you would be well advised to start reading something that will get you thinking about the long term.

6) Think long-term. The final piece of advice could well be your best at times like this.

For any of you that think you can make your first million in just one market uptick, while interest rates are at record lows, you might just be setting the trap for your own personal armageddon – because I don’t think judgement day (i.e. higher interest rates) is that far away! In case you need some more positive inspiration though, I’ll let Mr Buffett sum up these thoughts better than I can: “Wealth is the transfer of money from the impatient to the patient.”

Gavin McPherson is the chief executive of Oasis Property Group. His book, 'Value Investing in Property - What would Warren Buffet do if he was buying property in Australia?', takes aim at the get rich quick property experts and explains instead the sturdy path to wealth through value investing in property.