Why pessimists make the best investors
HTML5 Shim and Respond.js add IE8 support of HTML5 elements and media queries [if lt IE 9]> <![endif]
End Facebook Pixel Code [if lt IE 9]> <link rel="stylesheet" type="text/css" href="/sites/all/themes/saturday/css/ie.css" /> <![endif]
Property investors come in all kinds. Optimists, pessimists and anywhere in-between but over the years, I’ve discovered why some of the best property investors are the pessimists.
Are they common
Unfortunately, from time to time, when we analyse a new clients existing portfolio we will discover a horrifically under-performing property, such as a two-bedroom fibro shack in the middle of the town of Nowhere Special. They undoubtedly bought because a recent mining discovery or some new but remote infrastructure project was driving gross rental returns to extraordinary highs.
They, of course, hadn’t factored in the flimsy composition of this equation and had no room for error among their borrowings. Come the localised downturn and BANG! their equity and rental disappears, leaving them with an unserviceable mortgage. This is the curse of the eternal optimist – ever convinced that the perpetual motion machine of capital growth will continue indefinitely.
Taking care of your analysis up front is paramount – greed and ego have no chapter in the savvy investor playbook. Even I’ve been guilty of not being conservative enough when investing. Early on, I forgot it was all about the numbers that drive the investment rather than the number of properties you own. Overoptimism isn’t just within the realm of the less educated investors either. Doctors, lawyers and other high-end professionals have been caught out too. Not surprising really because greed and ego can be common among this cohort.
Numbers are key
People have a tendency to adopt numbers that suit them when it comes to deciding whether to buy or not. It’s a classic case of confirmation bias. If the market is bullish, optimists will factor in an extension of the good times and great returns, and revel in the future figures.
If the market is slow, they’ll reason we’re due for an immediate uptick – without factoring in how they’ll cope if everything remains sluggish for longer than anticipated. Apply your grey demeanour to numbers like interest rate rises. We’ve become accustomed to cheap money.
Worse yet, there’s a whole generation of new investors who’ve never seen double-digit interest rates. They did happen, and they can happen again, so be prepared.
The GFC is an excellent example. No-one lost their property due to a fall in equity. They lost it because of lack of cash flow or cash flow management. The other financial ‘look out and duck’ moment is loans flipping from Interest Only to Principal and Interest. This is where monthly repayments suddenly go up. If you’re ill prepared for the change and poorly budgeted, it can be your undoing. Rent returns and vacancy rates are further elements worthy of caution. There’s nothing that will cause a furrowed brow faster than seeing your investment sit untenanted for an extended period because rental levels have dropped and you still can’t find any takers.
The thing with realistic pessimists is this – their first step is to be dreary on the outcomes. Their next is preparation for the worst. The smart pessimist will factor in downturns and keep a nice healthy financial buffer on hand that will keep them out of the trouble should it all go to pot.
Make sure you also allow for what your future holds. Are the kids about to go into private school? Congratulations, but your household costs are also about to skyrocket. Are you working in an industry undergoing extraordinary change and upheaval? Factor in a healthy buffer so if you do need to suddenly join the job search, making payments for the next few months is the least of your concerns.
Be careful, not frozen.
While I’m all for the cautious approach of the pessimist, you want to avoid swinging too far in that direction as well. Conservative procrastinators are doing themselves a disservice because they will undoubtedly stall in their plans to the point of stagnation. That said, you must cater to your internal comfort zone. At the end of the day if whatever you do doesn’t let you sleep at night them you just shouldn’t do it. There are a million other ways to create money – you’ve just got to find the risk sweet spot that gives you peace between your ears.
This article provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such as it does not take into account your personal circumstances or needs. Professional advice should be sought prior to any action being taken in reliance on any of the information.