When it comes to property investment, the concept of compounding is considered a good thing. That growth-on-growth model is normally associated with rising values and exponential gains, building your wealth at an increasing rate over time.
But there is one form of compounding in the real estate game that can end up costing you plenty.
I’m talking about ‘emotional compounding’. Those instances during your investment journey where you become overwhelmed by the tough times – and the results can be financially devastating.
Here’s how emotional compounding can have you throwing the proverbial baby out with the bathwater, and some strategies to help stop it overtaking your good sense.
A great example of unreasonable emotional stress was one I witnessed with an ASPIRE advisor’s client.
The client bought a new-build investment in an excellent growth location that will deliver capital gains and solid rental returns for years to come.
However, once the home was completed and the tenants moved in, some minor shortcomings in the design became apparent.
The primary problem was a poorly positioned mixer tap that made it difficult to open the shower screen in one direction – not a huge deal, but still inconvenient for the residents. Of course, this small bother only became obvious once the home was being lived in because the property’s practicalities were being ‘test driven’ by the tenants.
Repositioning the tap would cost a few hundred dollars and could be completed fairly quickly.
Unfortunately, rather than simply bringing in a plumber and making the change, the client became extremely emotional about it. There were threats around pursuing the builder (who had completed the home as per the plans) and even our advisor for the rectification cost.
Worse still, the client argued the home was, “Too much trouble and had become a ‘bad asset.’” They considered selling up and being done with investing altogether.
For me, the reaction was entirely impractical, unreasonable, and made no long-term financial sense. Why would you sell a great asset – or upset an excellent builder – over a badly positioned tap? Particularly when, by the time the tap was noticed, this client’s property had already increased in value by $120,000 dollars.
I can tell you from experience, I’ve seen a lot worse to deal with. A tenant left a tap running which flooded the property and required a comprehensive insurance repair. Another had, in breach of the lease, a veritable zoo of animals in their home.
But instead of the investor throwing their hands up, they simply got things fixed. After paying for repairs, and making the homes rentable once more, they continued to proceed with their long-term strategy.
And guess what? After not renewing the pet owner tenants lease, making the fixes and freshening up the home, they managed to increase rent to market at 45% higher obtaining $200 a week higher in rent. In addition to yield increase, the value of that property rose 40 per cent in two years.
Teachings from tough times
This client episode, plus our own experiences, reveals a few lessons every investor can learn from.
Firstly, owning an investment property is not all sunshine, rainbows and lollipops. Sure, the past twelve months have made it seem like building wealth through real estate is a walk in the park. But, in truth, there’s going to be the good, bad and ugly to deal with.
Booming markets are good, but you will also run across bad tenants and ugly periods of vacancy. There will be times maintenance can feel overwhelming or rising interest rates appear monstrous.
The key is to have strategies in place to help you push through. You need to be able to ride out the hard times and enjoy the great moments.
Here are coping strategies you can employ.
When you start investing, be consciously aware that you will face challenges. But also know that staying the course through the tough times will bring extraordinary rewards.
Market value fluctuations will test your mettle. Property management problems such as difficult tenants or vacancy periods will feel insurmountable. Changes in legislation – hell, even a global pandemic – may come along and upset the apple cart.
Just be prepared mentally to face these headwinds before they arrive.
Next, when they are upon you, take a moment to calm your emotions and remember why you’re investing. This is about long-term financial security, not short-term comfort.
A range of studies indicates the average investor will hold onto a property for around eight to 10 years. This is barely enough time to see a full price cycle of growth, which normally takes approximately 10 to 12 years. This statistic also shows that many people are selling up too soon. These are the people who are paying buy-in and sell-out costs for no benefit.
The second way to stay the course is to make sure your financial safety nets are in place.
Firstly, ensure your resources can cope with a few months of vacancy or unexpected maintenance. Keeping, say, three months’ worth of rent and running costs in an offset account is a prudent strategy.
Next, factor in rate rises. I like to run my buffers based on paying double the interest rate I signed up for. This might seem like a huge safety margin, but as rates rise you will be comfortably placed to service your loan.
Finally, revisit your portfolio and your strategy at regular intervals. A revaluation of your assets and looking at your rental returns might deliver some emotional good news. You can refocus on your goals and be ready to take on whatever may come.
The other benefit is you might discover that you’re ready to invest further and take advantage of opportunities when others panic sell. It’s that time-proven approach of being counter-cyclical in your investment decisions.
Knee jerk reactions can torpedo your long-term success. Don’t throw the baby out with the bathwater in an emotional lack of reason. Instead, stand strong and look to forge on. Your persistence and tenacity will be rewarded.
Always review any property location research and investment analysis data, with a professional, QPIA (PIPA Member) qualified & accredited ASPIRE Property Advisor Network Advisor. Never rely on glossy sales brochures or property marketing information, ensuring a property is right for your strategy. Property Investing is about BUYING a property that matches your goals and aligns with your investment strategy, never be SOLD an investment, know your numbers!
Visit www.aspirenetwork.com.au or call our office to be connected with an accredited and independent Property Investment Advisor on 1300 710 933