Much has been said and written about Australia's booming property market – although many have suggested the boom is strictly located in Sydney.
Looking at the chart below, it certainly seems like that's the case.
Various explanations have been cited, including a lack of supply close to the Sydney CBD, foreign investors and/or domestic investors cashing in on ultra-low interest rates and/or a lower Australian dollar, first-home buyers exiting the market as Sydney's median house price approaches $1 million, and the advantages of negative gearing for Australian taxpayers.
Whatever the reason, whoever is buying houses in Sydney seems to expect the recent trend to continue forever. Unfortunately, trends end, usually when it is least expected.
That's exactly what happened in 2008/09 and again in 2011/12 across Australia. During 2008/09 – while the Global Financial Crisis was occurring around the world, property prices around Australia plunged. Perth lost 7.7% in 12 months while Sydney median house prices dropped 17% from December 2007 through to the bottom of March 2009.
Property investors, particularly younger investors, seem to have no comprehension of property prices heading lower. They certainly have little or no experience in falling markets.
A recent newspaper report highlighted a 24-year old who 'owned' 5 investment properties and some land in Scotland, valued at a combined $2.3 million, including three apartments on Sydney's Northern beaches. A 17% fall would see that property portfolio lose close to $400,000 in value.
At age 24, and having only been 'investing' for three years, a 17% fall in the value of those 5 units (excluding the land in Scotland) would see the young investor with negative equity of more than $75,000. Granted, two are in Brisbane, so they could track at different rates to Sydney, but equally, it's a high-risk investment strategy to leverage up your assets through the use of debt.
As many individuals and companies throughout history have found, debt can be a killer. Equally of concern is the fact that if you consider the loan to valuation ratio is 80%, then the young investor has $1.8 million in debt – on which repayments are $9,663 per month at 5%, according to National Australia Bank Ltd's (ASX: NAB) repayment calculator.
That doesn't take into account other costs such as strata fees, water rates, landlord's insurance, life insurance, repairs and maintenance and property management fees either.
That's a huge risk, especially if one or more of those properties struggled to find a tenant or was vacant for an extended period of time. While the investor says those properties are positively geared, meaning the rental income more than covers all the expenses, a tenant-less property generates zero income.
And then you have the potential for interest rates to rise – increasing those monthly premiums. A perfect storm could see the banks take control of all five of those apartments for a default on just one property, depending on how the borrowing has been structured.
Foolish takeaway
If you're going to live in the property yourself for many years, then go ahead and buy a house in Sydney. Over the long term, property generates compound annual returns of around 9% after tax, according to the ASX 2015 Long-term investing report. That's lower than shares – which generate close to 10% after tax over the long-term – but still a decent return.
The above case is a classic example of what NOT to do when it comes to property investing, or investing in any asset class for that matter. Having all your eggs in one basket and leveraged to the hilt is a recipe for disaster. Glad it's not me.
