Positioning Yourself for an Economic Downturn
About the Author:
Matthew Gilligan
Director at Gilligan Rowe & Associates
Matthew is a chartered accountant who has been practising since 1992. He heads GRA's property planning division and specialises in asset protection, estate planning and tax minimisation.
Matthew Gilligan of Gilligan Rowe and Associates comments on the softening of business sentiment and property market coming off the boil in Auckland. In 2015, he had predicted this, pointing to the 40-year pattern, with markets peaking in 1987, 1997, 2007, and now 2017. Focusing on the Auckland market, he picks up the argument and provides some practical advice to investors who are looking to limit risks.
You don't need to be a mathematician to spot the trend. The next peak is due in 2027 with at least five to six years of the market "flatlining" until we can see upside growth. This is because it will take five to six years for rents and household incomes to rise, when asset values will start to make sense again and allow more growth.
EXACERBATING FACTORS
My biggest concern is the rapidly expanding supply of housing in Auckland, with the Unitary Plan taking effect.
Moreover, in a very good recent radio interview, Sir John Key expressed concerns that we are heading into a global economic downturn, which would naturally impact upon New Zealand. (Google: "Newstalk ZB John Key economic downturn" to hear the replay).
WHAT DOES THIS MEAN FOR YOU?
In periods of uncertainty and volatility it is best to play it safe and limit your risks. In the event of a credit crunch, interest rates could spike again. If you have debt (e.g. on your home, investment property or a business), assess your capacity to service your loans if interest rates were to rise in the next few years.
Consider fixing your interest rates long while rates are still low, and have your loans maturing at different times (or divide your borrowing into tranches). You won’t get the cheapest rate in the market by doing this, but you will de-risk your household in that you won’t have all your debt maturing at the same time when future rates are hard to predict. Further, you reduce your exposure to rate spikes.
Get lines of credit in place now while you don’t need them – such a facility could stand you in good stead should you need further credit when it is tight.
One more technical point: we have noted banks being less agreeable to allowing borrowers to roll their interest-only loans back on to interest-only, a trend coming from Australia. If a bank forces you to hold the term of your loan to your original application, this can cause surprisingly difficult cash flow obligations, depending on the term of the original loan.
For example, if you have a loan that is a 20-year term, with 5 years interest only, then at Year 6 you have to pay the entire principal off over the residual term of 15 years. Compare this to the same loan written on a 30-year term. At Year 6 you can pay the residual off over 25 years principal and interest – much softer effect on cash flow. Moving from an interest-only loan to principal and interest, your monthly repayments would increase by 40% over 25 years, 58% over 20 years or by 90% over 15 years.
COMMERCIAL STRATEGIES TO MANAGE PROPERTY INVESTOR CASH FLOW
Property investors would be wise to assess their portfolios and consider adopting strategies to increase cash flow (e.g. flat conversions, rent-by-the- room, extra bedrooms from existing dwellings, etc.).
If you believe your cash flow could not withstand a spike in rates, we would do well to recommend you selling now to get your finances in order. Don’t wait for your banker to push you to do it when others are being affected by a downturn and in the same boat.
In our experience as a practice, during the downturn investors go broke because of a lack of cash flow (i.e. not being able to service their loans) rather than because property values are decreasing for a time. So consider these recommendations:
If buying, ensure you purchase at a discount so you can absorb a decrease in market value without losing equity. In the absence of capital growth prospects, you need to be making money as you buy property at present. Instant equity strategies are key.
Ensure you have the right tax and legal structures in place so that your personal assets are protected should something happen with your property investments.
Find out what property investment strategies are working at this stage in the cycle – a good education can help prevent you from making costly mistakes. We are offering free Property Investment and Education seminars in our Auckland offices where you will hear about strategies that are working in this market.
For investors with good cash flow and who, after assessment of the risks, are seemingly immune to price and interest fluctuations, we note that past performance does not guarantee future performance. However, if we continue to get the long-term growth rates Auckland and much of the rest of New Zealand has enjoyed, then we will be well paid for our efforts in 2027 - assuming the past pattern continues.
Director
Gilligan Rowe & Associates
09 522 7955
Related Articles
Deploying siloed tactics does not equate to purpose-driven strategy. This is as true in purpose-driven strategy as any other. While there is potential to deliver social impact this way, it can slip easily into “special projects” that organisations do on the side and the public is savvy in recognising authenticity.