How to Protect your Property Investment from Real Estate Bubbles

In 1997, while Hong Kong was in celebratory moods because of its handover from China, a devastating property market crash hit the real estate industry. The real estate bubble was most likely triggered by the Asian financial crisis, although other economic imbalances had a role in the crash. The property bubble was so devastating to property investors because it triggered the fall of real estate property value by 60%-70% and it lasted for 6 years as the government struggled to fight deflation and its wrecked economy to correct the property crash.

No single real estate market is immune from property crashes no matter how booming the market is. As much as a weakened economy plays a major role in housing bubbles, other factors such as disproportionate balances between demand and supply of real estate property can also lead to a bubble. In Hong Kong, during the year the bubble was first experienced, 1997, there was a huge imbalance between the demand and supply of housing. It was during that year when the government rolled out its plan of providing 85,000 cheap and subsidized housing units to its citizens each year through the newly created House Ownership Scheme. Of course, the housing units did not seem to pose any dangers to the industry given that there was a huge population and the market was booming. However, the housing scheme must have a direct effect in prolonging the period of a slump before correcting the house index in Hong Kong.

Today, the real estate market in Hong Kong is vibrant once more. The nominal process and value of real estate property across the country are relatively appealing. However, as much as the property market seems ideal for investing in real estate, you need to be cautious while investing. You must be wary of the losses and inconveniences that you may face in case of a crash in the property market.

Effects of Property Market Crashes

When the property market is booming, investors are confident in investing because their property has higher equity against homeownership because of the fear of a high default rate.

Therefore it becomes difficult for homeowners to service their mortgage payments leading to a high rate of credit defaulting. Those who are still able to service their mortgage payment usually feel disadvantaged because the property crash lowers the value of the properties, hence the mortgage payments and other outstanding credit payments may be far much more than the real market value of the property. This leads to negative equity on the property.

The worst-case scenario is the fact that crashes of the property market have devastating effects on the economy too and usually lead to the stagnation of the economy or lead to an increase in the unemployment rate.  These two, among others, may further depress the property bubble and derail the recovery of the market because there will be a low demand for consumption and deflation rates rise, thus the market may take years before recovering. This was the case of the Hong Kong property market bubble that lasted for 6 years.

Every investment is prone to bubbles, which usually result in massive losses to the investors. In real estate, bubbles occur when the prices of investment deflate considerably leaving investors with huge mortgage debts more than the value that the house is worth. This is usually occasioned by a rise in interest rates paid on mortgages and result in foreclosures as the bubbles burst.

Principles that should guide you in your real estate investment journey

The real estate industry in Hong Kong may be presently attractive. This does not make it immune from market crashes as attested with how past vibrant property markets have been affected by crashes in Hong Kong and across the globe.  You need to realize that each day potential investors are bombarded by investment advice and guidelines that may not work if you were to factor in economic and market changes that may later prevail. Therefore, such advice can be misleading and lead to wrong investment decisions.

Below are some pieces of advice or, you can call them, myths that people fall for which can result in huge losses.

• Investment in real estate is solid and can never yield into losses

This is misguided advice that has been peddled for a long time. People peddling this advice usually prey to investors who are privy to owning real estate property for the first time.

However, investors who were on the market in 1997 when property bubbles and crashes started plaguing the real estate market will attest that property investment can yield losses.

Therefore an investor should take due diligence and consult widely on the best investment opportunities which will generate positive returns and tax benefits in the long run while enabling the investor to build significant equity from property appreciation.

• You do not need to obtain financing for property investment

One fact, which is usually ignored, is the fact that real estate property involves a lot of financing. Therefore, an investor should not fall for the advice that they can successfully invest without sourcing for funding. Without the right financing, an investor can easily stall midway which is frustrating. Therefore, an investor should seek a good source of financing which offers the lowest interest rates.

• Commercial real estate offers the best investment opportunities

This is another misguided piece of advice that many investors believe. On the contrary, commercial real estate is not easy to operate and manage profitable as is in residential real estate investment. The latter is easy to understand, operate and manage, unlike commercial property. Commercial property usually attracts many expenses and operational costs that could utilize a considerable amount of the returns thus yield too little or no profits than residential property.

• You can be successful at DIY investment

Although this is true to some extent, it works best for seasoned investors. Otherwise, an investor will need the advice of several parties to make a good investment decision. These parties include a mortgage broker to find the best financing which suits your investment, a financial adviser that can ascertain inflation and other financial implications that your investment is likely to face, a solicitor, an accountant and a property specialist to help you in gauging the appreciation or depreciation of your property. These people can help you make a sound decision on a property that will yield good returns on investment.

Investors can prevent themselves from bubbles if due diligence is observed before one invests. The following are precautions that can be taken to prevent an investor from crashes in real estate investment. There are various measures that you should undertake to prevent yourself from property crashes.

• Always pay a down payment when investing

It is no brainer that if you cannot afford to pay a deposit for a home, you simply will not be at ease paying the monthly deposit. It is prudent to pay at least a 20% deposit on the total cost of a home. However, Millenials and the average middle-class income earners in Hong Kong have been swayed by the trend of homeownership. Most people are raising their own homes even when they cannot afford to pay the initial deposit. In such circumstances, the effects of the crashing of the property market can be harsh and more devastating because the equity of the property will be too low.

Additionally, not being able to afford the initial deposit is a clear indicator that you are not in a better position of owning a home currently. It is vital to have a clear plan of how you are going to raise/ save cash for the initial deposit and how you are going to afford to service the mortgage.

A foolproof plan will help you to have confidence in investing and will help in mitigating the risks associated because when a leader may shy from lending because of the high leverages, you will still have a means of repaying your mortgage and thus you won’t be in default.

• Never use home equity credit for personal purchases

At times, you may be carried away by the need to make personal purchases, and if you do not have the cash to do so, you may be tempted to use the home equity credit to make the purchases. This is a bad decision, which in the end may leave you unable to pay the real estate credit on time. There are times that you may be having financial difficulties and feel tempted to use the home equity to obtain financing to cater for school fees and other personal matters. This is undesirable because obtaining a loan in furtherance of other personal matters may impede you from obtaining another financing option if a bubble occurs when you haven’t finished repaying the loan that you obtained.

Moreover, although furniture and fitting are usually considered as part of the home, you need to set a ceiling limit on how much you are going to spend on these items. The need to modernize your home by purchasing high-end furniture and other accessories should not tempt you to spend the home equity on these items.

Modern Furniture and fitting can be quite costly and hence they may take a sizable share of the home equity thus considerably reducing your ability to repay your mortgage. Therefore, in case of a real estate bubble, you will be left with a huge burden of a low-equity home and the prospect of not being able to secure financing for the home which may ultimately lead to default. It is always advisable to use the home equity wisely. If you have to use it as collateral to obtain financing, do it to further your repayment of outstanding due of your home investment.

Always safeguard your homeownership from the effects of real estate bubbles by protecting your home equity.

Research and have a deep understanding of the market before investing

An important step that can help you to protect your investment from property crashes is having a deep knowledge of the market. You will need to study the market trends, consumer patterns and the healthy state of the economy of Hong Kong before you invest. One troubling indication about the market was some early warning from experts in the real estate industry who earlier this year (May 2017) hinted at a possibility of an imminent real estate bubble.

Another importance of studying the market is to give you the ability to think twice before investing. During a boom, when the property market is stable, you may feel the urge to invest. However, before you jump at any offer that presents itself, it is important to establish how long the market will be attractive. You need to bear in mind that real estate investment calls for patience and thus your capital may be held by the property much longer than you initially anticipated. And, you don’t need to be caught unaware when all that you have is helped by a property that you are having difficulty moving.

By understanding the market, you will be able to make sound decisions that will positively affect your investment. For instance, a deep study in various property markets in different parts of Hong Kong will reveal that it is advisable to invest in green markets that are emerging and young than investing in mature markets

• Don't take a home financing option if you have a bad credit score

A bad credit score usually attracts higher interest rates. If you have a bad credit score, it is important for you to naturally repair your credit score first before you consider getting finance for your home. This helps to protect you from having to pay higher interest rates. You need to remember that interest rates usually inflate the total costs of the financing obtained and thus a higher interest rate will have a huge impact on the total amount of financing repayable. Moreover, today, regulations are getting tightened by regulating authorities that seek to cushion lenders from credit risks by introducing new policies with regards to defaulters as well as people with bad credit. This means that the introduction of further policies in the future could potentially disadvantage you if the policies seek to increase the interest rates on credit facilities extended to people with a bad credit score. Thus you would end up repaying a higher amount than you had initially anticipated which further dwindles your returns on investment.

• Buy a home if you are certain that you will live in it for a few years

The cost of investing in a home usually takes several years to recoup and break even. Therefore, in case you do not plan to live in a home for the first few years before you can recoup the investment costs, then you don’t need to invest in the home. You'd rather consider the option of renting unless you invest in homes that you intend to resell later.

• Don't invest if you cannot afford the home that you want

Many home investors usually rely on the advice of mortgage lenders and real estate agents to work out the value of the home that they can afford. This is good advice, but in most cases, it never works out. You'd rather work on your budget and estimate future expenses that you may incur so that you can decide the value of the home that you are going to afford. Some of the future expenses to factor in include a rise in the interest rates, introduction of new statutory fees and charges as well as any potential reduction of your income. The latter is not an expense, but ultimately it affects the amount of money that you will be left with after deducting your expenses from your income. You should also factor in the possibility of having to shoulder some new personal expenses in future such as school expenses that you might be paying for your kids, a rise in the costs of living etc. By factoring these expenses in you are in a position to determine what will be left to cater for the home equity financing payment.

You need to remember that future inability to finance your mortgage repayment may lead to foreclosure of your property in which case you stand to forfeit the mortgage down payment that you had made as well as being driven away from the home. This was the scenario that happened in 2008 in the United States of America after people who couldn’t afford to purchase homes flocked in number to acquire low-cost mortgages that were being rolled out through a government directive which sought to increase the national homeownership rate of America. The cheap mortgages that required only a deposit of 5% on the value of the homes lead to an increased demand for homeownership which eventually leads to an increase in the prices of property. Eventually, this culminated in a massive market crash because those who took the mortgages could not afford to make the repayments later. Therefore, ensure that you are capable of purchasing the home.

In Conclusion…

It is always paramount to carry out due diligence before considering an investment in real estate. This is because real estate investment takes a while before payment can be completed and you do not want to strain in making payments if they are not realistic.

For more information or advice on property investment, contact your local real estate agency in Hong Kong. If you are looking to invest in a luxury property in Hong Kong, contact Engel & Volkers for more information regarding the best properties in the best areas of Hong Kong.