Ruling out emotion is easier said than done. Find out how you can master your rational decision-making to avoid emotional pitfalls when investing in property.
Trusting your “gut instinct” should never form the basis of a property investment strategy, however buying a property is an emotionally-charged decision and inevitably there’s room for mistakes.
Property investors are riddled with emotional barriers including fear, indecisiveness and procrastination which can lead to poor decision-making.
A fear of missing out, over-capitalising, pursuing the ‘perfect property’, blurring your purchase intention and/or objectives, and renovating to your personal taste are some faults which can lead to financial downfall in the form of untenanted periods, low rental income, or limited capital gain.
Here are some emotional blunders and how to avoid them.
Fear of missing out
One of the most common emotional mistakes made by investors is listening to the media and thinking that you need to get into the property market quickly, according to Christine Williams, property strategist from Smarter Property Investing.
“The emotional mistake is fear when they’re not doing their numbers or due diligence”, she says.
To overcome the fear of missing out, or a sense of impatience, Williams says that investors should know that there will always be another opportunity no matter what time of the cycle you buy. You need to know how to read the micro and macro environment.
If you can’t find a property that falls within your budget or purchase criteria, consider looking in neighbouring suburbs.
Patience is a virtue.
Paying too much for a property is a frequent mistake made by property investors who are swayed by sentiment and an overarching sense of optimism. If you overcapitalise and borrow more than your budget allows, you can worsen your debt position which can harm your financial wellbeing.
Investors often don’t understand the financial obligation of property investing and they fail to prepare for the worse-case scenario. Williams recommends having a cash buffer in place with 3 months of mortgage repayments in an offset account to prepare for a rainy day.
Evaluate your budget and your offer strategy and be prepared to walk away if the vendor doesn’t accept your offer. Although you may be time poor and it may be tempting to pay 5-10% over your assigned budget, you need to be diligent.
Overbidding at auction
It’s easy to get caught up in the theatrics of a faced-paced auction, and this is the prime environment for desperate buyers to overbid. Most real estate agents will generally want at least 20% more than what was advertised in the price guide so keep this in mind when you’re bidding (again, lower your sense of optimism).
Before going to auction, have a clear bidding strategy and set your limits. Overpaying for a property can be an issue particularly when the property isn’t valued as highly by your lender as this could reduce your borrowing power.
If you can’t eliminate emotion from your bidding, consider getting a family member or a buyer’s agent to represent you.
Check out our tips for buying at auction.
The great Australian dream mindset
Investors generally have the mindset of buying rather than renting in order to chase the great Australian dream. Williams says that many single parents believe they need to provide a family home in an area that is close to a desirable public school, but she maintains that renting can be a better wealth creation strategy.
“They [single parents] don’t have to buy, they can rent in the area they want to live and start investing in other areas that have good capital growth rather than buying a house that no one helps them pay for. They need to escape the great Australian dream”, she says.
Williams believes that investors need to shift their way of thinking to consider renting and building wealth through a diversified investment portfolio.
Being too honest
You may feel obliged to disclose as much information as possible to everyone involved in your property search. However, this can work against you.
For instance, you should be selective about what you tell the real estate agent. If the agent knows your budget or just how much you want the property, they may use tactics to tap into your emotions in order to negotiate a higher price. They may tell you that there are other interested buyers who are willing to pay more to create a false sense of competition.
An agent's objective is to secure the highest possible price for the seller so be mindful of people’s motives when discussing your purchase intentions.
Becoming emotionally attached
It’s easy to become emotionally invested in a property based on the way it makes you ‘feel.’ You may be attracted to the manicured garden or the lush kitchen design. If you find that you are emotionally drawn to a property to the point that you are compromising your investment strategy, try to negotiate from a distance.
Seek independent advice from experts such as an investment or financial planner, an accountant, a buyer’s agent or a conveyancer. This will help you formulate an unbiased view on the property to decide whether or not you should go ahead with the purchase.
Due diligence may seem expensive, but it’s worth it.
Combining investment and owner-occupier objectives
Many investors fall into the trap of buying a property that will be an investment now, and a home in the future. Blurring your objectives in this way is risky because you may make a decision based on your own lifestyle, and this may not be a good fit for the location or the target tenant.
Research the demographics of the suburb so that you understand the type of property, the amenities and services that the target tenant desires. For instance, if you discover that 75% of residents are elderly, you may want to consider purchasing an apartment on the ground floor with wheelchair access. Alternatively, if you find that the majority of residents are young students, then you may want to ensure that the property is within close proximity to restaurants and bars.
Separate your investment and owner-occupier objectives by having a clear strategy in place.
Renovating to your personal tastes
Some investors renovate with their personal tastes and preferences in mind, rather than the target tenant. This is a frequent problem for competitors on The Block who featured some daring bathroom designs that potentially ruled out a larger pool of prospective buyers.
Renovating to your personal tastes is problematic because it means that you may find it difficult to attract high-quality tenants.
To increase the sell-ability potential of your home, and to attract the target tenant, de-personalise the space and upgrade areas that are most likely to add value to your home.
When it comes to colour scheme, furniture, and floor plan Williams says it’s best to go neutral and practical.
“If you’ve got mosaic tiles everywhere you’re reducing the amount of tenants that will want to rent the property because it will never feel like home for them because it’s too quirky”, she says.
As appliances are tax deductible and depreciable, they’ll generally need to be replaced every 10 years, so Williams says that you don’t necessarily need to splash out on premium appliances.
Trying to time the market
You should never try to time the market. While it’s tempting to feel euphoric about buying when the market is experiencing an upturn, remember that the market could be entering a stability phase which may mean that there is no price growth for a given period of time.
If you pay a premium for a property that’s headed for correction, you could forgo equity growth.
Markets are unpredictable and they go through several phases including growth, stability, correction and recovery.
Instead of timing the market, ensure that you understand the historical trends of the suburb and research the demand and supply factors of the area to enrich your understanding. For instance, you may want to ensure that there is a low days on market (DOM) and little change in the asking price for properties as this can indicate that there is strong demand in the area.
Taking your time
While you shouldn’t rush into a purchase, you also shouldn’t take too long to make a decision.
Many investors "window shop" and take time to find the perfect property. However, by the time you’re ready to purchase, it may have been snapped up by someone else or you may have run into significant hidden search costs.
If you’ve done your due diligence and you’ve built a cash buffer (Williams recommends having approximately $10,000 - $15,000 in an offset account) and you’re comfortable with the return, then you should take the step. In some situations, it can make sense to buy sooner rather than later.
Williams says that if you wait for the "perfect property" you would have lost two years by the time you’ve found it and then you’ll become more desperate because you’ll realise what you’ve missed out on (capital gain) which could lead to an irrational purchase.
To overcome indecisiveness, have a plan in place. What is your budget? What is your strategy (e.g. positively or negatively geared)? What’s your timeline? Are you financially ready? Having clear answers to these questions will guide your decision-making.
How to avoid emotional blunders
Creating a diversified portfolio, enlisting professional help and crunching the numbers are some of the best ways to avoid emotional mistakes as an investor.
When it comes to diversifying your investment portfolio, Williams says this should include investing in different areas, different dwelling types, and investing in areas that are at different stages of the market cycle. When you sell, you'll have the flexibility to sell the property in the area that’s outperforming the other locations.
It’s important to think about your exit strategy and to know why you’re buying and how long you want to hold onto the property for.
Williams says that investors should also understand that investing in property is a business and that they should view investing as a business plan.
“You need to know your tax flow you need to know your obligations. You need to be on the pulse all the time and know what’s going on”, she says.
What emotional characteristics should investors have?
Successful investors need to be good listeners, they need to be modest, non-complacent, and studious according to Williams.
“If their property manager says it could be a good idea to replace the carpet or to repaint in order to get more rent, they need to be prepared to listen to this advice”, she says.
Property investors also need to actively seek out information and if they seek professional help and they don’t feel comfortable with the advice, they need to go out and get a second opinion.
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