by John Bolton*
When buying property near the top of the property cycle it's important to understand the risk return trade-off and not blindly buy into a simple rationalisation on property prices.
There are clearly widely differing views on the property market, some informed, and plenty driven by anecdote. Those driven by anecdote tend to pick up on a few key headlines that reinforce their personal beliefs or what they want to believe. They don’t tend to think much beyond that.
For what it's worth, my view is that the Auckland property market is over-valued by about 25% but I don’t see a short-term reprieve for buyers. The lack of supply will prop up house prices for the foreseeable future.
However, at some point there will be some sort of market correction as they tend to come around every 7-10 years and it has been seven years since the GFC.
Right now interest rates are low, we have strong immigration, and everyone is wet with excitement that prices might keep increasing. Psychology and confidence are major drivers of price, so it becomes self-fulfilling. Prices will continue to rise this year.
How long they’ll increase for is anyone’s guess. Six months, maybe a year. Throw in an anecdote of hot Chinese money flooding Auckland and maybe it could go another two years.
But prices are heading well above fundamentals and increasingly it’s a speculative play.
We all know the party will come to an end but nobody knows when.
Who predicted the Swiss would drop their peg to the Euro? Or that oil prices would tank and send Russia into a severe recession?
The point is there are a number of possible global events that could start the next major correction. None of them are predictable.
The more risky or naïve will keep speculating right up until the next market correction. Some will get it right and many won't.
Most discussions on property tend to be a simple discussion on whether or not prices will increase. It is rare to have a proper discussion of risk versus return.
That brings me to an example.
I had a new client come in recently who wanted to buy a new owner-occupied property and keep his existing house as a rental. This would be his sixth property and take him to $2.4m of debt. His servicing was so tight that only one lender would approve finance. It would also take him up to an 80% overall loan to value ratio.
My feedback was by all means to trade-up, but to sell his existing property.
Although average prices will likely go up this year, his was already a high price for West Auckland and wouldn’t appreciate nearly as much.
I was concerned with both the high LVR but also the weak servicing. In the unlikely event he found himself in financial trouble, they’d have very limited financial options.
I questioned whether he was prepared to put all of his equity ($600,000) at risk for an extra $40,000 of speculative capital gain. If he was right he’d get $40,000 and if he wasn’t he was at risk of losing everything. He decided to keep his old house and play those odds.
I find property investors underestimate how illiquid property can become.
The mistake is often assuming that equity is like cash.
It isn’t.
In a market correction, lenders are likely to force all proceeds from the sale of property into debt reduction. So, good luck on getting any cash out.
Similarly, Revolving Credits are a one-year renewing facility. Although it hasn’t happened here in my working life, it is dangerous to assume banks wouldn’t cancel them if we had a major economic crisis and things got ugly.
Luckily we haven’t had it ugly for a long time and hopefully it stays that way.
Leverage works extremely well when there is liquidity and when prices are trending up. For the most part property has and will continue to deliver on this.
However, it’s those small periods where the rules don’t apply that hides the risk.
For the most part the risk of market failure is swept under the table due to lack of hard evidence in the past 20 years. Nonetheless, it exists, and for all of us - including me - I hope we never see it.
-------------------------------
John Bolton is the principal at Squirrel Mortgages. This item first appeared here and is used above with permission.
39 Comments
Good points John.
"Who predicted the Swiss would drop their peg to the Euro?" :) made some bucks on that I did. although my dateline was out by three weeks, does it still count? Could not see the Swiss continuing to stand by continuing to buy up the price of the Euro (artifically supporting it) while most of Europe was hell bent on driving the fundamentals of trade into the dirt. With the spat they were having with one of their major clients the Euro *should* have been falling but it wasn't. Whomever was buying in was going to swap direction on that basket of poop sooner or later, and before the QE completely ripped value out of their buying position.
I agree , I dont believe residential property is fundamentally a sound long term investment and worse as a speculative investment , except in NZ where the tax laws are skewed in favour of such investment and rampant immigration and a local authority without a plan are compounding the problem.
These ''problems" still dont make it a fundamentally sound investment , because in due course , the problems will diminish or get sorted and the market will correct , simply because thats what markets do , always .
I can only assume the tax incentives were deliberately crafted to encourage the private sector to provide rental stock to a starved market.
Our immigration policies have got out of kilter with common sense and eventaully sense will prevail , and Auckland council will be forced ( screaming if neccesary) to accomodate demand by removing its deliberate obstacles to development .
That said, I dont see "value" at current prices for run-down houses in untidy suburbs , and the North Shore has gone really stupid with Chinese buyers snapping up everything they can get their hands on.
They do see things through a different prism to Kiwi's , houses here are really dirt cheap compared to major Asian cities , our properties are also fee-standing houses not high-rise , and there is cheap money aplenty in many parts of Asia to fund the meryy-go-round .
A really excellent article.
People often forget how illiquid property is. In each of the three recent downturns 2008-2011, 1998-2002 and 1990-1993, I have seen owners forced to take large haircuts to off load property. Any perceived equity and even cash contributions can quickly evaporate when fear takes over.
I'll just add that the last 3 booms were roughly (depending on location):
1993-1997 (focused and started in Auckland, but also hit Wellington then ChCh, Queenstown also boomed, much of the country (the regions) only barely noticed)
2003-2007 (strangely started in Nelson in 2001/2, hit Auckland next in 2002, then Wanaka and Queenstown joined in, along with every beachfront spot in country (even Colac Bay and Kaka Point!), Dunedin joined in in 2003, then every other cheap town and city starting in the Deep South and heading up to include places like Wanganui and Tokoroa! Chch simmered along initially only reaching the boil towards the end of the party in 2004/5).
and
2012-201? (Started firmly in Auckland and Chch once insurance cash arrived plus strong immigration. Timaru has done well as has most Canterbury areas, however the rest of the country has just been simmering or going cold...)
The question is ... does the question mark cover a 6 or 7?
There is no question it is unlikely to be a 5, however I do feel that we may be reaching or have already seen the peak on some individual sale prices in some locations.
BTW, I posted on here in 2008 when BH was predicting a 30% downturn, that prices would likely be flat in dollar terms (fall in real terms) before seeing another boom from 2013-2017 (based purely on the theory that history repeats, but also influenced by the lack of construction, higher construction costs, demographics etc). The earthquake brought that forward a year.
considering the last down turns were triggered by international events, asian crisis, GFC coupled with already high interest rates, I think it may actually be 2018 or later before we see anything significant happen. Auckland has now become fully priced however and I expect a leveling off and some consolidation for a few years while the rest of nz plays catch up
Dont follow AU market. I don't think the sydney price to regional city price ratio has changed to the same extent as Auckland price to NZ regional city price ratio.
If Auckland property was considered twice as valuable as a regional city 10 years ago, why is it now deemed 3-4 times as valuable? These things balance out over time as the dust settles and time allows the movement of people and money to regions that become relatively attractive on a bang for your buck basis
Because Auckland is maturing into one of the most desirable places in the world to live, climate, work, lifestyle, family, schooling, environment, culture, excitment, sport, events etc etc, immigration stats speak a thousand words. Regional NZ hasn't moved for 20 years, infact in some cases have had reduced populations (especially rural towns, the ghost town syndrome).
Nice article. Of course it's stupidly ridiculously overvalued. Nothing like doing the sums for putting a 50% deposit down on a place and seeing that all your money is tied up and the rental income won't even cover the mortgage.
Personally, I'm faced with the choice of throwing in the towel and buying a house in Auckland now from the Internet for when I move back from overseas in a year or two, or to hold off a few more years until I actually move back and pray the prices aren't even worse. The correction is an absolute certainty, but when will it be and how bad will it be is impossible to figure out. Im getting old.
Either way I can't win I feel I'm speculating if I do and speculating if I don't, but the past few years of inflation has nullified everything I have ever saved.
Its impossible to know what will happen but the question I ask myself is whether it is worth spending an extra 10+ years paying off a house in Auckland? (Probably with a long commute). That's a lot of 'lifestyle' the city has to provide to make up for it. Its incredible what $500k NZD will buy you in many parts of the world.
I agree with you about the "lifestyle", but I've been away too long and all my family and most of my friends are in Auckland. I wish they weren't. As a software engineer it's difficult for me to live and get work anywhere "cheap" sadly.
Probably ten years on an Auckland salary, staying here longer would make it less.
I often hear people criticise or question the Auckland lifestyle. I'm not from Auckland and have lived in a few parts of the world. I've been here for about 12 years now. For me the lifestyle is second to none. You have to be a water lover and get out on the water to truly appreciate how special Auckland is though.
I often think about selling up in Auckland and "retiring" in another region / country, mortgage free and all. For me no where else can provide me with the lifestyle and my kids with everything that Auckland has to offer. My home is worth less than a million bucks but I've got a million dollar lifestyle.
Yeah, I've tried to continue with the Auckland beach/ boatie things in other southern cities. What I have found is that you do need to modify the activity depending on what city it is.
eg I needed two hands to turn my door key after coming back from a rather chilly surf in Dunedin. Not enough strength in one hand.
Lot's of people on here critise Auckland and 9 times out of 10 it's the green faced monster raising it's ugly head, tall poppy syndrome really is alive and well in NZ. Auckland's got the perfect mix of calm harbours on one side and consistent surf on the other. You can lose yourself in the Waitakere's or the Hunua's and not see anyone else all day. Then there's the benefits of the city lifestyle that no other NZ city can compete with. And of course average Auckland house can now buy two houses anywhere else in NZ. If you surf Maori Bay or Piha mid week they'll be no one else out, can't say the same for Raglan...
To be clear; I think Auckland does provide a great lifestyle. I'm a born and bred Aucklander and love the place.
My point was that there is a cost to enjoying that lifestyle and the amount someone is willing to pay for it in the form of higher house prices will vary from person to person.
Equity doesn't help you make the mortgage payments...
and of courses houses where the owners have messy finances are likely to be messy all round, hence harder to sell, or the owners are too disorganised to get them sold before the bank sells it for them... (In genuine cases of hardship (death, illness etc) bank's don't normally pull the pin...)
A mortgagee sale in Remuera has only one explanation
Quite simpy the Bank has screwed up .
Most likely . the bank in question was too slack to value the security properly and reclessly and carelessly lent way too much against it as a mortgage in the first instance or in subsequent mortgages .
And this explains why these supposedly high skilled highly paid Bank executives neeed Dr Wheeler to hold their hand , protect them , and advise them how to run their banks.
When the bank is owed more than the value on the open market , there is no other way out other than a forced sale, foreclosure sale , or what we call a mortgagee sale
Thanks for the interesting example.
Not long ago, middle aged and older people were competing for holiday homes in order to position themselves for retirement. Many will not have seen any price appreciation. There are still large beach side subdivisions where there are no buyers. There is definitely no lack of supply of beach sections.
Some of these people will have become enamoured with buying property and would have slowly switched focus to the city rental market.The income tax breaks require them to be working. Therefore I don't think that these people will be retiring early. The tax breaks would be intoxicating. They are (voluntarily) stuck.
That's a side effect of this strategy.
The main reason there was a correction in 2007 was because interest rates were 10%, hence the reserve bank created it. Once they dropped back the buying frenzy started again. NZ is immune to what happens overseas and the RB controls when the crash will happen. Otherwise why the hell do we pay two to three times interest costs compared to the rest of the developed world?
Great article JB. Not sure about 25% overvalued. How can we say what true value is in today's world? I am a property bull (at present) but even I'm not certain about buying in Auckland right now. I think prices will go up for the next 1-2 years but then correct possibly back to today's values, maybe a bit less. Who's to say though. I guess it will depend on how quickly rents rise as well as immigration, Auckland housing development and Chinese money!!
I hover around 60% LVR. My thinking is a sensible property investor (ha, is there such a thing?) should be able to ride out a 20-30% price downturn. I wouldn't be putting my home on the line for an IP in Auckland today. Your client is risking a lot.
On the flip side I only see rents heading up, so good for those of us holding for the long term with enough equity to withstand a price decline. I still see property as an excellent long term investment - think 30 years.
Artifice and artificial pumping of property and monetary gains are a means to an end.
GFC2.
Some people never learn.
Man ipulation..I think it should be called. Then hide the proceeds.
Ask the 1%. They mostly won on the " print and be damned rules of modern finance'
Some calling it "kicking the can down the road".
"Theft" by any other means is another.
how interesting
There is a difference between speculation and gambling
Gambling is un-informed risk taking
Speculation is "informed" risk taking or "considered" gambling
In my expert opinion (as a giver-of-advice) the Auckland property market has moved beyond investment grade, and beyond speculation grade. If I were asked to give advice on investing in Auckland property today I would decline the engagement and refer the client to his local bookie
This creates a dilemma for anyone considering property as a repository of funds
For it to fall into the speculation category they would need to be fully informed, and where would they get that advice today. Most unlikely you could get any positive advice from a financial advice professional. You would be on your own
Heard an interesting story a couple of weeks back and have been waiting for a suitable thread to post it on. My source was told by someone in the auction room, both work for a bank.
At the top of the auction the auctioneer worked out that the leading bidder, likely of Chinese origin, didn't have a clue what he was doing and was waving his hand at anything just to make sure he won. Even though the gentleman was already the sole remaining bidder the auctioneer elicited three more bids from him at $50K increments. But what is $150K on top of an already overpriced property?
If there isn't a market correction then how on earth can FHB's get on the ladder?
We just went through a hectic hunt for a rental - for one house there were 50 people lined up to view a 3 bedroom in Avondale. Half of the people there had kids, they were typical FHB's who clearly can no longer afford the deposit. We didn't think we'd have a chance but we threw in an application and guess what - we got it. Speaking to a couple of agents, it turns out that we got it because my girlfriend and I don't have children, "Do you have kids? No? Good - the landlord doesn't want kids."
So we have a situation where, due to high values and 20% LVR, investors are buying the houses that FHB's used to - but more importantly, they're not renting them back to young families because they don't want kids ruining their investment. Where do they go? We managed to stay with family in the interim and I'm guessing these young families are doing the same - there must be some heavily overcrowded houses out there and you wonder how the stress of not finding a place is affecting these young mothers and fathers. Not that these "investors" give a toss...
This government is the opposite of family friendly. New Zealand has become so callous that I hardly recognise it anymore - it makes me ashamed of being a kiwi.
I agree Value Added. For every person you hear about how great the Akl lifestyle is, there would be ten others that struggle in Akl and don't have the time and money to live that lifestyle.
But for those 'I'm alright jack,' people this means nothing and in fact they would argue that is the natural order of things.
Lest we forget, most of the population don't live in Akl, and not because they think Akl is bad, but because they enjoy where they do live.
A sensible article but really only a re- hash of previous articles that have appeared on this site
and elsewhere saying the same thing.
What is of concern is John's description of the advice he gave to somebody about their borrowings, risks, over leveraging and how he made them change direction.
He is giving personalised financial advice and to do that he has to be an Authorised Financial Adviser (AFA) or risk being prosecuted by the FMA.
For financial advice only use AFA's or lawyers.
Mortgage brokers don't qualify.
Big Daddy - according to the FMA website RFA's and QFE advisers can give personalised advice on category 2 products. However, if advice on category 2 products is given as part of providing an investment planning service, then the adviser must be authorised as well as registered.
Category 1 Include securities, land investment products, futures contracts and investment-linked insurance contracts.
Category 2 Include term deposits, transaction and savings accounts, home loans, personal loans, personal overdrafts, personal credit cards, most personal insurances.
Johns personalised advice to his client went well beyond these but to be charitablle let's say he meant well.
You sound a bit self-righteous Big Daddy.
Luckily I was discussing the risks of being overleveraged and having tight servicing (aka home loans) within the context of a risky property market. The advice given was not to an overall investment strategy but to the risk of him defaulting or getting himself in a hole with his lenders.
Funnily enough the client was happy to take the risk - 80% LVR with failed servicing across 90% of lenders. Hope that decision works out and it probably will.
To not have the conversation about the risks would be unprofessional.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.