Hawes: Beware property bubbles
I lost a lot of money in the share market crash of 1987 - inexperienced as I was, I thought that the share bubble of the 1980s would continue forever and ignored anyone who said that the market was heading for a fall.
By the time that the late-1990s came around with its dot com boom, I had learned my lesson and kept out. Ditto with the boom in markets leading up to the GFC.
The lesson that I learned in 1987 (the hard way) was that booms and bubbles are dangerous beasts and that it is the boom that you have to watch out for, not the inevitable crash.
It is the boom that sucks you in and it is the boom that provides the madness to suspend rational decision and judgment. The crash is only the cleanup afterwards.
Hence my concern at the moment that the property booms we are seeing in parts of New Zealand is seriously dangerous: you can never be certain but it looks to me like a lot of property investors will be hurt.
This is not to say that people should not buy their own house - owning a house to live in has a different objective than speculating. Owning your house is a good thing to do financially as it gives accommodation, stability and the discipline of mortgage repayments.
Property investors, however, need to be very wary - they are aiming to become wealthy and everything is hanging on the performance a single asset class.
A house price bubble is inflating in some New Zealand markets. If it goes much further, like all speculative bubbles it will burst and when it does, it will splatter far and wide.
It is probable that prices will continue to rise for a year or two yet as a housing shortage remains in place, but eventually supply will catch up with demand and then the bubble could turn to trouble.
I do make a distinction between home ownership and investors - although some home owners could get hurt when the bubble bursts, provided they have not thought that they were going to become wealthy by buying a house and they can carry on making the mortgage payments, they should maintain a roof over their heads (which was, presumably, the objective for buying a house).
However, property investors (or at least those speculating on housing) may be in much worse shape. Many of these will be relying on continued house price growth for their financial futures and with little or no diversification, along with high gearing, their long-term financial plans will be ruined.
Two main things characterise a bubble: first, the value of the asset gets out of line with the income that can be derived from it. This has certainly been the case in most of the bubbles that I have seen, particularly the share boom of the 1980s and the dot com boom a decade later.
At the moment, house prices are way out of line with rents: yields are pathetic, a sure sign of a bubble.
Second, bubbles are characterised by an implausible view of the future: the belief that price growth will continue indefinitely. I have heard such stuff about property recently and that scares me.
There is a kind of mania rising up: an hysteria that demands that you get in at all costs. Whenever there is such frenzy in a market, it is time to be careful.
Before deciding to speculate on house price growth by buying a rental property, consider the following:
House prices do not always go up (consider the situation in Ireland and Spain)
You will be very concentrated to just one asset class - your future in just one basket
House prices are already very high - and markets eventually revert to the mean
Politicians and others are very keen to curb house price growth
You will be very exposed to a hike in interest rates or another credit crunch - can you meet the mortgage repayments when rates are 8 or 9 per cent?
History is full of bubbles and busts. Before you decide to buy a rental, have a look at some instances of bursting bubbles in the past and consider that if you don't remember history, you are doomed to repeat it.
Martin Hawes is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at martinhawes.com. This article is of a general nature and is not personalised financial advice.
Sunday Star Times