As Safe as Houses?

AS SAFE AS HOUSES?

The debt fuelled excesses of the early 2000’s drove house prices in many parts of the world to incredible heights. When the bubble burst in 2007/8 it sent prices into retreat, and after a few years with corrections of up to 40%, valuations were (in some parts of the world at least) once again at fair value. Since then prices have generally recovered, as valuations once again rise to normal levels. However this recovery has been quite patchy with some areas recovering normally, some parts of the world soaring to post 2007 highs, and other parts of the world stagnating or falling further.

This recovery from low valuation levels is quite normal and part of the repeating cycle from low to high and back again that we witness in all asset groups. However, this specific nature of the global house price recovery is being driven by the increasing stream of money looking for a safe haven. Due to a combination of political uncertainty, higher taxes and a deteriorating economic outlook, this money, which is flooding out of China, Europe, Russia, the Middle East and Latin America is looking for an asset that is in a safe location and relatively liquid. As a consequence we are seeing high-end property booms in places like New Zealand, Australia, Canada, London and a number of cities in the US.

This phenomenon is causing serious distortions in those property markets, and with the top-end continuing to power away, the market is getting extremely stretched and out of balance in some countries.

Back home here in New Zealand, the effect is particularly acute as Auckland has a disproportionate effect on the NZ property market as a whole. With it being the centre of commerce for the country, the place where most migrants come and settle, and with almost a quarter of the country’s population residing there, what happens in the Auckland property market has implications for the rest of the country. As when house prices take-off, whatever the reason, the Reserve Bank resorts to raising interest rates to try and control it, and often what is right for Auckland is wrong for everybody else.

Despite many arguments in favour of a broad range of measures to combat excessive house price rises, the blunt tool of raising interest rates has been the default setting of reserve banks around the globe for many years. In previous posts I have commented on the need for changes in both the tax treatment of property investors, and changes in the rules for high Loan to Value (LVR) mortgages, as well as treating mortgage risk on the lending banks balance sheet differently. And back in October last year, the Reserve Bank of New Zealand (RBNZ) did finally introduce new restrictions regarding banks ability to lend at levels greater than 80% of the property’s value. This has had the effect of reducing demand amongst first-time buyers in the lower house price bracket where the high LVR’s are more prevalent, however its had absolutely no impact on the top-end, and because of the lack of restrictions on property investors, the potential beneficial effects of this policy change have been mitigated.

Also in New Zealand’s case, these effects are being compounded by the relative lack of new houses built over the last few years, plus the increase in net migration. And so we see the gap between the top and bottom of the property market continue to grow.

However, even if Governments and Reserve banks around the world developed and introduced cohesive policies to prevent excessive house price rises (which is highly unlikely), it still would not eliminate the current problem. These types of rules work fine during ‘normal’ economic periods where relative investment return is the driving factor -  if the return of one investment is reduced by taxation etc, money simply moves to the next best alternative. But when the economic landscape changes, the imperative becomes the return of your money, not the return on your money. This radically changes the mindset of investors and renders many of the normal rules obsolete.

We will likely see this trend continue for some time, with the underperforming cities, regions and countries continuing to lag as money increasingly flows out of these places, whilst the outperformers race ahead as it is redeployed. It is important to understand that this process has got nothing to do with value, in the property hotspots of the world we left value behind long ago. It is purely about the weight of money, and whilst there is enough to levitate prices higher, it will continue.

My guess is that things will start to crack once we see the next global downturn, the second and much more damaging leg of the GFC sometime in 2016. Once it really starts to bite and finally affect the US, its safe haven status will be undermined. At that time, the money that has distilled out into these property hotspots will start to look for the exits. And is when we will see these incredible price gains unwind, brutally, if history is any guide.

If you are a property investor in these hotspots, I would recommend you pick your moment to leave the party very carefully.

If not, then just sit back and enjoy, it should make interesting viewing