October 08 ~ Half way through October already, just amazing!!
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Scary to realize but Christmas is just round the corner!!
And if you’re an investor Christmas has arrived early. As I stated at my event on the weekend if there was ever a time to buy property it is now.
Just today I got offered brand new brick and tile houses cashflow positive after tax, and we have interest rate cuts coming!!
I mean how good does it have to get before we jump in.
Shouldn’t we be pretty excited??
It’s also a bit of a bumper read this month so i have included drop down links if you want to skip some stuff!!
Headings
Interest Rates
Property Values
Borrowing Money
Oh yeah, there’s an election soon
Final Thoughts
So what is going on and what should we do??
Interest Rates.
So given that OZ has in the last 48 hours had significant drops to fixed interest rates and the strong prediction of it continuing, it is a reasonably safe bet that NZ will follow suit.
In fact analysts in many major currency companies and banks are predicting 6% or less by Xmas.
Is there a VERY HIGH PROBABILITY of lower interst rates in the next 6 months?? ABSOLUTELY.
So as I have always said, if you can find a deal that works at today’s interest rates, buy it. The rates are over 90% likely to improve.
Values.
Well we all have to crystal ball gaze to some degree here.
However there are 2 fundamentals I want to highlight.
Replacement cost baseline.
Let’s say that a house is 200 square metres, and to build that house brand-new including landscaping, driveways etc. would cost $1500 sqm, or $300,000. But, of course, the building isn’t new. If you were to bring it up to the standards of new construction, let’s say it would cost you $50,000. So that means, to stay below replacement cost, you’d want to buy it for less than $300,000.
In other words, if you spent $300,000 on the property and $50,000 to upgrade it to brand-new status, you’d be spending no more than anyone else who was willing to build a new house in the same area.
In fact, your cost would still be under theirs, as you would have gotten the land FOR FREE along with your purchase of the building.
Now staying near or below replacement cost isn’t always possible – especially in increasingly popular, higher-end neighborhoods. But in today’s market, it is becoming pretty easy.
Buying below replacement cost is not a guarantee of success. However providing you stick to regions where there is population growth and therefore demand for new housing, it is a powerful box to tick. And you’d certainly be worse off if you bought in any area that went into decline and you had paid far more than replacement cost.
So at the very least, buying at or below replacement cost will greatly reduce your risk on every purchase. I believe it should be a standard part of our due diligence and risk minimization strategy
Make this part of your DD, getting the numbers right, buy undervalued on a $/square metre basis and on a replacement cost basis.
Material costs are only going ot increase and our labour rates are already unacceptably low so this is a great baseline benchmark for buying in this current climate.
The “who cares” test.
I don’t mean to sound flippant here and I must stress this is my opinion. But I think we can spend an enormous amount of energy and time trying to pick the bottom of the market.
I explained this in a recent blog so won’t repeat myself now.
(By the way if you want to be notified so you get to read my blogs when they are posted you can subscribe to them separately to this newsletter)
But the principle is simple. If you can buy a property that costs you nothing to hold today, who cares if it drops in value a bit before it recovers. I would care much more if I waited and ended up paying a lot more for it in 6 months or even worse couldn’t get the money at all.
“Why there is unlikely to be a large across-the-board fall in New Zealand house prices as there has been in the United States
Not only do I hope these predictions will be proved wrong, I also think they will be. They (and others) are of course wholly correct in pointing out that NZ house prices are very high (relative to incomes), both by historical and international standards, and that Kiwi’s have accumulated a lot of debt (again relative to incomes) in the process of pushing house prices to where they are. And house prices have already fallen significantly in some other countries – notably the US and Britain – where both house prices and household debt have previously risen by similar proportions as they have in NZ.
Despite these undeniable similarities, there are nonetheless some important differences between the NZ and American housing and mortgage markets.
First, NZ does not have a physical excess supply of housing. America does, because unlike us, it actually built more new dwellings than it required to meet growth in underlying demand.
In NZ, the reverse has happened: we haven’t built enough dwellings to meet underlying demand. In spite of low levels of immigration, we actually have a backlog of unmet underlying demand for housing (as also indicated by the upward pressure on rents in recent years).
Reflecting this, the IMF’s World Economic Outlook released last week specifically acknowledges that ‘if some country-specific factors are taken into account, the results [of a cross-country study of the extent to which house prices could be explained by ‘fundamentals’ by IMF researchers] do not produce evidence of a significant overvaluation of [NZ] house prices’3.
Second, NZ does not have a huge supply of existing dwellings for sale at any price hanging over the market because of the huge increase in foreclosures that has been the primary source of downward pressure on American house prices. Mortgagees in possession will sell at any price because they don’t want to keep the house, they want to get at least some of their money back as soon as possible. That is now happening on an unprecedented scale in America. But it isn’t happening, and in my view is unlikely to happen, in NZ.
One reason for that is that there has been far less imprudent lending here than in America. “Non-conforming” loans (the closest thing we have to sub-prime) represent around 1% of all mortgages outstanding in NZ, as against around 15% in the US; while “low-doc” and “no-doc” loans account for around another 7% in NZ compared with about 15-20% of American mortgages being “Alt-A” which is their equivalent of “low-doc” or “no-doc”.
More generally, the Reserve Bank of NZ was one of the very few central banks which did not make the mistake (which the US Federal Reserve under Alan Greenspan in particular did make) of keeping interest rates too low for too long in the first half of the current decade, after the risk of recession and deflation in the aftermath of the bursting of the “tech bubble” had subsided. That’s why proportionately far fewer Kiwis than Americans were enticed into taking out mortgages that they couldn’t hope to be able to service when interest rates returned to more “normal” levels.
Secondly, mortgage lending in America is typically “non-recourse”: that is, in the event of default, the lender can take possession of, and sell, the property against which the mortgage is secured, but cannot make any claims against any other assets or income which the defaulting borrower may have.
That means that when an American borrower finds him- or herself in a position where he or she can’t (or even doesn’t want to) keep up the repayments on a mortgage which may be worth more than the home, it can be quite rational for him or her to “walk away”. Yes, he or she will have a bad credit rating, and may never be able to get a mortgage again: but many of the borrowers were in this position to begin with – that’s why they got “sub-prime” mortgages in the first place.
By contrast, in NZ the generally applicable legal position is that lenders can go after a defaulting borrower’s other assets and income, if any, in order to make up any shortfall remaining when a foreclosure sale results in proceeds which are less than the outstanding debt. That, together with the generally greater social stigma which the NZ culture attaches to default, provides a powerful incentive to Kiwi home buyers to avoid default if possible.
And that is one reason why default rates on NZ mortgages have remained vastly lower than on American ones – even though the interest rates which Kiwi borrowers have been paying have generally been somewhat higher than those paid by American (or British) homebuyers.
Because there are proportionately far fewer dwellings in foreclosure, and thus “on the market” for whatever price someone is willing to pay for them, in NZ than in the US, there has been far less downward pressure on house prices here than in the US.
And provided (and this is an important proviso), unemployment in NZ does not spike sharply higher (as it did in the early 90s) this is likely to remain the case – especially now that interest rates are falling, and falling a lot. If mortgage defaults rose only a little while interest rates were high and rising, provided unemployment remains low, why should mortgage defaults start rising when interest rates are falling?
Here’s the simple but critical point: house prices will only fall significantly if lots of owners have to sell them for whatever price that they can get.
It is increasingly true that vendors are finding that they can’t get the prices they would like. Sometimes they find that if they really do want to sell, they may have to settle for less than they had hoped. But the more common reaction, among the vast majority vendors who are not selling because they have to, is not to sell, and to remain in the property for longer.
Turnover drops, perhaps sharply and real estate agents’ incomes decline. But prices don’t fall sharply across the board.
There will of course be exceptions to this generalization. Here are three.
First, in areas where non-traditional mortgage lenders (whose customers included a larger proportion of more marginal borrowers, and who in cases lent on higher loan-to-valuation ratios, and who in general are much quicker than banks or building societies to foreclose in the event that a borrower falls behind in his or her mortgage repayments) had a larger market share than the national average, there are likely to be relatively more “forced sales”, and house prices are more likely to decline in such areas. Otara in Auckland is a prime example.
Second, prices of premium properties in the most expensive suburbs of Australia’s major cities could experience large declines. That’s because prices of such properties are often determined by how much money a particular purchaser who desperately wants to live in a particular house or in one of those suburbs has access to and is willing to throw at it, rather than reflecting any objective assessment of its intrinsic value. There are clearly going to be fewer people in that position now, as a result of the global financial crisis. And some people who were in that position and who have also had large debts secured against share portfolios or their business interests may be forced sellers.
Third, areas in which investors have been a particularly large share of the market may experience price falls if sufficient of them give up any hope of eventual capital gain or are unwilling or unable to sustain the negative cash flows associated with their investments (even with the tax subsidy provided by “negative gearing”).
But these are exceptions to the general rule. Provided, again, that unemployment remains low so that the overwhelming majority of home-buyers remain able to service their mortgages, there will not be the excess of forced sellers over willing buyers required by definition to produce a generalized fall in house prices.
Of course, it may also be a long time before house prices start rising again.
The key proviso in all of this is that unemployment doesn’t rise sharply, so that a large number of home borrowers don’t find themselves unable to keep up their mortgage repayments despite their wish to do so. I’m not suggesting that unemployment won’t rise at all: clearly, and unfortunately, it will, and by more than the Government forecast in this year’s Budget.
However I would suggest there are two good reasons to believe that unemployment won’t rise by anything like as much as it did during the recessions of the early 1980s or early 1990s.
First, NZ employers are under much less pressure from high levels of business debt and high interest rates, or from steeply rising real labour costs, than they were on either of those two occasions.
And secondly, employers are aware that, as a result of demographic changes, one of the biggest challenges they are likely to face over the medium term is a shortage of labour, rather than an excess of it.
Hence, unless they believe that NZ is facing a deep or protracted recession, they are more likely to be willing to ‘hoard’ labour – that is, to keep their employees on their payrolls even at some short-term cost to profits – than they have been during previous downturns.
This, incidentally, would be much more ‘socially responsible’ on the part of employers than cutting prices in order to ‘share’ some of their profits with customers. Cutting prices in current circumstances would increase the risk of deflation – that is, outright falls in the general level of consumer prices – something which is one of the key differences between a ‘depression’ and a ‘recession’, and something which is much more difficult to reverse than a conventional recession.
Together with appropriate reductions in interest rates, it would help ensuring that NZ home-buyers were able to continue servicing their mortgages, reduce the risk of rising mortgage delinquencies and defaults, and minimize the risk of sharp and destabilizing falls in house prices.”
Saul Eslake Chief Economist, ANZ 13th October 2008
Borrowing money
Markets can be very unforgiving in that regard as you might have noticed.
So given that no-doc and low-doc lending has vanished, at least temporarily, this forces a change in tactics.
There are 2 main things to consider.
- Activate no money down strategies. There are many ways to invest without money. Have a look through my newsletter archives or if you want some up to the minute strategies grab my “Up strategies” DVD recorded last weekend. This will help you get going with some of the more out there opportunities like underwrites, JV’s, syndicates, plus the more traditional things like assignments, you name it, we taught it.Underwriting probably caused the biggest stir all day, getting paid a $200,000 fee now to buy a property for half price and you don’t have to settle on it?? How does that work?? Easy is how it works.
(In fact since the event I have had 2 attendees set ting these up for themselves, they can’t believe how easy it is!) - And here’s the forced change….. Get a job!!
Yes as counterproductive as it sounds, getting a job to create some provable income is a great strategy for the next little while. Many of us will be forced to sit on the side lines or trade instead of hold because we simply cannot get a mortgage.Income verified heavily regulated lending is GOING to be the order of the day. I will do everything I can to bring creative solutions to this problem but if you are in a job keep it, and if you are keen to build a portfolio and you know your income is dodgy, consider doing something, even if just for 12 months, to enable you to qualify for mortgages.
Sadly our financial institutions don’t recognize the fact that many people can make a lot more money if they don’t have a job, so you may just have to play the game on this one.
Of course you only need the job till you draw the loan down
. I’ll repeat that for the slow ones at the back of the room. Of course you only need the job till you draw the loan down.It’s a bit like cancelling your credit card to prove your debt servicing so you can get a mortgage, the first thing they do once you get the mortgage is pre approve you for a credit card!!
Oh yeah, there’s an election soon.
Now what is important about this is that you think about who to vote for. I don’t care who you vote for, I just hope you do it on an informed basis.
The only relevant comment I want to make is to try and answer a question I am asking myself:
“Which political party will be best for property investors?”
This is an extremely complex question because we have had the same party in power for 9 years, and they have been subject to the vagaries of incompetent and heavily biased minor parties, it is very difficult to look fairly at either side.
So if politics aren’t your bag go and put the jug on, otherwise here is what I have discovered as part of my own decision making process.
Labour over the last 9 years: Relevant (to property), positives
- Facilitated a property boom by
A: increasing personal tax rates to 39 cents and
B: providing a huge tax loop hole for property investors. - Made the boom even better by including foreign investors.
- Made the boom even better by disadvantaging ordinary income earners by not sharing the tax breaks with them.
- The above, combined with Labour’s determined efforts to drive up the price of every government service, the size of the government sector and their own incomes all helped massive property “inflation” at around 15% per annum for five years(also partly funded by cheap credit on world markets)and huge wealth transfers within the society to the property owning sector.(Interesting most Labour MP’s owned rental properties including the PM.)
- This boom environment also drove the growth of NZ Finance Company’s.
So to be brutally frank that has all been fantastic for property.
How much of it was global and what is attributable to Aunty is difficult to quantify.
On the negative we have either in place or coming the following negatives:
- RMA, without doubt the most ridiculous piece of legislation ever to get on our books.
- Deliberate and unjustified attacks on property investment through tax law changes
- Changes to the RTA that primarily make it even more biased towards tenants
- A knee jerk reaction to wealth creation through property resulting in changes to associated parties legislation that specifically penalizes a huge number of non investors like builders etc.
“We are now in the last week of what has been a very long election campaign. And we’ve talked about the fundamental value which must underlie every thought and action of the new government. That value is fairness. Because what has been happening in New Zealand isn’t fair.
That takes some leadership!
I know that people are responding to our message of hope for a new deal in the new century. I know that they have stopped listening to those who campaign on fears and smears and offer only more of the same old shambles and unfairness. But in the end there is only one poll that matters. That poll is next Saturday. I take nothing for granted except that this party will leave no stone unturned to win this election to give New Zealand the fresh start it needs and it deserves. Let’s see it through, and let’s begin to make the difference our country is crying out for.”
I guess this goes to show that politicians never change. They simply repackage the same platitudes and promise the same things, but rarely achieve them.
Final Thoughts
I firmly believe in principles. I try and live my life by them and I find that they apply in every area of our lives. I find the same is true in property. We would call them laws rather than principles I guess.
But things like the law of supply and demand just are. So when I look at property and try to look forward I apply the same rules I would in any area of my life. So as things have gone weird in property I looked at things like supply and demand, replacement cost, historical levels of building etc., and immediately started saying that our current situation is simply going to create a chronic housing shortage that would fuel another boom. Combined with the baby boomers retiring I also predicted this boom would be a monster.
So I was “gratified” to see Tony Alexander in the Herald today state that we are setting up for a chronic housing shortage by end of 2009 and he was “really worried” that this would create another housing “bubble”.
Now firstly there is no housing “bubble”, houses simply get more expensive because labour, land and materials are dearer.
What Tony really is saying is that the principles of supply and demand, population growth and inept fiscal policy that crippled the building industry is going to cause another mass recovery and increase in house prices.
Well welcome to reality, welcome to life. Housing is going to go off shortly and that’s why I have said to keep going with building your portfolio, hang in there, manage your situation, even the tertiary educated geniuses are identifying what are basic laws of the universe!!
Stay Safe ~ Dean, Raewyn and the Massive Action team.
PS: As always many thanks to all of you who attended our event last weekend and especially the unsung heroes who make our events so successful, Raewyn, Ben, Zharna, Kent and Chris.
