My thoughts on property investing in 2011

Housing Market Written by John Bolton, Oct 23 2011

There is plenty of evidence around us that the Government and businesses like banks are no better at forecasting the future than Ursula the tarot card reader from Whakamaru.

Our Government deficits are tracking far worse than forecast and in my opinion the revised forecasts still look too optimistic. Meantime Governments overseas continue to put their collective heads in the sand and are not addressing the cause of the financial molasses. The paradigms that once shaped my world are changing. I don’t know what I believe anymore. Even Marx is getting a look in. The world has become an exciting but scary place and the stakes are high. It feels weird not having any answers. What I do know is that with so much uncertain around there are opportunities but you need to be equally astute with the investments you make.

I still like property, but like any investment you need to be careful in this market. I think property trading in this market can make sense. Traders/renovators are in and out of the market quickly. They still need to buy the right property, at the right price, and know their market in terms of an exit strategy. The mistake we most often see is them buy the wrong property (one that is hard to sell), or pay too much for it. Long term investing where you get a decent yield can also make sense. I think a positive cash flow property makes sense in any market. How can you go wrong with a property that pays itself off? Higher yields on commercial properties can also make them attractive although my view is that generally yields are still too low on commercial property relative to the risks and that prices need to fall further.

Strategic investing to take advantage of zoning changes and demographic changes can work. Not all parts of the housing market behave the same all of the time. Gentrification of suburbs and price increases will be a natural consequence of population growth. This isn’t rocket science. Take Te Atatu Peninsula, which has become a popular suburb for first home buyers. Since 2009 house prices on the Peninsula have increased by around 12%. Inflation over the same period was around 15% ... ... so the argument goes that everyone is worse off. Ironically you would be worse off if you were debt free, as the real value of your investment will have decreased by a net 3% to $388,000. Perversely if you had a mortgage, you’d be better off.

For example, a house worth $400,000 would now be worth $448,000. If you had a $320,000 mortgage your equity will have increased from $80,000 to $128,000 an increase of 60%. Even in real terms you’re still be up 45%. (But leverage can work both ways too!)

So what doesn’t work?

From my perspective what doesn’t make sense is buying any old property with a low yield hoping that it will increase in value. Far too many people seem to adopt this approach and then put their head in the sand. Average properties do not necessarily make good investments. On average properties have stayed flat over the past 3 years whilst inflation has reduced real values by 15%. In the absence of growth there is no leverage benefit for investors as there was in my earlier example. So in this case the real value of their equity has decreased by 15% and the investor has probably lost another 5% from negative cash flow.

So, on average, most investors are worse off in the current market but probably haven’t noticed. We should consider this normal.  I'm learning that most people are pretty dumb at managing their money and tend to do what everyone else is doing whether or not it makes sense. People also hate materialising a loss, even when they should move on. Although the market is volatile and in my mind property prices are still too high, there are opportunities for those brave enough to look and clever enough to strike on the right deals. We live in exciting times.

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