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Time To Question That Blind Faith

Time To Question That Blind Faith

Property has enjoyed a decade’s worth of growth in just two years, but there needs to be a correction at some point, writes John Bolton.

By: John Bolton

31 March 2022

As far as investments go Kiwis have worshipped at the altar of the property gods for a while now. And for the bulk of us, who have started our investment journey in the last 30 years, it’s no wonder.

But with all the headwinds facing the market at the moment is that blind faith still well placed?

Over the years I’ve heard some pretty bizarre theories about what drives house price growth.

In reality it comes down to two things: Gradually increasing household income and, more importantly, declining mortgage or interest rates.

Since the late 1980s mortgage rates have dropped from around 11% to 2% – and when the interest (or discount) rate on an asset is low, its value goes up. It’s simple economics. It’s not just property that’s benefitted from declining interest rates, it’s everything from bonds to the share market and even art.

House price performance has been so good, for so long, that it’s given rise to this assumption, almost indoctrinated, that property will double in value every seven years.

But with interest rates on the up, and for modern investors with little (or no) experience buying in this sort of environment, that’s a really risky assumption to cling to moving forward.

A long-term view of the property market (through interest rate cycles and everything else), tells us property values go up by about 1.75% per year in real terms, or 3% to 4% with inflation added in.

Interest Costs

We’ve had a decade’s worth of growth in just two years, meaning house prices are a long way from where they should be, and there needs to be a correction at some point.

The Reserve Bank is currently predicting a drop in house prices of somewhere between 5% and 10%. Even if house prices were to stay flat in the current high inflation environment, in reality they’re still losing value. Inflation does the job for us.

Between higher interest rates, inflation, loss of tax deductibility (on all but new builds), and all the other expenses that come with owning a property, many will find themselves in a position where they’re now paying to own their properties.

With yields as low as they are right now, interest costs alone are probably enough to tip you into a cash-flow loss scenario.

For investors who have pursued a “property at all costs” approach, now is the time to reflect on that strategy, and whether it’s going to serve you well moving forward. Can you stick out the cash-flow impacts, or should you de-leverage and consider other options?

With every part of the market overvalued, there aren’t a lot of obvious opportunities.

It would be nuts to invest any lump sum in an extremely overvalued share market. Some commentators think the current “super-bubble” could see share values drop by as much as 40%.

Ironically, cash is probably one of the best-looking investments at the moment. Warren Buffett is currently holding $149.2 billion in cash – the most he’s ever held – waiting for the market to turn.

Ship Has Sailed

Perhaps we are going through a period where simply not losing money, or getting a low return on funds, is an appropriate strategy for some, particularly for older borrowers who may only want to play for the next decade or so.

Right now, people shouldn’t be overextending themselves, taking on too much debt in a market where the risks of some sort of price fall are much higher. Property can be illiquid, just when you might need cash flow, and that feels dangerous.

It’s also lost its shine as a “get rich quick” scheme. That ship has definitely sailed. That said, property is a great long- term investment class. It’s relatively secure and stable, and there’s something great about an investment you can see, touch, smell and manage yourself.

To get a better return on your cash investments check out investing into mortgages via our peer-to-peer lending platform or a mortgage fund. Both give higher returns than other types of deposits with the underlying security of residential property that we all know and understand.