When The Ship Hits The Sand

Four nights of kissing doesn’t make a marriage. It just feels like it at the time.

It’s almost impossible to see any negatives at the beginning of a relationship. The positives seem to be everywhere and endless. Almost omnipresent. But eventually the negatives appear and you wonder where they’ve been. Truth is, they’ve been there all along, it’s just that you ignored them. Its human nature.

The Sydney and Melbourne property markets are much the same. The hot and steamy affair with property in each capital city feels more like The Love Boat and everyone wants to get on board. Let the kissing begin!

Not surprisingly, when markets are this strong it is hard to imagine they can correct. So what could suck the confidence out of a market made of bricks and mortar?

Jobs will be King!

The ship will hit the sand if unemployment worsens. The Australian economy is struggling to find second gear and if unemployment increases, the fear of losing one’s job will drain confidence faster than anything else. Low interest rates will not be enough to offset this.

Household debt now dwarfs Government debt

Homeowners have leveraged themselves up to the eyeballs with more debt again. Many have turned the equity in their homes into a massive credit card and are now sitting on more debt than when the GFC hit. Household debt now stands at $1.8 trillion, its highest level since 1988 (adjusted for inflation).

To put this into perspective, government debt is 12-14% of GDP while private debt is 100% of GDP. (Source: Steve Keen, Economist)

Escalating private debt presents two significant risks to the housing market:

• Short term – spending slows, the economy shrinks and unemployment increases. Remember jobs are king.
• Medium to long term – interest rate increases will bite homeowners hard who have maxed out their lending. Many continue to make minimum repayments in a low interest rate environment.

“When others get greedy I get scared, but when others get scared I get greedy” Warren Buffett.

Risky home lending on the rise, again!

It’s hard to believe lenders have gone back to their pre GFC ways of lending to high risk borrowers. Everything old is new again. Here’s two examples.

• Low deposits – 1 in 3 home loans are now being approved with less than a 20% deposit. E.g. RAMS now allow up to 120% loan value. (Source: Tom Godfrey, ‘Choice’)
• 40 year loans – this cohort of borrowers are most vulnerable to an interest rate increase. The difference between a 30 and 40-year loan on a $300,000 home is $140,800 in extra interest.

Change in government policy

Ten years ago, the NSW hotel lobby believed they were so powerful the state government wouldn’t dare put smoking bans in clubs and pubs. Eventually the government did and an unprecedented number of pubs and clubs went to the wall.

The residential property market is no different. Already there is talk about banning lending in SMSF’s. Foreign investment is another hot topic because it is not being monitored. The Foreign Investment Review Board may as well not exist. Changes in government policy could turn any of this on its head in a heartbeat.

The Solution

Just to be clear, buying property is never the issue, it’s the approach. In this market buyers should keep the following three points in mind:

• Stress test interest rates as if they were at least 8%. This will buy you plenty of sleep.
• You must take a 10 year view. I would not be trying to ‘flip’ properties in this market just for capital gain. If you do, just make sure you’re dancing near the door when the music stops!
• Investors should generally allow two property cycles (15 -20 years) to do well from property. The first cycle enables you to break even and recoup all your costs (assuming a negatively geared property). The second cycle is where you make all your home runs.

Right now many first home buyers think they have missed the boat. I’m not convinced they have. My tip is they will end up buying off someone at a cheaper price whose ship has hit the sand.

And I think there will be a few to choose from!

Have a great week!

Adam