wow how prophetic was that article that I posted!!!
If you had taken note then you'd have been sitting pretty.
Now your sitting on an a geared asset that no one wants to buy and the price is getting set to plummet as it has in the US.
Who is the real LOSER here?
Just read the article and make up your own mind. v v v
Residential's danger signals By Michael Pascoe Watch the Simon Ibbetson interview Hear the Simon Ibbetson interview
PORTFOLIO POINT: Simon Ibbetson says that compared with the sharemarket, investing in residential property makes little sense and that many investors face tough times.
Residential property does not stack up as investment option and, what's worse, it's going to remain flat for years. That's the view of Simon Ibbetson, the director of investment consulting at the influential global ratings agency Standard & Poor's. Ibbetson, who is paid to compare the relative attractions of different asset classes such as shares against property, is convinced property investing is doomed for the near future as low yields and low capital gains combine to crush investors’ enthusiasm.
As he tells Michael Pascoe in today's video interview, share investments are offering superior returns to property, especially on the basis of yields. As Alan Kohler pointed out in Monday's Eureka Report, share yields are probably higher than most investors realise (click here). The challenging news from property investors from today's lead story is that property yields are probably worse than many might realise.
Is Ibbotsen correct? Is he underestimating the “pull” of residential property for many investors. After all, more people on average incomes hold negatively geared properties than rich investors.
Ibbotsen says the “domino effect” of negative equity – where investors can no longer hold on to investment properties – is already happening at the bottom end of the market.
The interview
Michael Pascoe: Your latest asset allocation report states that residential real estate yields are too low. Now that’s something that most real estate investors realise. So what flows from that?
Simon Ibbetson: Well, Michael, it’s very interesting. While yields have not been high for a while it’s becoming more critical now, and the reason that it’s becoming more critical is because there are no longer the capital gains to sustain the growth in this area.
Because capital gains have always been the excuse for getting away with low yields?
That’s right.
Why do you think the capital gains aren’t there any more?
Well, we’ve had a period of very low interest rates and a lot of liquidity and, coupled with the tax benefit of negative gearing, it’s encouraged people to borrow more and more. What they’ve done is they’ve released equity from these properties. They’ve geared up very significantly and they’ve relied on the capital growth to make these ventures actually worthwhile.
And why won’t the capital growth continue at the rates we’ve seen?
A number of things. Interest rates are starting to ease up. You’ve got liquidity now starting to come down. It’s not actually a credit crunch but they are tightening up on the lending requirements and money’s getting a little more expensive. And there are more competing areas for the money as well. You have a lot of merger and acquisition activity going on, which is competing for that liquidity.
Does housing affordability come into your equation?
It does. At the moment, we’re seeing very strong employment rates and the economy is still reasonably strong, but if you start to see unemployment go up or the economy slow down then you’re going to have problems – certainly at the bottom end with affordability: they’re not going to be able to pay their mortgage payments.
You note that there’s not the same degree of objective assessment for residential real estate as other forms of investment. Standard & Poor’s doesn’t usually go around rating residential real estate.
I think we’d like to, actually, but you’re right and property’s always been … there’s two major aspects. There’s the price and the value of the property, but also the emotional aspect. People love to hold bricks and mortar. What they don’t understand is the amount of leverage that they’re taking. They don’t really understand that if you’re borrowing 85–90% that’s a huge amount of leverage on the money they’re putting down and it relies on this capital growth. If the capital growth – which you’ve seen explode in the past five or six years, in fact really since 1996 we’ve had this huge ramp up of property prices, in some states in some areas, 200–300% rise in property prices. That’s extraordinary. When you think that property should really only grow in line with GDP plus inflation, so at best we anticipate an extended period of flat prices. That’s the best-case scenario.
So you’re saying that this is really a problem for the people who have been talked into gearing up on multiple properties? That’s really where the danger area is?
That’s certainly the biggest danger area because when they lose a tenant or a big boiler blows up and they’ve got to replace it, and they don’t have the cash flow to do that and there’s no more capital in the property, they can’t redraw more money down because the property value hasn’t risen – then what do they do? Well, they become a forced seller and if they become a forced seller of that property then the whole thing starts to collapse.
They may raise some capital there, but if the property price hasn’t gone up and the dealing costs on buying and selling houses is extremely high … you’ve got stamp duty, you’ve got all the estate agent’s costs. There’s time, value and money. All that time in the delay of dealing in a house, actually trading a house is very expensive and that means that could eat up whatever residual capital there is in the second house. And then they might be forced to sell that and then you get this domino effect.
Is that likely to happen though while the economy’s doing so well, while unemployment’s low?
We’re not seeing much of it at the moment but we are anecdotally seeing it starting to happen and it happens for individual reasons as well. Someone becomes unemployed or not earning enough to make good use of all the tax breaks they get from negative gearing and suddenly, with the rent being so low, they just can’t fund the repayments. So yes, we are starting to see the edge but I think the big catalyst will be if interest rates go up even marginally, that will drive some of these people out of the market.
There’s still plenty of property spruikers out there who keep telling people that property is the secret to wealth – just borrow and gear up to the hilt. You’re saying they’re lying?
Property is a very diverse asset class and there is no doubt that in some areas, in some geographic regions, there are good reasons to buy property. There are still people moving to that area … it is still a very desirable area. I think that the ones that are going to be at stress are things like inner-city units where we’ve seen already significant falls in capital values, where there is no unique reason to buy, or maybe in the distant suburbs where people are leveraging up because they aren’t looking to actually rent them at a price they need to pay their mortgage.
As an investment consultant who normally looks at a much broader picture, in terms of portfolio diversification, what sort of percentage of a portfolio would you normally recommend property be?
Well property falls into an interesting asset class. It’s what we call illiquid assets and that involves anything that we can’t trade out of quickly and the difficulty with illiquid assets, as we’re seeing in property at the moment, when the market environment turns it’s so hard to get out and one of the characteristics of property is that the buyers go away. So even if you’re trying to sell there are no buyers.
And they want to wait until that market really has bottomed out, and in that market it’s really, really hard to actually sell and you become a forced seller and you have to take a significant discount. So it is a very interesting asset class. We do include those in larger portfolios. They are a component of … you know … illiquid assets are a component of most portfolios, but we have to be aware of that illiquidity premium which needs to be charged over and above normal risk premium to get the full benefit of those assets.
And residential property doesn’t have that liquidity premium, in fact the opposite?
Quite the opposite. Yes, that’s right. In fact if anything it’s just not yielding enough. It’s not even yielding you equity risk premium.
ASX Price at posting:
0.0¢ Sentiment: Sell Disclosure: Held
(20min delay)