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Property Buyers See Property as an Investment by Kris Sayce on August 25, 2009
It’s tempting to make this week a ‘Property Week’ in Money Morning.
We weren’t surprised to see the Money Morning mailbag bursting at the seams here at the Old Hat Factory yesterday.
Within minutes of yesterday’s email going out the replies started flooding in.
Perhaps the most remarkable response was from the property bulls.
Look, let’s be fair about it. When we asked on Friday if readers had authentic research to back up the ‘housing shortage’ claim, it was probably the busiest day of the week for property bulls.
After all, there’s all those ‘open for inspections’ to prepare for over the weekend.
So it’s not surprising that we received less than a handful of emails from property bulls, offering opinion – which is fine – rather than the real evidence for a housing shortage.
We’ve no problem with people expressing opinions – we’ve done that once or twice ourselves.
But roll forward to yesterday and ‘BANG!’ The property bulls have woken from slumber. The responses were enough to split the Money Morning mailbag.
Unfortunately, there was a distinct lack of hard evidence in the responses. In fact it was the usual stuff – not enough houses being built, too many immigrants, not enough ‘quality’ housing.
So, rather than getting into a “yes there is, no there isn’t” argument, we should probably follow the lead of Money Morning reader Jason:
“The resilience, stupidity and arrogance of the ‘property’ crowd is incredible. I no longer even entertain them with a discussion any more. When I hear them say ‘Property prices always double every 7 yrs’ or ‘Housing shortage’, I reply with. ‘ I completely agree now is the perfect time to buy a house, I’d get in while it’s still cheap’.”
We couldn’t have put it better ourselves. Hats off to Jason.
But despite Jason’s example, we will stick with property for today. But we’ll take a slightly different tack.
Regularly we receive emails into the Money Morning mailbag asking us for advice on whether the reader should buy a home now, or sell their home now.
Our response is always the same – no response. That’s because unfortunately our licence prohibits us from offering personal financial advice. All we can do is keep things nice and general in these emails.
But the reader emails do have a striking similarity. Almost always – when asking if they should buy – the phrasing is the same: “I can borrow $500,000″ or “I can borrow $700,000.”
We don’t recall ever seeing an email that states, “We’ve seen a nice house in X suburb, with three bedrooms. It’s a nice area and the price is $450,000. Do you think we should buy it?”
Obviously, our non-answer would still be the same.
For all the talk about property being excellent value and a great long term investment, we’ll make a bold claim – that property buyers actually don’t have any interest in the property they’re buying.
In fact, I’d go so far as to say that property buyers are not buying property at all.
Rather, they are ‘buying’ a loan and using the house as security.
Why would we make such a claim? And what point are we trying to make?
Well, it just seems that the actual house is a secondary consideration. Sure, we see plenty of comments about a lack of ‘quality’ properties, but as soon as the property loses its ‘quality’ it seems to become a ‘renovator’s delight’ or a ‘demolition job.’
Then even though it’s only land value, the price of the land suddenly becomes the value of adjacent properties less the cost of building a new house. That may be obvious, but is it logical?
But back to the buying ‘psyche’ for a moment. The fact that property buyers see property as an investment rather than a dwelling is precisely the reason why there will be a property price crash.
It’s no different to the stock market. If investors were always rational and approached the buying of shares as though they were buying the whole company, then share prices would be unlikely to rise to such extreme levels.
But that’s just how a market works. Speculators add liquidity to the stockmarket through buying and selling. They don’t buy because they believe the company has strong cash flows or because they like the net profit after tax forecasts. They buy because they believe the price will rise – nothing more, nothing less.
Property investing is the same. Many people buy a house because they want to live in it, and because they prefer ownership to renting.
However, more and more, property buyers and home owners have been brainwashed by the ‘location, location, location’ mantra. They are buying not because they want a place to live, but because they believe the price/value will rise. They buy not because it is close to the train station for their own benefit but because they are told it will ‘add value’ when they sell.
They don’t buy because it is close to the shops, but because it will ‘add value’ when they sell. Even though the buyers are just as likely to drive a car to the station or the shops. But that doesn’t matter, it’s all part of the ‘location.’
Take a look at this brief news story from News Ltd: “The average price of a Sydney home could rise by $100,000 in the next two years, according to an [property] investment group.”
The article states, you guessed it, “A shortage of homes and a growth in population will cause the property boom.”
See what we mean? Not a single mention of an actual property or a type of property, or the benefits of owning rather than renting, purely that the price will go up because there isn’t enough supply and too many immigrants.
As I mentioned above, property buyers are not buying homes or houses any more. They are taking out the biggest possible loan to buy the most expensive property they can, because, well, the more you leverage the bigger your returns.
Why buy a $200,000 loan against a house that will only be worth $400,000 in ten years after it doubles, when you can buy a $400,000 loan against a house that will be worth $800,000 when it doubles in ten years?
As for the other issue I mentioned above about land value, look, your editor is aware there are economic studies and theories that could fill entire libraries on the subject of land and rent. So we’ll state here up front that we have no intention of competing against such learned thought.
We’ll just write what’s on our mind, whether it’s right or wrong.
So what we say is this. Why, for example, should the land value in Richmond be X times greater than the land value in Dandenong?
What extra value does the land in Richmond have that the land in Dandenong does not?
The cost of building a home on the land should be the same.
Of course, the simple answers could be that land in Richmond is more desirable than land in Dandenong. That inner city types typically have more disposable income than outer suburban types and therefore they can bid the price up higher.
But is the land any more useful or productive in Richmond than the land in Dandenong?
Here’s our point. A house in Richmond is no more productive to the economy than a house in Dandenong. Yet it is X times more expensive, and most probably requires a debt that much larger.
So, the only things that can have driven the price is supply, demand and price. Which brings us to the final point. How reliable is price as an indicator of supply and demand?
This is perhaps the real reason the property market and property prices have taken off.
One of the comments we regularly receive is that: “There must be a shortage of houses because house prices have gone up. If there was a surplus of housing then prices would fall. Simple as that.”
Well, it’s not quite that simple. Let’s use an analogy to make our point and round things off for today…
Imagine that someone announced, “There is a shortage of apples, buy apples now.”
And then assume many people started saying it, almost every day. It would most likely have an impact on the price of apples.
You could quickly go to the local orchard and buy apples from the apple grower and he may charge you 50 cents, because that’s the current market price.
The apple grower is happy because business has been slow so he’ll sell them for 50 cents each. But then he notices an increase in business. More people are going to buy apples from him.
Within days queues are forming at the orchard door. The apple grower realizes he can charge extra because of the demand. So he raises the price to $1. But there is still demand because people believe there is an apple shortage.
So the apple grower raises the price further to $2. There is still demand… but not quite as much. But the apple grower doesn’t notice the queues are getting shorter, or if he does he doesn’t care because he’s making four-times as much money as he used to for the same apples.
So he cranks up apple growing production.
Eventually, the apple grower takes a look at the millions of apples that he has in the barn and works out if he can charge just an extra 20 cents he will be a multi-millionaire, so he raises the price to $2.20.
Unfortunately for him, when he opens the barn door, all the buyers are able to look inside and see there is not an apple shortage at all. There is an apple surplus. Buyers no longer feel have the same urgency to pay $2 per apple.
They figure the apple grower will need to lower his price to get rid of all the stock. The buyers are happy to come back tomorrow to see if they’re cheaper.
The price of apples plummets.
You see, supply, demand and price do not necessarily mean that all three are at the correct level. Levels or supply, demand and price change all the time. Therefore, just because prices are high it does not necessarily mean there is a shortage of supply.
Sometimes it is just the belief that there is a shortage which creates the high prices. And can you blame the majority of people for thinking there is a housing shortage?
Of course you can’t. Not when you read day after day in the mainstream press news items telling you there is a housing shortage, and telling you there are too many immigrants who are buying up all the property they can eat.
In summary, there is no difference between the application of supply, demand and price in the housing market to its application in any other market.
Strip away the distortions and the untruths about a shortage of property and the whole thing crashes around your ankles…
Of course, we could be wrong, and house prices could continue rising forever!
