Bubble trouble (15/10/2013)
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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Andrew Legget
:
Havent looked at the video yet but thought i would discuss my thoughts on the real estate “bubble”.
It is hard to dsay whether real estate prices (sydney in particular) are in a bubble or not. What i believe however is that even if it is, the catalyst isn’t here yet.
I do think there is a fundamental problem brewing in the current real estate climate fuelled by the low interest rates. Basically i can see this current situation lasting for as long as the current low interest rate levels stick around.
What i believe is happening is that the desires of people to live in certain areas outweighing the financial implications as they are able to currently borrow at low rates to live there. Think about the hundreds if not thousands of people who want to live in the inncer city suburbrbs of sydney. They are all able to borrow at low rates so it seems like something they can do, they all go to auction and someone “wins” the auction by buying that old one bedroom town house for a really high price that would buy you a 5 bedroom mcmansion in another suburb in say the south west.
The sensitivity to interest rate rises is possibly quite small or margin of safety if you will.
When interest rates start rising (and they must at some point) i do not think it is unreasonable to assume many will find themselves in trouble, defaults and emergency sales could become quite a common sign all driving down prices lower.
This will obviously have an effect on the economy as a whole with the banks being particularly effected, see them perhaps tighten their lending arrangements and all the flow ons from that etc.
I am no property expert and what i said is no nobel prize winning economic theory (interest rates going up leading to more defualts) but the more articles you read about unrenovated, small, old, “fixer uppers” being bought for prices approaching 1 mill, the more i believe the above might be starting to happen.
The RBA will hold the key, and some people will not be happy.
Daniel Falster
:
Well put Roger!
I had previously read a bunch of property investment books and articles, and then more recently about value based investing (primarily Valueable). I was fascinated to see the difference in perspective. The property books focus almost exclusively on capital gains; they recommend borrowing as much as you can and buying property even when you can’t cover costs. Financial advisers will help you arrange your finances so that you can maintain as properties as possible. All in the hope of capital gains.
The insights from Valuable suggest an entirely different perspective: that most investment properties have bad business fundamentals: high debt, low ROE, over priced.
Having reached the conclusion that we were first and foremost speculating on capital gains, and otherwise receiving a paltry return on our capital, my wife and I sold our investment property. We’re now happily invested in the Montgomery fund and feel much better knowing that we am investing in companies with solid foundations. Less stressful (as an investor) and better for society (as my capital is invested in the more deserving “wealth creators”, to use a classic property investment phrase). We are still happy with this decision, despite the current rise in property prices.
Amusing also to see Robert Shiller getting the Nobel prize for economics, while irrational exuberance takes hold down under.
Robert Summers
:
When the capital gains made in a speculative market arises due to increasing leverage of the participants, you have the makings of ponzi finance and the setup for bubble type dynamics. In my opinion, this is a better measure of a bubble than just price movements vs valuation.
When leverage reaches some systemic limit, and new entrants become priced out of the market, that is when we get to find out whether a slow leak develops, or a crash.
In the history of residential property, rapid crashes are not all that common, and it is more likely that prices take decades to normalise to fundamentals like rental yield. See this recent update by Eichholtz and colleagues:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1439735
Daniel Falster
:
New entrants are definitely being priced out of the market. Evidence emerging that recent rise in house prices is driven mostly by investors and that the number of loans being taken out by first-home buyers is in sharp decline.