Roger Montgomery has penned a great article today on his website, entitled Hold on tight: the great property sell-off has begun, which includes (among other things) a very good explanation of the ‘greater fool’ theory of real estate investment:
Property income yields are at historic lows and yet property buyers couldn’t be more enthusiastic. Buyers who tell me that they don’t mind buying on a yield of 2.5% because they will get a capital gain need to understand that the capital gain will only come when a buyer is willing to accept an even lower yield. And yields cannot fall much further when your oversupplied property Is vacant and your yield is zero… The end of every bubble is marked by the appearance of the the greater fool principle; betting a bigger fool will come along and accept an even worse return. It’s speculation, pure and simple.
If you are buying a property on an unattractive yield, it is not made more attractive by borrowing. Record levels of household debt to GDP, and household debt to income, and record levels of credit card debt, mean that when bond interest rates rise – they’ve already started rising – investors will be able to least afford the additional costs thanks to having previously paid and borrowed too much…
Meanwhile, some financial planners have reported to me being cold-called by developers and offered 7% commissions to market properties to their clients. This on top of the free holidays, free cars and free frequent flyer points being offered as incentives to property buyers. Reports of some apartments being revalued 30% lower than 18 months ago isn’t going to help either…
Financial stress is increasing even though employment looks fine. Witness the tripling of calls to national debt helplines with much of the increase attributed to mortgagees with multiple investment properties. Note that at current low interest rates 30% of family income is required to meet mortgage repayments in Australia. And that’s using pre-tax incomes…
My bankers have told me all of their smartest and most successful property investors have sold up or are getting out, and they cannot lend them a cent – they won’t take it…
Why should Tweed Heads and Bowral prices be 9 or 10 times incomes, when thousands of similarly-sized towns around the world – and the same distance from capital cities – can be purchased at half the multiple? It doesn’t make sense and it isn’t sustainable. And neither are low interest rates. Australia’s debt-fuelled property boom may be handing Australia an unlucky hand. Hold on tight.
