REAL ESTATE - BOOM AND BUST
If you want to be safe in today's real estate market
If you want to be safe in today's real estate market, this series of four articles might help you.
PART 1 - WARNINGS
THE REAL ESTATE MARKET WILL CRASH. It always does. And the bigger the boom, the bigger the bust. Anyone who says real estate always goes up and it's the world's best investment does not know much about real estate. If you tell someone that the real estate market will crash, the next question you will get is, "When?". Now that's a more difficult question to answer. But let's look at some ominous signs.
THE DANGER SIGNS
The first sign of danger is "yield" - the percentage return you get on an investment. The bigger the yield the better the investment - and the more chance of the price rising. In many areas, due to the recent price rises, yields are low. That's a danger sign.
Another danger sign is the "vacancy factor" - the percentage of rental properties which are vacant. The lower the vacancy factor the more chance there is of prices rising. Right now, in many areas, the vacancy factor is high. That's a danger sign.
And then there's the "replacement cost" - that's the cost of the land plus the cost of building the home on the land. When the total replacement cost is ABOVE the selling price, that's a sign that prices may rise. For instance if a home costs $200,000 to build and the land value is $100,000 but the total selling cost is $250,000, that is a sign that prices may rise. But now, in many areas, the situation is the opposite. The replacement cost is BELOW the selling price. That's a danger sign.
THE INTEREST RATES
If it wasn't so dangerous, this would be the joke of the moment. "Good news for Home-Buyers" scream the headlines.
Good news?! If prices rise every time the interest rates fall, how can this be "good news"? In many areas, the extra cost of homes has obliterated the advantage of being able to borrow more to buy the homes. This is bad news for home-buyers, many of whom are being priced out of the markets. Sure the First Home-Buyers grant has helped, but there is an ominous sign here too - if the only way people can buy a home is with a grant, what does this say for their ability to repay the loan in the future - especially when interest rates rise?
The Prime Minister is saying that the average "saving" caused by the fall in the interest rates over the past six years is $350 per month. What he does NOT say is that the average amount borrowed has DOUBLED in six years. Goodbye $350. Hello $500. And more.
The amount people are borrowing has grown a lot faster than the amount they are earning. If they don't earn enough to cover their mortgage costs, they are headed for trouble.
"Negative Equity" is when home-owners owe more than their homes are worth. It's caused by a FALL in real estate prices. And for those eager buyers who have borrowed to their maximum and relied on two incomes to pay their loans, there are two questions many have not asked - "What happens if interest rates rise or if one income is lost? Or both."
Are they going to rely on their personal savings to get them through? Hardly. Saving is a lost art in this spend-spend-spend age. Our national savings rate is close to zero. In some cases, it's negative. Many people spend more than they earn. They are doing it on credit. In 1995, total consumer debt was about half the annual income of an average family. Now it's more than 105 percent.
There is only one way this explosion in debt is heading - an explosion in misery as families buckle under the weight of their repayments. There are few sadder sights in real estate than home-owners who are forced to sell. In the Home Fund debacle of the nineties families found themselves in serious trouble - falling prices and high interest rates crippled them. The more they paid, the more they went backwards.
To be sure, no two real estate markets are identical. But there are similarities. The British real estate boom of the late 1980's had similar danger signs. In 1991, when the market collapsed, 75,000 families lost their homes through mortgage foreclosures. Negative equity was common.
Events, not dates, set the mood of society. The turning point of the last century was not January 1900, it was August 1914. The world changed after "the Great War".
The turning point of this century was not January 1 2000, it was September 11 2001. Suddenly we are a shocked society. Safety is becoming our major concern. And it's not just our physical safety, it's our emotional and financial safety. We realise that happiness is not caused by what we own but what we might lose. And so we are starting to think differently. Believe it - the world has changed.
An economy depends on consumer confidence. The politicians realise the dangers, that's why they lower the interest rates - to encourage us to keep spending. But there's a good chance it's not going to work. Can't you feel it - that false bravado where we say one thing but think another? What if….? No, don't say it. We'll just be a bit more careful and hope everyone else keeps spending. And for a while, they might. Until… the next time. Until we can no longer deny that we are in trouble. As Elizabeth Warren, the co-author of 'The Fragile Middle Class', wrote, "The next time the economy contracts, bankruptcies will explode."
The signs are all there. Several solicitors are saying that people are cancelling sales because they "don't feel confident". How many more corporate collapses will it take to shake our confidence?
At the moment many of us are thinking things we dare not say. Soon we will do the things we are thinking. We will be more careful. We will restore our confidence through our caution. And this means we will spend less. We will hold on to what we have. We are beginning to realise that the best things in life are not things and that it's hard to be happy unless we feel safe.
Safety is going to be the concern of the future.
NEXT: PART TWO - SAFETY
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