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Housing Bubbles

Have you noticed that there is a lot of noise around at the moment about “Housing Bubbles” and whether we are in one or not. We think it’s a good time to look at this emotionally charged subject and provide our take on it.

What is a Housing Bubble?

According to Investopedia.com;

A housing bubble is a run-up in housing prices fuelled by demand, speculation and exuberance. Housing bubbles usually start with an increase in demand, in the face of limited supply which takes a relatively long period of time to replenish and increase. Speculators enter the market, further driving demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices — and the bubble bursts. Traditionally, housing markets are not as prone to bubbles as other financial markets due to large transaction and carrying costs associated with owning a house. However, a combination of very low interest rates and a loosening of credit underwriting standards can bring borrowers into the market, fuelling demand. A rise in interest rates and a tightening of credit standards can lessen demand, causing the housing bubble to burst.

So we can see that to have a housing bubble you need low interest rates AND a loose credit environment. Loose credit standards allow underprepared borrowers to enter the market who are unable to resist any changes in cost or price, increasing the likelihood that they would have to sell in a crisis. Our Banks have robust credit criteria in place right now, along with regulatory restrictions being placed on them to reinforce the quality of borrowers.

Yes, we have low rates that make borrowing attractive but we also have tough restrictions in place to limit the borrowing capacity of borrowers and Lenders. We have seen Banks lift interest rates in relation to funding costs but property supply is still limited.

1. All markets go up and down

All markets go up and down, whether it’s shares or property. The mere fact our property market has gone up is not a reason to believe we have a bubble on our hands. These movements, or cycles, happen regularly though their duration can and does differ each time. Another thing to consider is that not all of our capital cities are experiencing growth right now. In the same vein, the property market is made up of diverse and smaller markets that have their own ebb and flow. High density apartments have a different appeal than House and Land for example. The dynamics of the buyer is not the same for each property type. So you can see how a drop in demand for apartments would not affect the demand for House and Land.

2. When to revise = Where are you on the emotional scale?

When prices are increasing people tend to overestimate what their property is worth, whether it’s a PPOR or an investment property, it doesn’t matter. Some may even be tempted to take advantage of the rising prices to make a quick profit and if your strategy allows for it then good luck to you. Most people though look to the long term so the question of when to revise or review your portfolio is quite important. There is a direct link between greed/denial and profit and loss. The link is your emotional state at the time you make decisions.

As an investor you have to be in control of your emotions or at the very least have an understanding of where you are in the property cycle emotionally. You see, your emotions will play a large part in how you deal with the ups and downs of the market. How you cope under pressure will have a bearing on your ability to make sound decisions concerning your portfolios performance. Selling prematurely because of greed can have as much impact as being in denial during a stagnant market and failing to act to protect your position. In any case, it’s harder to sell property than shares which is generally why people tend to lose less with property as they stay in longer.

3. Success = complacency

As well as being emotionally prepared for change, you also should have a financial support in place. Having money sitting in reserve means you can face obstacles as they occur, comfortably prepared for any event. It’s easy to feel confident or even smug about your property portfolio when you have the ability to absorb any adversity that the market can produce.

In many respects then, Success could be said to equal Complacency in the sense that your confidence and satisfaction with your position comes primarily from making the right choices early on in the process. While others may view your efforts at managing your portfolio as complacent, they won’t have seen the effort and research that goes into setting up a successful property portfolio.

4. To hold the course or not – weather the storm

Property purchased to create wealth is usually a long term investment. At some point though, you will be faced with a market correction or similar event that will threaten your strategy. How many of you remember the GFC for example? Some investors had to sell while other investors held on, coming out stronger than before. The point is that there will always be some form of growth and correction cycle while you hold on to your property. In fact, there will still be movement even if you have no property at all; you just won’t be a part of it. What you do to weather the storm and come out the other side will have a huge bearing on how well you do financially.

5. Defence = Risk management

The best defence is to manage the potential risk from the outset. If we are top consider the fall out from a potential bubble then we should understand how a reduction in value affects our position. A further consequence could be the forced sale of the asset into a market filled with similar desperate sellers. That is a sure fire way of losing money. To avoid this we should be preparing a suitable defensive position. That position is called Risk Management. Identifying those potential problems will make preparing a defence far easier. Consider the possible scenarios that can upset your plans to own property and plan accordingly.

6. Risk Management = Financial Planning

Financial Planning is about identifying risk and putting into place strategies to manage that risk. First and foremost Financial Planning is Risk Management. If we accept that each person’s situation is unique then we must accept that each solution will be unique also. From a first time property investor to someone who needs to plan for retirement Financial Planners can help. Identifying risk is part and parcel of creating a plan and covering off that risk is essential to establishing the foundation of the plan. The time has passed when you could get away with not using a plan to create wealth.

7. Financial Planning = Expense management in the absence of returns

First and foremost, property investment is about creating wealth, be that in the form of passive income or capital growth. Most people would accept this premise to be true. But what happens if the return is negligible or the growth becomes stagnant or, worse still, negative. At that time, the focus naturally falls on to the cost of the asset and while some are pretty obvious there are some that can remain hidden. Interest rates and Bank Fees are the most obvious areas but they shouldn’t be the only ones to examine. Financial Planning provides the tools when returns reduce.

8. Banks and their Role

Banks play an interesting part in the overall scheme of things. They obviously provide the finance for home purchases as well as funds for investment, but they also provide a range of financial products from Financial Planning to Commercial Loans. They are bound by Responsible Lending rules and are overseen by Government Regulators so they continue to provide a stable financial environment. However, they are also in the business of making profit for their shareholders so they are in a conflicted position. They have to compete in the market place, aggressively at times, to win business and taking risks is part of business. But they also have to answer to the shareholders if profit is not deemed acceptable as well as being seen to be a good corporate citizen by upholding the Lending standards required by the Government Regulators. How well they manage this conflict has a definite impact on the financial markets.

9. Government and their role

For their part, the Government of the day is responsible for providing the guidance on how the financial system will run. They regulate the financial system; monitor its performance and work to provide an environment that supports business, both large and small, so the population can be employed in work that adds to the country’s wealth. Most of the time the Government will allow the financial system to work its way through any issues, only stepping in when it seems there is an issue that threatens stability. Of course, politics being what it is, sometimes the issues are not as threatening as they may seem.

10. Proper Planning can avoid waste

To create anything worthwhile requires planning. When money is limited, it’s best spent wisely, and money is always limited. Planning provides a structure on which you can build. Much like the foundations of a building, you need the support of a sound plan to allow you to construct a portfolio of assets. Proper planning equals efficiency, simple as that. To continue with the building analogy, a plan lets you build a house, but more importantly, end up with the one you want. It allows you to buy the correct number of windows, the correct amount of bricks, engage the contractors at the right times and so on. Without a plan you always have waste and wasting money is not the preferred method to create wealth.

If we know anything about a housing bubble, we know this. With proper financial planning and advice, housing bubbles have little impact on your journey to achieving your financial goals.

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