As the daily predictions of the coming housing apocalypse grow increasingly strident there is some natural push back from the sell side of the industry who have adopted an equal but opposite position. As I said before I do have some sympathy from property investors because the price discovery in their markets is very poor which does make accurate judgements very hard. Added to this is the heterogeneous nature of their market. For example the demographic and therefore reactions of people who have bought or who are buying homes in Toorak, Brighton, Double Bay or Potts Point are very different to people who have bought in the outer west or what are called the growth corridors ( read miles away from civilisation). Property investors are also lumbered with a range of psychological and cultural impediments ranging from the somewhat odd dated notion of everyone owning a quarter acre block to the idea that housing only ever goes up. Throw into this mix an overdose of self interest from the industry and you have a recipe for confusion and distress.
My observation of all of this has been that one of the impediments that property investors face is that most do not understand how markets actually work. For example I recently came across a piece on LinkedIn (Facebook for people with a job) that was trying to present a there is no need to worry argument but the argument reflected a poor understanding of markets and how they and the people who drive them behave. The basic argument went like this. If you had bought a house in 2000 for say $190,000 then you have nothing to worry about as the median price is now $600,000. In support of this argument it presented a graph like the one below which is the Valuer Generals median house price for Victoria,
There are few flaws with such an argument.
It initially works off the notion of survivor bias and the same argument is used in equity markets. Once every so often a media outlet will trot out someone who bought Apple at a split adjusted price of $0.23 in 1982 and have held it ever since. Arguments based upon survivor bias are not reflective of real world decision making since they are very much akin to the idea of if only I had only picked the right six numbers in the lottery. It also ignores the notion of anchoring – people anchor their reactions to price not upon the purchase price but rather upon the current price. To use an equity markets example CBA went into the GFC worth around $60 which was its all time high at that point. As the GFC unfolded it halved in value. For investors who had bought CBA in the low $20’s they were not interested in the fact that they had purchased it at $25 and it had now fallen from $60 to $50. They were interested in the fact that it had been $60 and was now $50. Their panic intensified as it fell to $40 because it had only a short time earlier been worth $50 and was now worth $40 – the fact that they were still in profit was irrelevant to them. The argument of you bought early also struggles from the notion that it is not the early adopters who set the price – it is the late comers who are all rushing for the door. So investors with a different mindset and time frame are setting your emotional agenda. This was the scenario that unfolded during the Dot com boom which is probably the closest analogue we have in recent years to the real estate boom. Those who got in late and were over leveraged drove the market down much harder than it would otherwise have experienced and they dragged prices with them to a point where everyone was affected.
Whilst the argument of if you bought early dont worry seems calming and compelling it is not an accurate assessment of the reality of markets. It also does not take into account the fact that all property investors are leveraged or margin investors – a fact that surprises people in property. That is you add in a deposit and the bank gives you the rest, in this respect it is no different to an equity margin loan. The borrowing of money to invest brings with a totally new dynamic – this dynamic doesn’t generally affect the average home buyer since they are in buy and forget mode but this has been a speculators market and the one thing speculators do when they can is over leverage. My understanding of how real estate has been spruiked is that when your property goes up in value you draw down that equity and buy another property – you then rinse and repeat. Equity markets have a corollary in our margin loans. Borrowing money to invest in a rising market is a powerful strategy and one I endorse but eventually markets stop rising and there is no further growth in equity and if markets begin to fall then the person who lent you the money will quite rightly ask you to top up your buffer. This is easy in an equities market since you simply sell the position down to a point of comfort. In real estate you cannot sell off part of your house. This is where the relax if you bought early model runs into further trouble. The people who bought early have done one of two things – nothing or they have continually drawn down the equity they had to buy something else and sooner or later people are going to want to get their money back.
This is how markets work and if those involved in property had spent a little time looking at the history of markets and the understanding the law of gravity, that is nothing goes up forever then they might not have gotten such a shock when things started to slow down.
