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Property bubble must burst
The Dominion Post | Tuesday, 30 January 2007
By DAVID MCEWEN
What's the difference between investment and speculation? One of the best descriptions of the chasm that separates them comes from billionaire investor Warren Buffett.
He says speculators tend to act like Cinderella at the ball. "They know that overstaying the festivities – that is, continuing to speculate in assets that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice.
"But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: they are dancing in a room in which the clocks have no hands."
Speculators buy with the express intention of selling, preferably in as short a time as possible, at a whopping profit. The flaw in this plan is that they require someone equally as greedy and presumably less intelligent to buy from them at the inflated price.
Such buyers are not hard to find when a market is raging and prices are rising steadily. However, they are extremely hard to locate when the market dips.
Many people are aware that the market has gone wild during a bubble, but most wrongly think they have got enough talent to know when a crash is coming and get out before that happens. I am concerned that the property market in this country is a bubble. Recent articles that quote research showing that New Zealand has among the most unaffordable property markets in the world underpins this view.
Essentially, during very long periods, property price growth struggles to run away from the inflation rate. It can do so for extended periods, only to fall back below the inflation rate.
The reason is that our salaries are tied to the inflation rate – in fact, our salaries are a big component of the inflation rate – so if property is rising much faster than inflation, eventually nobody will be able to buy property, and the property market will have to stagnate for as long as it takes for inflation linked wages to catch up.
By adjusting the long-term rise in property prices by inflation, you get the real growth in values. Robert J Shiller, professor of economics at Yale University and a leading authority on markets, set out to do long- term research on property values adjusted for the distortion of inflation.
Professor Shiller searched the globe to find the most reliable property statistics over the longest period on record. He found this in the central suburb of Amsterdam, the Herengracht, where reliable statistics date from 1600.
Professor Shiller then produced what must be the longest range graph of property prices ever recorded, covering 350 years, starting at 1628.
The prices were adjusted to remove inflation and showed an extraordinary thing – the price of a house in Herengracht, adjusted for inflation, had barely moved in 300 years.
But the graph also showed extraordinary cycles where property outpaced inflation for up to 20 years, only to fall below inflation for the next 20.
The notion that after a decade of booming prices in New Zealand, the property market will now settle for a steady growth rate still well above inflation, seems to me to be deeply flawed.
David McEwen is managing director of Investment Research Group. He can be reached by email at [email protected] .
The Dominion Post | Tuesday, 30 January 2007
By DAVID MCEWEN
What's the difference between investment and speculation? One of the best descriptions of the chasm that separates them comes from billionaire investor Warren Buffett.
He says speculators tend to act like Cinderella at the ball. "They know that overstaying the festivities – that is, continuing to speculate in assets that have gigantic valuations relative to the cash they are likely to generate in the future – will eventually bring on pumpkins and mice.
"But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: they are dancing in a room in which the clocks have no hands."
Speculators buy with the express intention of selling, preferably in as short a time as possible, at a whopping profit. The flaw in this plan is that they require someone equally as greedy and presumably less intelligent to buy from them at the inflated price.
Such buyers are not hard to find when a market is raging and prices are rising steadily. However, they are extremely hard to locate when the market dips.
Many people are aware that the market has gone wild during a bubble, but most wrongly think they have got enough talent to know when a crash is coming and get out before that happens. I am concerned that the property market in this country is a bubble. Recent articles that quote research showing that New Zealand has among the most unaffordable property markets in the world underpins this view.
Essentially, during very long periods, property price growth struggles to run away from the inflation rate. It can do so for extended periods, only to fall back below the inflation rate.
The reason is that our salaries are tied to the inflation rate – in fact, our salaries are a big component of the inflation rate – so if property is rising much faster than inflation, eventually nobody will be able to buy property, and the property market will have to stagnate for as long as it takes for inflation linked wages to catch up.
By adjusting the long-term rise in property prices by inflation, you get the real growth in values. Robert J Shiller, professor of economics at Yale University and a leading authority on markets, set out to do long- term research on property values adjusted for the distortion of inflation.
Professor Shiller searched the globe to find the most reliable property statistics over the longest period on record. He found this in the central suburb of Amsterdam, the Herengracht, where reliable statistics date from 1600.
Professor Shiller then produced what must be the longest range graph of property prices ever recorded, covering 350 years, starting at 1628.
The prices were adjusted to remove inflation and showed an extraordinary thing – the price of a house in Herengracht, adjusted for inflation, had barely moved in 300 years.
But the graph also showed extraordinary cycles where property outpaced inflation for up to 20 years, only to fall below inflation for the next 20.
The notion that after a decade of booming prices in New Zealand, the property market will now settle for a steady growth rate still well above inflation, seems to me to be deeply flawed.
David McEwen is managing director of Investment Research Group. He can be reached by email at [email protected] .
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). They are under pressure from EU etc to raise.
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