The Greater Collapse -- Buying
Let me start by reiterating a rule at the heart of my property
investing philosophy: You should invest in real estate when
interest rates are high but falling. You should not invest when
interest rates are low. They are now at the lowest they have
ever been since the beginnings of recorded history. That means
investing in real estate is not a good idea at the moment.
The logic behind the maxim is disarmingly simple, and obvious
once you think about it. The value of real estate is dependent
upon buyers entering the market, and it is new buyers who push
prices upwards. In short, if the number of people trying to buy
increases, that will naturally tend to push up prices because of
the scarcity rule.
Existing house owners will only increase the size of their stock
and new buyers will only enter the market if costs are
relatively low. The important word here is Ďrelativelyí.
Let me go over the basics once again. There are two ways of
using property; renting or buying. People will tend to choose
the cheaper method. I use the simple example of two identical,
or at least for all practical purposes, almost identical
properties, numbers one and three Windsor Road. If I buy number
one, and you rent number three we ought to be paying roughly the
same for the same service, namely, a roof over our heads.
If I put down a deposit and then borrow from a bank to buy
Number One, I should be paying roughly the same for the cost of
the money (including the opportunity cost of the money that was
used as deposit) as you are paying in rent. I will be paying
more money because I will also pay a certain amount towards
buying the house, but let us leave that aside for the moment.
If the difference between the cost of the money, and the cost of
the rent is more than 20% there will be a change in ownership
habits. If the cost of the mortgage is lower than the cost of
the rent more people will tend to rent. If the balance tilts in
the opposite direction, more people will buy.
People decide on whether they can afford to buy based on the
cost of the money they have to borrow. This means that if
interest rates are low, the cost of the money will be lower.
This will encourage certain people to buy. What then can happen,
and must happen over the course of the life of the mortgage, is
that interest rates will at some point increase making the cost
of borrowing rise. This will put repayments under stress.
Calculating the difference in repayments based on interest rate
changes can be a traumatic experience. Let me just give one very
simple example. I underwrote a mortgage for my daughter some ten
years ago. The interest-only payment at the time of purchase was
in excess of £550 a month. The figure at todayís date is £160 a
month. That is a ridiculously wide difference. But turn the
figures round and give yourself a fright.
Letís say you buy now, and sometime over the next five years
interest rates go up to where they were a decade ago. If you
have bought a house on the basis that you can afford the monthly
payments, where are you going to be financially speaking when
the rates go back to where they used to be? A 3% rise in the
mortgage base rate will triple your mortgage costs. How long
before you go broke and have to sell?
That effect will then trickle through to the market prices,
which will drop like a stone to levels that people can afford.
It isnít the price of a house that is important to a buyer, itís
the cost. The higher the interest rate, the higher the cost.
Thatís why the sensible person will load up on property when
interest rates are high but have started to come down. Thatís
when the price of the house will be at its cheapest, and the
cost of the money will be at a high, but will gradually come
down, making life easier to bear, not harder.
Now letís look at whatís happening in the money markets.
For about eight years interest rates have been on the floor.
This is wrecking the business model of the banking system as we
saw in a previous episode. The system is unsustainable. It will
have to change. We are also seeing the beginnings of a tick up
in interest rates. We are likely to see a rate rise in the US
soon after I publish this bulletin. The real problem is, money
lent out is seriously at risk in todayís financial markets.
Investors are going to increasingly want more security, not
less. In any event, no-one can get less than nothing. And who is
going to lend when rates go really negative? The answer is
already clear. People are emptying their bank accounts.
How do we manage this scenario?
I would suggest there are two important points to take on board.
First, one should be ready to buy real estate when there has
been a shake out of owners who have taken on mortgages at a low
interest rate and canít cope with higher rates. I think the
answer here is to buy after what I call The Greater Crash. Weíve
already been waiting a very long time, but it would be foolish
to increase oneís investments in real estate just before the
crash, and it is coming. You can bet your boots it will come the
month after youíve given up waiting.
The second thing to do is make sure you buy in quality areas
where people can afford to pay the rent, and where properties
will hold their value. In short, stick with the London area, the
better parts of Manchester, areas of high employment like High
Wickham, and so on. Leave Hastings and Torbay well alone, and
that also goes for out of the way places like the northern end
of East Anglia and Barnstaple.
In terms of warnings, dont buy in a currency you dont earn in,
and dont under any circumstances buy in a country where the
banking system is at risk, or the political system is shackled
in debt. You will regret it if you do.
<<< Part Two