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2017 and The Greater Collapse -- A view of the economic disasters ahead for 2017.


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The Greater Collapse -- Buying Real Estate

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 ‘relatively’.

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 today’s date is £160 a month. That is a ridiculously wide difference. But turn the figures round and give yourself a fright.

Let’s 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 isn’t the price of a house that is important to a buyer, it’s the cost. The higher the interest rate, the higher the cost.

That’s why the sensible person will load up on property when interest rates are high but have started to come down. That’s 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 let’s look at what’s 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 today’s 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 can’t cope with higher rates. I think the answer here is to buy after what I call The Greater Crash. We’ve already been waiting a very long time, but it would be foolish to increase one’s investments in real estate just before the crash, and it is coming. You can bet your boots it will come the month after you’ve 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.

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john

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