Real estate professionals have been urging property investors to get in quick to purchase investment property and beat the rush as cashed up baby boomers transfer their wealth from the stock market to the real estate market. This may seem like a reasonable claim as many Australians; especially those around retirement age feel that they understand real estate as in investment. It is something that they can see and touch where as the stock market is something that works in mysterious ways that they do not fully understand. The decline in share prices across the globe over the last 18 months has entrenched this position and there is a desire to protect what is left of their retirement savings rather than being burnt by further declines in the stock market.
However based on the latest lending data the anticipated increase in property investments is yet to materialise. Rather than real estate investors it is first time owner occupiers who are racing into the market helped in part by government stimulus spending. So why are real estate investors not doing the same? There are a number of reasons why investors may not be entering the property market.
Tougher lending criteria
As a result of the Global Financial Crisis (GFC) banks have been setting higher hurdles for investors (and owner occupiers) to qualify for a mortgage. No deposit loans which are in part blamed for causing the sub-prime crisis are increasingly rare with many lenders looking for a minimum 20% deposit and proven lending history before providing mortgage finance. With funding harder to come by there will be investors who wish to purchase property but are unable to do so. It has been suggested that these more stringent lending standards will help protect the Australian real estate market from suffering the kind of falls that have been seen in the US and UK property markets. In reality it will be the banks providing the mortgage finance that are protected by the tougher lending criteria not the real estate investors. If an investor or owner occupier finds they are unable to meet mortgage loan repayments because of unemployment or rising interest rates a gearing level (percentage of debt compared to the value of the property) at 80% or lower is not going to provide any assistance. The tougher lending criteria will mean that should the bank need to sell the property to recover the amount it had lent in mortgage finance they will still be able to recover the full loan amount even if they need to sell at a large discount to the original purchase price, either because the real-estate market has fallen or they want to recover their money quickly.
Loss of equity
The magnitude and speed of the downturn in equity markets has wiped out trillions of dollars in shareholder equity (The ASX All Ords index fell more than 40% in 12 months). Until the start of the Global Recession stock markets around the world had enjoyed significant gains year on year back as far as the tech wreck of the early 2000s. Investors had been able to invest in the share market and take profits to fund real estate acquisitions. In a financial double whammy these investors now find themselves not only without a source of investment income but have also having to provide cash to cover margin calls on loans secured on their share portfolio. With many shares at rock bottom fire sale prices many investors would be reluctant to sell and may therefore look to sell their investment property to raise funds, raising the possibility of a falling real estate market.
Job security fears
Despite record low interest rates and rising rents many investment properties are still negatively geared (net rental income after real estate agent fees does not cover mortgage repayments and other costs meaning that the investor has to cover the shortfall in the hope that this will be repaid in the form of capital growth). With rising unemployment some real-estate investors may have already lost their jobs and finding themselves unable to cover their existing mortgage shortfall they are forced to sell the property, again raising the possibility of a falling real estate market. Other investors may not have lost their jobs but the possibility of being out of work may make them hesitant about taking on additional liabilities that will need to be serviced.
Most real estate investors are investing to make a capital gain (i.e. to sell the property at a profit at some time in the future). In the last 12 months the property market has at best been flat or has been falling. The real estate industry has been quick to call the bottom of the market but as real estate agents have a vested interest in this being true many investors are sceptical about this advice especially as these claims have been made many times before. It is true that there has been an increase in demand at the bottom end of the market driven in part by government stimulus payments to first home buyers however this effect is likely to be temporary. Other evidence such as rising unemployment and reduced availability of mortgage finance suggests that the real estate market is likely to head lower
Potentially larger gains elsewhere
Despite the worsening economic outlook some forecasters are claiming the equity markets have bottomed. Share markets around the globe have rallied in recent weeks with many more than 10% up off their lows. Not all investors have been frightened away from investing their money. Some heed Warren Buffett’s advice to be “fearful when others are greedy and be greedy when others are fearful” Any cashed up investors with a strong appetite for risk will be tempted by gains that may be larger than the lacklustre performance expected from the real estate market.
Over the last decade it seemed that all one needed to do was borrow money and buy shares or property to make a profit, many were fooled into thinking that they were wise investors by these easy gains. Unfortunately this debt fuelled spending could not last and like any bubble it had to burst resulting in the economic melt down and Global Recession that we see today. The GFC has both reduced investor’s ability to purchase new investments and their appetite for risk. Many will prefer to hold cash or bonds until the markets become less volatile and a capital gain looks more assured.
Worldwide investors have lost billions of dollars by placing their money in investments that they did not fully understand. There was an expectation that investors would switch to real estate as an investment that is tangible and easily understood. But the latest data shows that the rush of real estate investors is yet to materialise. Why?
Nicholas Butler is part of the smartvendor.com.au team