The Real Estate Market Has Peaked
Friday 16 July 2004
Studies of real estate cycles show property prices go up in the first four stages of the cycle, go flat in step #5, then go down for four stages, says investment consultant Charles Drace, author of “How to Survive the New Zealand Residential Property Crash”.
By The LandlordWe are in stage #6 now. Therefore, anyone buying a property now must expect it to go down in value over stages six to nine.
Historically, real estate values in New Zealand go down 20% to 40% in inflation-adjusted terms during stagess six to nine.Theory of the Property Cycleresearch by Henry George, Fred Foldway, and Charles Drace
1. Population growth and commercial growth at the early stage of the economic cycle, often supported by government encouragement/ low interest rates, creates an increase in the demand for housing and commercial buildings in excess of current supply.
2. It takes time for construction to gear up. This construction increases demand for vacant land. Bank loans are attracted to construction and real estate sales as prices begin to rise.
3. As vacant land prices rise a boom in land develops, leading to sub-divisions and speculative resale.
4. The real estate cycle peak is characterised by a high volume of subdivision and sales.
5. Construction catches up with demand and a small surplus is created. Rents can’t go up enough to support the higher property costs, making new construction and rental property investment unprofitable. Land values start to adjust downwards, the bubble is broken.
6. Rising interest rates hurt confidence and profits, adding to the downwards pressure on prices. Real estate enters a ‘hanging’ slow phase. Asking prices stay high but there are few buyers. Building, subdivisions, and speculation drops quickly. Sometimes a panic or crash begins at this point; often the market just slowly dies. Many keep speculating during this phase as they’re unaware of the market having turned.
7. Real estate starts to get marked down in price. This tends to take quite a while as owners tend to cling to mortgaged property longer than they would to other assets, like shares. Foreclosures rise but the foreclosure process is not quick.
8. Mortgage costs/interest rates are higher, rents decline, and vacancies increase. The market is dying rapidly. Foreclosures increase; speculators and investors are forced to sell as the capital value of their property decreases below lending margins and rents decrease below holding costs.
9. The bottom of the market has the following characteristics: high vacancies, low construction rates, foreclosures and no speculation. Debt must be written off and properties sell at a deep discount. Only those who entered stage 6 with little or no debt survive to buy the dramatically discounted properties.
Note: leverage/borrowing is advantageous during stages 1 to 4. Mortgages should be paid off during stages 5 and 6. Cash/excess collateral should be carried forward to stage 9, then used to buy discounted properties. This use of leverage only in stages 1 to 5 characterises the professional property investor; high mortgage exposure past stage 5 characterises the amateur who loses to the professional.
Friday, 16 July 2004, 10:16 am
Press Release: Charles Drace
CFP Certified Financial Planner PO BOx 3833,
charles @ cdrace.co.nz http://www.satori.cc
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