Let’s talk about property bubbles. How can we spot them and what should we do to protect ourselves against them? In addition, I will share with you one way to find great property deals that can help to protect us against the potential impact of a property bubble by adding value, seeking higher returns or taking your profit as you go along instead.
The 18-Year Property Cycle – Interview with Akhil Patel
Stages in an Asset Bubble - Minksy’s Theory of Financial Instability
House of Cards – Tips on Surviving a Recession
Save Time, Save Money & Make Profit in your property deals with the Property Deal Tips service from The Property Voice
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Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and, as always, it’s a pleasure to have you join me on the show again today.
Let’s talk about property bubbles. How can we spot them and what should we do to protect ourselves against them? In addition, I will share with you one way to find great property deals that can help to protect against the potential impact of a property bubble by adding value, seeking higher returns or taking your profit as you go along instead. So, stick with this one to hear all about that.
Right, now on with the show.
- 18-Year Property Cycle – although average has been somewhere between 15-20 according to Homer Hoyt, exceptions were World War II and Federal Reserve doubling of US interest rates in 1979.
- Minsky’s Theory of Financial Instability from 1986.
Signs of a bubble
Rising prices without increased fundamentals – consider rental returns and mortgage affordability (based on take home pay rather than income multiples). Case-Shiller Home Price Index. Affordability – average wage inflation versus house price / rental inflation (lag period).
Heavy use of leverage – easy credit underwriting, high LTV loans, financial innovation (e.g. self-cert, interest-only, same-day remortgaging), etc. under-priced cost of money (low interest rates).
Political interventions – relaxed regulation and lending policy, QE, currency manipulation.
Excessive risk-taking – speculating on price growth without adding value, single exit option, bigger fool theory.
Narrative played out in popular culture – pub & dinner party conversations, housing tips from cabbies.
Withdrawal of foreign investment – Brexit, high Sterling valuation.
Interest rate rises – make mortgages less affordable, especially with variable mortgages or short-term fixes.
Reversion to the mean – average house price growth:
- Last 10 years 2.1%
- Last 20 years 7.2%
- Last 30 years 6.1%
- Last 40 years 7.7%
- Last 50 years 8.9%
- Last 60 years 8.4%
- Since 1952 (55 years) 8.1%)
Oversupply – city centre apartments, Dublin, etc.
Economic signals – recession (high interest rates & unemployment), rapid interest rate rises
Property indicators – house price & rental growth, vacancy rates, average time on the market (sale or rental), prices outstrip intrinsic value / rebuild cost (plus land value), suspension of disbelief – the only way is up, it’s different this time, fear of missing out, Dutch Tulip Manis from 1630s where the cost of a tulip exceeded 100 times annual wage. Gazumping, sealed bid auctions, lack of affordable homes in local area (some parts of London display this but masked by foreign and domestic investors).
Anecdotal cues – world’s tallest building records tumbling, lavish Gov spending on public works fuelled by debt, repossessions start to rise along with other indicators of bad debt
Minsky’s 5 Stages of An Asset Bubble
- Displacement – new paradigm or new normal e.g. a decade of record low interest rates
- Boom – prices rise slowly initially, then gain momentum as more people pile in. Lots of media coverage. Fear of missing out, so more ‘retail investors’ pile in.
- Euphoria – Prices skyrocket, ‘Greater fool theory’ kicks in, valuations surpass fundamental measures and new valuation methods start to emerge.
- Profit-Taking – The smart money starts to sell to take profits / gains, hard to time accurately and difficult to spot.
- Panic – asset prices reverse, people in fear sell, which worsens the problem and liquidate at any cost. Banks call in loans and strengthen terms / enforcement.
10 Protection Measures to Avoid Falling Foul of a Property Bubble
- Have some equity in your property. Ideally 40% of more but I realise that might be a challenge initially when growing, however, keep this figure in mind and try to avoid remortgaging back up to 75% loan-to-value all the time is the main trap people can fall into. Personally, I do tend to take 75% LTV mortgage and even with a BRR strategy often pull out 80% or more of my starting capital. However, I rarely refinance at a higher amount after this and will just let natural growth and / or mortgage paydown reduce my LTV over time.
- Have some liquid cash set aside. Ideally a contingency fund in cash, some easy access savings or in an emergency situation only a credit card with plenty of headroom. I recall at one time hearing that Apple had a year’s worth of expenditure set aside in cash. That sort of level would be ideal and also probably sound a tough ask but how long could you keep up your mortgage payments with no income coming in? The more time you have available the better protection you have to weather a storm and storms tend to come quite often.
- Force the appreciation don’t wait for it. If you add value to your properties you automatically add equity and effectively beat the market, so this is an excellent way to protect your position in case prices should then drop.
- Invest for income first. Make sure you have plenty of rental coverage over your mortgage payments to provide monthly cashflow to build that liquid cash fund I spoke about. Then, if interest rates rise you should still be able to cover the mortgage. By all means have a bash at some capital growth in the early stages of the property cycle, but towards the peak, switch into income strategies or sit it out for a while instead and wait for the buying opportunities that will soon emerge.
- Diversify your risk. Ideally don’t have all your eggs in one basket. OK, so if you have enough for one small property in Durham that’s OK. But after that think of diluting your risk by having different property types, perhaps in different places and eventually potentially using different strategies. You don’t have to make every deal different, but try to avoid over-concentration to avoid being vulnerable to significant market or strategy shifts that can come with a bubble. You should also consider spreading your investment fund across alternative asset classes and not just property. Gold and bonds are usually countercyclical to property and stocks for example.
- Go Long. Have long-term mortgages for long-term buy and hold, not these 3-5 year commercial mortgages…a lot can change in 3-5 years. Fix your interest rate as long as is economic to do so and aligns to your strategy. 5 year and longer fixes take short-term interest rate spikes out of the equation.
- Ride out the storm. In a crash, hold your nerve and hold the property if you possibly can. After a storm the sun always comes out again…eventually. If you can hold your nerve whilst those around you are losing theirs, you will not only be in the minority, but in great shape too!
- Have multiple exit options. I usually have at least 2 and usually 3 alternative exits when I go into a deal. Can I rent a flip and still make money, can I sell a BTL and come out in the clear, can I refinance onto a better long-term product to buy more time, can I switch strategy say to short-term lets or HMO if I need to? When assessing a project, consider what your options are and if there really is only one show in town…you better make sure it’s a bloody good one!
- Stress test your portfolio. The best stress test that I have seen is a spreadsheet that accompanied an article called House of Cards produced by an investor called Ed Atkinson. It models all of the major recessions over the past 100 years and allows you to see how your portfolio would fare in each of them. I was very pleased to have a green light on my portfolio when I last did it. Drop me a line if you want a copy of the article and spreadsheet. Even if you don’t do this, model your portfolio with an interest rate at 5% higher than your mortgage and a 20% or more price drop. See what sort of shape you might be in in these circumstances and make plans to mitigate the position…probably by following many of my other suggestions here!
- Buy low, sell high. This sounds obvious but is very hard to do. What I really mean here is to try and avoid buying during the so-called ‘winner’s curse phase’ of the property cycle when the world’s tallest skyscrapers are going up and gazumping is being discussed by cabbies. There are ways to still buy at this time, for example if you can add genuine value, but do try and avoid buying at the peak of the market if possible.
So, there we are then…signs of a bubble and 10 ways to protect yourself when it happens. I will say this, bubbles happen with a combination of factors and not just one. So, if you see one of the warning signs that I have mentioned, for example, increases in interest rates or Brexit, then it does not automatically mean we are about to enter into a property bubble and see a housing crash! Just as a change in how you are feeling could indicate an illness, an upset stomach does not automatically mean you have appendicitis…it could just be a dodgy curry from the night before!
So, look for patterns, trends and clusters of the warning signs instead. If you start to see several warning signs starting to accumulate and add to one another, then perhaps it is time to take some defensive action and sit things out for a while.
Property Deal Tips
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Ok, in closing for today, you can of course email me email@example.com if you want to talk about anything from today’s show or more generally in property investing. Also, the show notes will be over at the website www.thepropertyvoice.net
But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao ciao.