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26 Nov 2017 0:18
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  •   Home > News > Business > Features

    Property Never Crashes, just ask a Londoner!

    Take a modern city with a large inflow of immigrants, a growing population and a high per capita income. How can you go wrong buying property in this place?


    Investment Research Group
    Investment Research Group
    Well, in London you could in the late 1980s and early 1990s when the property market slumped so badly that a material proportion of London homes at one stage had market values below their mortgage debt.

    Homeowners were walking into banks and tossing the keys to the home on the bank manager's desk, saying: "It's all yours now." And then they learned one of the brutal facts about home ownership; you cannot hand your house back to the bank and walk away from your mortgage.

    The banks took the keys, sold the house and then sued the owners for the difference between the selling price and the mortgage debt.

    What London seems to illustrate is that the distance between property profits and debt despair is fairly short when it comes to investing in a home. The problem with property is that it is illiquid - it is difficult to sell in a bad market. That doesn't matter if you are living in the house. But if you are one of the many property investors that flock towards residential property at the tail end of every boom, you could be in serious trouble.

    The London boom and bust followed a reliable pattern. Many factors had conspired to produce a house price boom in the late 1980s. Income growth after the early 1980s recession was strong. Financial liberalisation also permitted higher gearing levels, as borrowers were able to obtain higher loans relative to housing values. Demographic trends were favourable with stronger population growth in the key house buying age group.

    The supply of houses grew more slowly, with construction of social housing falling to a small fraction of its level in the 1970s. Finally, in 1988 interest rates fell and the proposed abolition of property taxes in favour of a poll tax gave a further impetus to valuations. The very experience of housing appreciation reinforced expectations of further gains and the market had become a classic speculative bubble. This could be seen from a very important speculative measure: the house price to income ratio, which stood at the second highest peak in the post-war period.

    The bust in the early 1990s was the result of the reversal of most of these factors. Interest rates rose from 1988-90. Income growth and growth expectations weakened. Demographic trends reversed. The revolt against the poll tax resulted in the introduction of a new tax, the council tax, which had at least some relationship with property values.

    Mortgage lenders tightened up their lending criteria. Under these conditions, not even the major falls in nominal interest rates that took place in the early 1990s were sufficient to revive UK house prices. UK housing remained very bad for very long, only booming again in the past few years as sufficient time had passed since the last crash to allow values to get into line.

    The UK experience is salutary because New Zealanders more than anyone believe property never really crashes. However, it does when too many negative factors line up. When property crashes, it is far more painful than a share market crash.

    The response from many property investors in New Zealand is likely to be that things are different here. We have a different attitude towards home ownership. We have a different tax regime. Property never crashes here, it can only go sideways for a while.

    We’ll have to wait and see.

    © 2017 David McEwen, NZCity


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