Will a Credit Crunch Crush Australia’s Property Investors

As housing values thaw across Australia, so goes the dreams of a nest egg built on a housing bubble.

Australian real estate has avoided the mass loss of property values seen in the US and the UK, partly because Australia’s economy was sheltered from the problems of the US led GFC. Did our better banking regulations and less credit to sub prime lenders save Australia four years ago? I think so. As did the stimulus package save retailing and jobs.

When will the Music stop for Australia’s 1.7 million Landlords?

In Australia we did not see the corrupt lending practices that allowed people to buy homes they could not afford, only to refinance that home on the ballooning growth of their asset to make the repayments and buy cars and such till the music stopped. So the music didn’t stop suddenly like it did in the US. [Its a little known fact that prior to the housing crash in the US, some people refinanced nine times in a single year.]

Right now property values in most Australian capital cities are heading south, and could to be lower for many years to come. [In the US they say that is a whole generation, which is 30 years. Why?  Because nobody in the US will believe that property is a good investment in the US after what was allowed to happen over there.]

The Reserve Bank of Australia now sees the train coming.

18 months ago my mortgage was due to be reset, and my personal banker of eight years offered very attractive rates to fix the loan. I chose variable at a higher rate. Why she asked? I told her that the Euro was in trouble and that the RBA would have to pay attention sooner or later. And I felt that a three-year fixed rate would bring me out in the middle of the storm for refinance. I am not an expert, but I had a sense that something was not right with the Euro. Now I hear experts warning it is weeks from collapse. That means massive reductions the interest rates. So I felt better sitting on a variable rate. Most “experts” had been saying to fix the rate.

Two recent RBA interest rate drops in a month have not encouraged home buyers to invest in a home. They have seen values shrink and they now sense there may be carnage ahead. The mum and dad property investor and landlord is in trouble. Here’s why, and its simple.

Trouble ahead for Australian Property Investors.

It is estimated that there are 1.7 million landlords in Australia, and most have wagered their own homes on property values rising. They have around a third of all homes in Australia. [That's a guess, but that's about 4 million homes give or take.]

Formula for success Property Investment, or a quick way to lose your own home?

Property has been sold in Australia as an investment on three basic rules.

1. Over the long-term property values will rise. Just go back to any time point in the past, right back to the Doomsday book in post 1066 Britain, and there’s your proof.
2. Negative gearing means you can use the power of leveraged investment to accelerate gains, based on rule number one above.
3. You can offset your income tax against the losses of “negative gearing”, so the effective loss is tiny.

The problems with these rules is:

1. Whilst no one can deny rule one, property values do mostly rise and sometimes fall. That fall period can be more than you can handle. And even you can, the banks can be fickle and pull your loan. [it's a little known fact that banks have a clause that allows them to ask you to refinance your loan at any time. When you can least afford to is the most likely time that this occurs.
2. Negative gearing means you are losing money. And that is even if you have the property fully rented out, and that your tenant pays the rent. Sometimes property is vacant, and sometimes tenants don't pay their rent. And it can take more time than you have before you can evict tenants, restore the property to a letable state, and pay the costs to re-let.
   1. And this all assumes that your income is stable. What if you loose you job,and what if your business goes sour, for any of a million reasons that you never thought possible?
3. Tax rules can change, but not usually retrospectively, but the Australian Government is discussing this very thing right now. Basically, it has failed to achieve more housing for low income earners and made it harder, and more expensive for then to own there own homes. So its seen as a failed policy. The fact that it could send many otherwise self funded retirees to the wall, and make them entirely dependent on the aged pension, would send shivers down the spines of those people seeking to reduce dependence on the older Australians on the Public purse.
   1. A what about when the income tax rates are reduced. It has happened many times over the past twenty years. That means your tax offsets are reduced and you are suddenly paying more out of your own pocket to keep the investment afloat.
   2. Can you afford it. In the past incomes were steadily rising, but now that may not always be the case.
   3. Miners are workers on top money. And they are big into negative investments. But what happens to them when the mines suddenly shut down. I once worked with a top insurance agent who sold insurance into the mining community. Well suddenly coal demand fell and prices made it impossible to sell at a profit. So the mines closed. The result was everyone cancelled their policies, and left town, and everyone in the town suffered so they sold their policies. And he was bankrupted on the "claw-backs" of commissions he suffered. He lost everything. Including his marriage. It happens lot.  Not a pleasant tale, but one that should give starry-eyed "margin investors" a face slap and a cup of ice-cold water down the pants.

So where is this formula? Keep reading.

Here's the irresistible formula, and here's the problem with it. Leverage works both ways. It can accelerate your gains, and your loses. In a futures contract investors can stop their loses. That can't happen with real estate. You sink with the rest of the market. Back to the sales formula.

1. The idea was that you have equity in your home, and you use that as the deposit on the next property.
2. Then you get a five-year interest only, fixed interest loan [to minimise repayments and maximise the tax offset of those repayments, and have a knowable repayment.] Works a charm when homes prices rise, inflation rises and wages rise.
3. But like all leveraged investments, there s a fly in the ointment. Something that could upset the apple-cart.
4. They can spell doom if values go against you longer than you can hold out. If property values fall continuously it will all go pear-shaped for property investors.
5. For the mum and dad property investor that means as long as you both have jobs, [so you can meet the repayments], and
6. As long as the loan can be refinanced.
7. This is where its going to hit the fan in my view. Here’s the thing. As long as these landlords can refinance, they are safe. But their home value falls, as well as the investment property, they will not be able to refinance.
8. Also, if it turns nasty in Europe, than we could see a credit squeeze. This could include, devaluing property , property valuers playing safe with low ball valuations, and re-jigging loan to value ratios to cover a falling valued market.

All these things could mean mum and dad property investors could be wiped out. It is that serious.

The Euro could be the last straw that breaks the back of the Australian property market

This is what you need to pay attention to. The Euro does not make sense. It never did, that’s why Britain did not buy in. All experts seem to be saying that the collapse of the Euro is inevitable. If that is true, then buying and owning your home makes more sense than ever. But buying property buying leveraging it on the value of the equity of your home, and tying your home collateral to your investment portfolio, regardless of the investment, does not make any sense at all. That is financial suicide in my view.

OK, Greece got refinanced. They will have their “snouts back in the trough” before you know it. And what about Spain, Italy and Ireland and Portugal? The Euro looks to me like a “healthy Germany” covered in flees that are on for the ride. I suspect that sooner or later Germany will have reached for the fly repellent.

If the Euro crisis does not end well, we should expect the worst, because we would be in for a credit squeeze as the economist in the sky would ordain. The banks will then refuse border line loans, and that will send properties falling further. As these values were the basis on which the loans were first made, if these values don’t stack up, then these Landlords will be forced to sell or find or funding from non bank lenders.

So where will all these home buyers go? We all need a home right? Back home to good old Mum and Dad! The average home has seen the number of people dwelling in them to fall to less then two, so there is a huge slack of empty rooms across Australia to house the “potential home buyers” that are commitment shy.

The bottom line for “Mum and Dad” Property Investors

If we in the non bank mortgage industry can’t find the finance, then property will flood the market.
So this is the thin edge for property investors in Australia’s housing market.

And here’s the real reason that this property values are likely to tank

Australia’s home values have risen far beyond what’s affordable for Australian homeowners and home buyers since the 1980′s.
What has happened is that as the wife went to work her wages were snaffled to be part of the affordability of home buyers.
This in my view is what has caused the housing inflation. The winners were real estate agents who got to drive “mercs” and “bemmers” and Range Rovers, and the banks who got to serve up those mega loans. The losers were all those who got a 30 year mortgage based on two incomes, because that meant you could pay more than you could have before, and pay longer.

House prices and salaries: The yawning gap

Housing affordability and credit guidelines have gone from 30% of the average Joe’s gross wages on a twenty year mortgage, to 40% of Joe and Joe’s partners wages on a 30 year mortgage! Some people are paying 50% of their gross wages before tax. The solution? Get more credit in the shape of a credit card! So you can feel OK while you sink deeper into debt.
So in real terms homes cost double what they used to. And we have the credit to pay for all this! Thanks for that!
That’s why the US experts keep saying that Australian home values will fall 40%. If economists were running the housing market, this what the price drops would look like.
But they don’t. However we must factor in their savvy, and the fact that the Australian Government may be paying attention, as well as the RBA.
So I feel that the values may have 20% still to fall, and that is if it does not get real ugly in Europe.
If it does then banks will shut the lending gates and the amount of loans that they will be able to approve will shrink. That mean less buyers and more property.

And if what happened with the GFC repeats itself, the non banking sector will be unable to get finance, and that means another credit source drying up.
Can you here the sound of a distant Property Crash getting closer?

What you can do now to protect yourself from the credit crunch

2012 should be the year that Australians get their credit cards paid out to zero balance, their car loans paid off, and get a 100% mortgage offset account home loan that allows them to stash their savings against their mortgage, helping to pay it off sooner, and also having the cash their for a rainy day.

The bottom line here is stuff the retail industry. They have been ripping us off for years. Your own home is more important than saving them. The retail industry may be just another Ponzi scheme that was built on loose credit. Its time to save, save, save.

By the way, you may ask Why is Rick so negative on negative investments? Well there are so many people out there who will tell you the opposite, so there is balance required. The other thing is I have seen what happens to people who lose everything, and more. The more can be relationships, kids being pulled out of private schools, losing your home, business  and health. That’s too much in my view. Its not nice. Invariably they all are wise in hindsight. I don’t want that to happen to you.

So who Could use negative investments? Those with nothing to lose in the first place. No savings? No home? No kids or relationships? Go for it. When you are young and you have nothing to lose, go for it. The problem is most that lose everything don’t have the time to make up the loses. Never stake your retirement payout of a venture.

Hope this helps you.

Source: Rick Adlam, Mr Mortgage

[This Article may be reprinted as long as the credit link left in tact.]

Mortgage Rates: Why you looking at non bank home loans is a good idea

As Mr Mortgage predicted last month, the RBA did not raise interest rates in October. Australia’s big banks did not listen and have paid a heavy price, losing millions of dollars.

Don’t you get caught paying higher mortgage rates for their error in judgement!

Is it time to move your home loan to avoid a mortgage rate sting?

I believe its time to move away from the big four banks, and to a non bank securitised mortgage lender if you want to have lower mortgage rates over the next twelve months, and here’s why.

1. The big banks were all set to jack rates up on you under the cover a Reserve Banks of Australia official rate rise. So this would mean that you would get two rises at the same time. Can you afford that? I don’t think so.
2. They also lost big time on betting on a rate increase on the financial markets.
3. The banks will be looking to offload these losses in higher mortgage rates on their customers.

RBA interest rates “talk up” outsmarts the financial markets and banks

Talk is Cheap. The Reserve Bank likes to outsmart the financial markets every so often, and it did in October. The RBA made noises that sounded like a rate rise was coming, and the Aussie dollar went up, and the reasons for the rate rise were then out weighed by the reasons to hold on any interest rates rise for another day, maybe even another year.
In effect the RBA board figures if by “talking about a rate rise” can do the job of an actual rate rise, its done it’s job of controlling inflation and keeping unemployment low, so no actual rate rise is necessary.  Is Mr Mortgage the only one that figured this out? No, but the vast majority of economic experts believe their own spin.

RBA Interest rate talk is gain without the pain of increased mortgage repayments.

The other benefit that the RBA has in employing the talk rates up ploy is, that it still has the interest rate card to play if home buyers and consumers stop listening to the messenger of doom. So the Reserve Bank has stretched the value of a rate rise and reduced the pain of the real thing that would lift mortgage rates. I like it.

Why you should move your home loan away from the big banks if you are worried about increasing mortgage rates

Based on their own assumptions, the major banks made deep losses betting the wrong way. So besides the major banks tipping that the RBA would raise the official cash rate by 25 basis points to 4.75 per cent, each of them had been raising hundreds of millions of dollars in short-term funds based on pricing that factored in a higher cash rate.

In fact these banks believed to be sitting on these big losses and are now looking for someone to milk it from. Don’t let that be you on your mortgage rates.

Mortgage rates summary

The major banks will have to raise mortgage interest rates, without the Reserve Bank moving rates sooner or later, and the RBA knows this.
The RBA can now sit back and watch the major banks squirm, knowing they’re under pressure to raise rates. This tension will create more uncertainty of a rate rise in November and by then the banks will have to move on mortgage rates even if the RBA sits on its hands. Result? The RBA can leave interest rates as is because the major banks will do its job for them.That is, if cooling the housing marking further is one of its aims.
If you are worried about mortgage interest rates I suggest that you start shopping for a non bank mortgage lender.

Author: Mr Mortgage

Home Loan Interest Rates: How much will you save on your mortgage repayments today?

Home Loans interest rates are likely to fall today, after the Reserve Bank of Australia meeting this afternoon. But how much if anything will they drop the rates, and how much of that rate cut will see see trickle into your mortgage account? Not much is my guess. Here’s why.

The RBA Board will meet to determine Interest rates today to determine what if any rate movement the Australian Economy requires to get the good times rolling. The good times are rolling. Before you spit the dummy at me, let me tell you how I figure this out.

I use Road traffic to figure interest rates?

That’s right road traffic. When I get on the highway early and see tradies utes three abreast, I know they are all on there way to a contract. When I see Semi-Trailers all over the highway going in both directions I see trade happening. When I see my exit blocked with trucks lining up to get onto the industrial estate near home, I know the wheels of business are spinning just dandy. When my wife complains that there are too many trucks back up on the roundabouts going north, I know contracts are being written and fulfilled.

Most economists are tipping a rate reduction, which was practically spelled out by the Reserve Bank Governor in statements he has made in recent times, and in the last meeting minutes that were released two weeks ago.

So how big is the official interest rate going to move downward.

That’s a good question. Most economists were punting on 0.5% reduction last week, but I would ask why. The economy isn’t exactly falling apart is it?

Sure we have a two speed economy, with mining taking the lead, but besides housing and retailing, under performing, what else is wrong.

And if we look at housing, its their own fault, IMO because they never questioned why land prices are so high. Now they are paying the price for their of care for their customers, they want the customers to help them by subsidising their business model with their taxes.

Interest rates and the retail connection

And retailing is largely connected to the health of home building, for two reasons.
1.    When people build homes they spend a lot on stuff to go inside and outside the home. Let alone tiles and carpets, and blinds and the like. That means a lot of new retails sales.
2.    People have stopped using credit cards and started to pay down debts. A lower credit card interest rate may help stimulate consumer spending, but there are two flies in the ointment here. Banks are not passing on the interest rates drop to small business and credit cards, and people won’t be dissuaded from paying down bad debt.
So hopefully the RBA knows that house prices have to fall, and that land prices have to half before the housing industry self corrects, and that is up to the markets, and interest rates should not be used to fuel demand for housing.

My tip on home loan interest rates.

I believe that the rate reduction will only be 0.25% for two reasons.
1.    As I have said before, there is nothing wrong with rates as they are. They are where they are supposed to be. the higher they are, the more downward pressure there is on inflation and particularly house prices.
2.    The markets have lifted the Australian Dollar value in the last couple of days. That tells me the money has shifted to a low interest rate cut.

With little new business happening on the home loan front. banks can milk their entire loan books for money, and if you don’t move, they will do it next time.

Even though the Government has made it easier for homeowners to switch to another lender, they are not doing it. If too much bother for very little gain.

So how much will you save? Not much. And that is assuming that the banks will pass on tall the rates reduction. If you really want to save money on interest rates, you should shift to a non bank lender. As long as you stay with the bank that does not pass on the interest rates, your lender will keep maximising their profits at you expense.

All Ponzi Schemes must end: Australia’s 2002 to 2010 Real Estate Ponzi Scheme won’t die easy

The US housing Market crashed in 2008, after its Real Estate Ponzi Scheme defied gravity for four years.

But someone imported the Ponzi scheme virus into Australia, and this one won’t die as quickly or as suddenly in the US. It’s yet to diagnosed, let alone cured, but die it will. And the longer it takes the greater the fall.

How to go bankrupt without even trying.

How do you go bankrupt without trying. By buying a home and paying too much.

How do you go belly up by really trying. Easy. Buy an investment property using the equity of your home, and cross colateralise the two loans. That way yo go broke and you lose your home at the same time. Nice one.

Is the Titanic about to sink in Australia?

I believe that who buy homes under the current price of land, will most probably go under with it, like the Titanic going down and sucking everyone near it down to the icy depths that is financial ruin. Will we see tent cities like in the US? I don’t thing so. We have a decent Government in Australia that puts people before the Almighty dollar.

Australia’s reality check

But street dwellers, soup kitchens and “couch surfing” friends and relatives that lose their homes are real possibilities for people who have paid too much for their homes.  That’s why the Labor Government and the RBA have got it right, in the primary focus of keeping people in Work, and in their homes. And in putting downward pressure on home prices, because they are still too high in Australia.

America’s Shame

America’s shame is that the fact they did neither, and the well concealed shambles that was the US mortgage Industry, became Barack Obama’s surprise package gifted to him by a Wally called George Bush. And now the rhetoric that we are going to build up America to be great again, sounds like the echoes we get from our right wing politicians. Small government, slash spending, stop the entitlement mentality, build up the military, work hard, pray hard and you will be rich. Yeah we have that BS going round here too!

Someone needs to point out that the 1950′s will not be returning anytime soon to these Polly Wally heads. And like praying for rain in a drought, or for the rain to stop in a flood, it’s a folly that some of our leaders actually believe.

First a little background about the Author

I have sold new homes and house project contracts for builders in the 1980′s, the 1990′s, and the first and second decades of this century. In between I have done mortgage finance. I have seen the booms and the busts.
The last month I left AV Jennings in 1985, I sold 7 homes in Adelaide, Australia. All sales stuck.
The typical house and land package in those days was $40,000, 3 bedroom, 2 car garage and two bath.
The land component was around $8,000.
When I bought my block to build on in Ormeau, QLD, in 2002 the blocks were all around $70,000. [640 sq metres] I got mine at $60,000 in a repo sale. Someone had put a thousand dollars sown, but never made a payment.

How the Great Australian Ponzi Scheme was created, fueled & sustained

The GST was introduced in mid 2000, and that killed home sales.  I understood the GST [Goods and Services Tax of 10%], never applied to land or land development. The Howard Governments answer? Free entitlements that will make it drop dead easy to sell houses. No deposit homes became an open secret, and so the Ponzi Scheme started.
Yet eight years later land prices had risen four times. And no one has ever asked why?
The cost of building a home [the home construction element] has not even doubled, in spite of shouldering the GST plus all the extras builders have had to add to meet new Government standards for power, and water saving standards.

How the Banks poured petrol on a blazing house Market

The banks became the big winners out of this Ponzi scheme, because they “sold assets” that will be returning them income for the next 25 years. How? By making credit easy. Way too easy, and financing borrowers on the basis of repayments based on un-sustainably low-interest rates.

How the Land developers kept the Ponzi growing

When I came up to Queensland I quickly worked out what developers were up to. The persuasion model is called scarcity.
I wanted to build a home, and looked at land. The land salesperson would show me three lots. I knew they had 50 lots to sell, but they never disclosed it. I wanted to see every block so I could determine what was best for me to buy, not what was most convenient for the developer to sell me.

My real estate career that never was

I even got sucked into the Ponzi scheme and got a Rea estate sales licence in 2003, with my local real estate agent offering me a position. There was an US real estate agent working there at the time, and he pulled out a real estate book to show me land prices over there. There were lakeside land lots at $35,000, yet here we were paying $250,000 for that type of land here, and he was asking why? Well that’s when I realised that we had all been sucked in, and that was the end of my stint at Real estate. I knew it would end in tears.

Soon the real estate industry shrunk by 20%, and it has recently shrunk by 40% according to a couple of mortgage mangers I spoke to last week. They are saying that mortgage brokers have shrunk by 40% in Australia, and that it could be 50%.

Creating an illusion of scarcity to keep the buyer stampede going.

Since 2005 we have heard an urban myth, That there was a chronic shortage of homes in Australia. Its been echoed by the Howard Government, the HIA, land developers and real estate agents. But house builds kept falling and prices started to fall for the first time in a long time. If you believed that one you got sucked into the Ponzi scheme between 2006 and 2009, you bought at the very top of the market.

In 2009 I was working for a builder and one developer who had 50 lots ready to go, would only allow me to package 5 house and land packages. We were willing to market 50 house and land packages, and make  full colour brochures as free fliers, but no. They only wanted me to do 5, because they wanted the land to appear scarce when it wasn’t.
Slowing the builders and the home buyers down has meant that prices have risen to levels that people can’t afford. A Ponzi scheme hatched by land developers. Supported by builders.
It gets worse. Local and State Governments have become dependent on super high charges and stamp duty, and they are still going broke, because everyone in the system wants to be paid more, because they have extracted more.
The result in my view is that they have effectively shifted the future infrastructure costs onto new home buyers, and home buyers are mortgaged to the hilt. That is, a lot of their mortgage is paying for State Infrastructure over the next 30 years. Nice one.
The HIA remained silent whilst this scam was being perpetrated on home buyers, but the damage was invisible to those home buyers when prices in the Ponzi scheme rose to make it look like you could actually make money by paying silly prices for land. That’s how all Ponzi Schemes are validated. They actually do give a return initially. Then even when prices are falling people keep pouring into the Ponzi, like lemmings queueing up to run over the cliff into the sea.

In the 1990′s when interest rates were 12% we could still sell house contracts. Because land prices were reasonable. This is where your low-interest rate is good for business theory collapses.

The contradiction of Joe Hockey and the Liberals. The needy versus the Greedy

Australian business is broadly represented by the Liberal Party in Australia, And they say they are for free enterprise and free markets, and cutting out entitlements for the needy. but the reality is they want to prop up an unsustainable real estate model, with Government subsidies for buyers, handouts to business and lower than normal interest rates, because they  don’t want to face reality.

That land prices are the problem, not interest rates! Land Prices need to be halved in Australia in my view.

Another story. I went to see a property developer last year and asked about land to do house and land packaging on, and we got talking about an adjacent development.
He laughed. He said that his group offered $2.4 million for the land, and yet a major developer bought it for $44 million. He said that these guys had rocks in their heads.
Now those lots are being developed, and guess what? The lots are so small that they all have to have two storey homes built on them, and this is virtually in the scrub.
So a builder has to contend with extra costs of building a two storey home of the same size [$20,000?] and the safety and time issues adding to the expense.

The customer has to contend with living in sardine city, in the bush, and in this case without a view. And having the inconvenience of stairs, and the loss of useful space that stairs take up. Yet we live in a land full of vacant areas.

By contrast land prices in the US are lower, and they have 15 times the population in a country around the same size. Why have you allowed land developers to make you bow and scrape to them, when they are doing you over up your rear?

Do the math. If interest rates were 15% houses would be more affordable than they are now, if land prices were halved. They are only where they are, because you have let them get there without a complaint.

How Land Prices are ruining building innovation.

Last year I went to see a manufacturer of a building system using insulated panels. I went to see his show home just coming out of the ground, and I asked why he was building it behind a railway station in an obscure location?
His answer was that he could get a 700 sq metre block there for $240,000, but a 300 sq metre lot at North Lakes was $330,000 and he did not want to build a two storey home.

The story of the magic pudding

Now I happen to have met Joe Emanuel, the man who bought Mango Hill from the APM when they were pine forest plantations. At one time Joe told me that he was Australia’s greatest ever land owner! A portfolio that he soon lost because of Tax issues.

He told me that he paid $3,000,000 for the whole of Mango Hill. The pine forest that became North Lakes development. He then got into trouble with the ATO and Lend Lease got it for a song. Now Stockland have it and they are selling it back at $3,000,000 an acre! Can you see anything wrong with this? Is land to be treated like a Magic Pudding that grows and grows?

The solution

The only way builders will control their destinies is to have at least some control of the land component of the house and land package.

Banks need to be controlled in having greater deposit requirements, and stricter lending requirements, to ensure that the Ponzi dies, and does not spring back to life. If we do this then houses become affordable and builders will find it easier to sell homes at a fair price & make a good living.

Interest rates are not the problem. They caused the problem. Its time to wake up and small the coffee.

Rick Adlam, Mr Mortgage