The Unconditional Blog

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10

Unlike shares, property almost always has a bottom price

Posted on: May 30th, 2009 | Filed in Buying / Selling a home, Property Investing

istock_000007480400xsmallOften comparisons are made between the property market and the share market, with the view that because the stock market has crashed, that in some way property prices will need to adjust by an order of similar magnitude.

As yet no international property market has seen a property price adjustment in terms of average house prices anywhere close to the collapses of stock markets over the past year. A commonly used expression to counter this comparison between equity and property markets is that “they are not making any more land these days”.

It was this thought that ran through my mind when I read this fascinating New York Times article on what the reporter sees as a bit of a buying frenzy at this moment for property in what must be one of the most depressed area of US property – Phoenix, Arizona (well one of a couple of markets which would include Florida, California and Nevada).

In this market where as a function of foreclosure (mortgagee sales) savvy investors have recently moving in and aggressively competing to buy up property as the current owners are ready to vacate and liquidate – offering those owners a lifeline at least from a lifestyle perspective. These investors are offering the opportunity for the owner to stay put and tenant the property at a rent lower than their recently re-adjusted mortgage payments, and thereby providing the investor with a secure tenant. This is effectively utilising the well established “sale and leaseback” model much favoured by commercial operations.

There is a great quote in the article from a real estate buyer who got burnt by buying into the falling market a year ago thinking it had bottomed – the classic “catch a falling knife syndrome” he says of his recent purchases:

“You need to buy when there’s blood in the streets,” he said with a shrug. “Even if it’s your own blood.”

The important point here is that unlike shares which effectively have no “floor price” – that is to say at some stage companies in liquidation or other state of collapse have zero value of shares. For property there is nearly always a price / value at which the market will actively and aggressively move in to buy. In this case in Phoenix that price is a massive discount to the once overheated bubble prices of a few years ago and clearly at a level which would show a paper loss for the owner, however the inherent asset value of almost all property does have a market value.

Note – If you have problems accessing the NY Times article a Pdf version is available here

Article Discussion

  1. Hi Alistair,
    Two points from me.
    1. Leaky homes. Some houses do go almost to zero.

    But, my more substantive point is this:

    2. There is a significant difference between house prices and the wealth of a house owner. The important difference being leverage. If you own a property with no mortgage, then yes. But if you have a 90% mortgage and the house price drops by 10% you have lost ALL the money you put into that house. Property prices don’t usually go to zero, but your wealth most certainly can.

    This reminds me of a point I read about recently. Many people see property as a solid investment. Solid as in bricks and mortar.
    But as the author pointed out, one should not confuse the physical solidity of houses with the financial solidity. Houses may be solid, but as point #2 demonstrates, an investment in property is subject to risk just like everything else. A severe drop in the market price can wipe out many people’s wealth.

  2. Dave says:

    “As yet no international property market has seen a property price adjustment in terms of average house prices anywhere close to the collapses of stock markets over the past year.”
    Well the Dow-Jones is currently down 40% from peak, and in the US Case Shiller figures we have Phoenix down 53%, CA-LA down 42%, CA-SD down 42%, Florida-Miami down 47%, Las Vegas down 50.4%.

    Ask the owners of houses in Detroit that are worth less than the local taxes owed on them whether they have a “bottom price”. Agree with Steve about the leverage issues too, especially when your equity goes negative. At least with shares you can’t end up owing the bank more than you bought them for.

  3. Andrew Burns says:

    Property has latent demand where at some price point people will buy back in while shares can become worthless forever. Rent levels act as a buffer to property dropping beyond a certain point, saying that, the NZ market continues to be over inflated and the fundamentals suggest that prices need to continue dropping before it becomes an attractive and sustainable investment vehicle. It’s all about timing and time frames.

  4. Some valuable comments – very much appreciated – my comments would be:

    1. Physical damage such as leaky homes, vandalism or fire would certainly lead to destruction of value.

    2. Certainly a house purchase is by no means a sure fire way of avoiding financial collapse, this point is very relevant.

    3. Dave – I stand corrected, I had used the concept of markets being whole-country as in the US / UK / NZ. Certainly when segmented to a state level the collapse of the US property markets stands up pretty poorly as compares to the Dow.

  5. Mason Parker says:

    The thing that sticks out most in my view is that as an asset class property seems pretty unique in that you can borrow significant proportion of the value of the “investment”.
    I believe the core issue is not the rise and fall of property values it’s our borrowing/gearing levels

  6. Andrew Burns says:

    Other unique things which seperate it from shares include;
    Unpaid rent, Willfull damage, High tenant turn-over, Theft of chatels. Being a landlord of enrty level Gisborne property i have seen and heard it all.

  7. Sam says:

    Totally incorrect to say they are not making more land. Just look at dubai. In our modern human history, we are not making land!

  8. Sam

    It is just an expression I have heard used in the context of people discussing the trends in property appreciation – there are many instances of land reclamation – Hong Kong airport as another example.

  9. J.C. says:

    “For property there is nearly always a price / value at which the market will actively and aggressively move in to buy.”

    And it’s the same with equities. Take Sumitomo Metal Mining (the world’s leading gold producer of gold for industrial purposes and business activities in copper, nickel, etc.). The stock bottomed out in November last year at around 600-700 yen, but currently sits close to 1400 yen.

    This begs the question as to “real value.” When a company like SMM (with no debt and a producer of commodities in demand) gets hit by sentiment, the behavior of residential property investors looks even more ridiculous in comparison.

    I will also point out that Japan is another example of a country where property can drop to zero (effectively). When the cost of holding property is greater than its worth, its value is zero. There are no two bones about it.

  10. Property will have a bottom price for some as Steve points out leaky homes and mortgage commitments could make your house worthless to you. But if the property price drops due to damage someone else can always buy it off you and redevelop the property if your wealth does not allow it. Someones loss is anothers gain that is how you can pick up bargains.

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