08/10/2013 - 13:30

Investment eggs need more baskets

08/10/2013 - 13:30

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When bank deposit rates are less than 3 per cent it’s hard to resist the siren call of an investment opportunity being spruiked at 20 per cent, which is why investors are rushing into residential property – and why many of them will get badly burned.

When bank deposit rates are less than 3 per cent it’s hard to resist the siren call of an investment opportunity being spruiked at 20 per cent, which is why investors are rushing into residential property – and why many of them will get badly burned.

Two events over the past week rang alarm bells about the property market.

The first was a forecast attributed to the firm RP Data, which made a case for Perth residential property following the trend evident in Sydney and Melbourne where values have been rising at a rate of more than 20 per cent a year.

If it’s happening over there, goes the argument, it will soon happen here.

Perhaps that theory of Australian property prices seeking some form of equilibrium is correct, but to dangle the prospect of a 20 per cent capital gain in front of investors when the best they can get on a bank deposit is 3 per cent (or less) is a red rag to a bull.

Whether the 20 per cent prospective gain is correct, or not, it is a factor in the rush by investors into the residential market, raising a few very important questions.

• Are investors driving genuine homebuyers out of the market?

• Are there enough tenants to occupy the investment properties being acquired?

• For how long will the Australian government tolerate self-managed superannuation funds diverting some, or all, of their assets into residential property?

The answers are obvious. Investors, keen to generate a higher return on their capital and worried about the future direction of the stock market (and the commercial property market), are pouring into residential property because of forecasts such as that extrapolated from research by firms such as RP Data.

Genuine homebuyers are being blasted out of the way by investors who have the capital to satisfy stricter bank lending requirements. And the banks are falling over themselves to do lend money to people only requiring mortgages of between 50 per cent and 70 per cent of a property’s value.

The federal government, through its various regulatory bodies, will be aware of what’s going on in the self-managed superannuation sector and will not be happy.

Of particular concern was a report over the weekend in the Australian Financial Review newspaper about a recommendation allegedly being provided by the financial advisory firm, TWD, that it made sense for a self-managed superannuation fund to direct all (yes, all) of its assets into a leveraged residential property investment.

At first glance I suspected it was an April Fools’ Day joke because the first rule of investing (if not the only rule of any importance) is never put all of your eggs in one basket.

But there it was; a report that said TWD, a well-respected firm, reckoned it made good sense for the owners of a self-managed fund with $150,000 in savings to use all of that, and borrow a further $350,000, to buy a $500,000 investment property.

If property prices continue to rise, and if good tenants can be found to pay the rent on the investment property, and if bank interest rates stay at record low levels, a case can be made out in support of an ‘all-in’ residential property investment,

However, and this is the key, it will not take much to go wrong for this eggs-in-one-basket investment strategy to go pear-shaped.

The greatest unknown here is how long the government will tolerate a speculative rush into residential property, which is creating boom-like conditions at a time when the underlying economy is flat.

What appears to be happening in Australia is a mirror image of what’s happening in the US, where super-low interest rates are causing irrational investor behaviour in the name of generating an acceptable return on capital.

In some ways this desperate search for yield on a retirement nest egg is understandable because very few retirees, even with $1 million in savings, can generate a decent return at a bank deposit rate of 3 per cent – especially given that the $30,000 in interest payable could also be taxable.

But no matter how understandable the hunt for yield, there is no logical reason to put everything in a leveraged bet on a single asset.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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