How to Avoid the Coming Lending Crunch … or: Will the Cure be Worse than the Disease? (Column)

Olly Newland’s column July 2013

Stories about the the property market dominate the headlines more and more as house prices increase especially in Auckland and Christchurch.
Hardly a day goes by without another horror story about some huge price being paid for some house that should be worth only half that was paid.

Of course, this has happened many times before … but on this occasion, the boom is based on REALITY and not some speculative fever.

Back in the mid-1980s, for instance, there was a massive share market boom. There was no rational reason for the huge up-swing in share prices. There were millions of shares for all to buy — but the ‘fever’ had set in and couldn’t be turned back. Likewise, the property boom that coincided with it was based on nothing more than money coming off the table from the share market its owners wanting/having to put it somewhere else.

This time it’s different

There is a housing shortage in Auckland — and in Christchurch — and there is no way that the shortage can be corrected in a short space of time. Not weeks, months or even years.

A shortage of any product, whether property or pineapples, houses or hairspray, will always result in a price rise …  until the balance of supply and demand is evened out.

The Reserve Bank of New Zealand. What? Regulating the property market now?

Controlling Loan to Value Ratios (LVR’s)

The Reserve Bank is widely tipped (signaled, really, as is the way with these things) to bring in restrictions on mortgage lending — targeting borrowers with small deposits/down-payments seeking to a high proportion of borrowings.

As to be expected, there are howls from all sides saying that such restrictions would hurt the first home buyer; are essentially ‘unfair’; or will send vulnerable borrowers into the clutches of ‘loan sharks’ and other unsecured lenders taking advantage of the situation.

I take the opposite point of view. Anyone who lends money to someone who wishes to buy a home (even if the interest rate is high) should be applauded … because in my view, home ownership is vital to create a stable society. The ends justify the means.

The proposed measures may sound practical and targeted, but I am convinced that if actually implemented, they won’t make a blind bit of difference. In fact, they will play into other sectors of the property market … to their great advantage.

Recycling old ideas

There is nothing new about these sorts of restrictions. We had them all through the 1960s, 1970s and 1980s.

The property market then was just as buoyant (in patches) as it is today. Maybe more so.

All sorts of creative ideas where dreamt up to get around the ‘regulations’. It’s clear to me and others that if the proposed LVR limits are imposed, these old tricks (and some new ones, no doubt) will be dusted off and come back with a vengeance.

In those ‘bygone days’ the maximum that could be lent by way of mortgage was two-thirds (66% – the horror!) of the purchase price, or valuation, whichever was the lower. (Some things never change.)

The deposit required, one-third (33.33%, and yes, it was that precise) was impossible to find by many purchasers. So all sorts of mechanisms were used to fill the gap.

These included:
1. Getting the vendor to leave back a second mortgage – a  very common practice, then, which didn’t really matter because when the vendor went off to buy another house they got a second mortgage from their vendor and so on ad infinitum.
This practice was cheap, as the interest rate was usually very low. Interest-free vendor financed second mortgages were common practice. Using them avoided any tax on interest received. The use of this stratagem actually increased house prices, as the forgone interest was often folded into the end price of the house bought and sold this way.

2. Mum and Dad would often stump up with the difference if they had it. But if they didn’t have it, it was common for them to raise a mortgage on their own home and advance the money that way. Of course, it wasn’t always Mum and Dad, but an Aunt/Uncle or Great Aunt (hence all the jokes) or family friends etc who would lend whatever was required. Sometimes in return they would get a slice of the eventual sale price when the time came.

3. The use of credit cards came to the fore. Then, as now, banks freely gave away credit cards with unsecured amounts that could be drawn upon. It was not unusual at all for a frustrated home buyer or investor  to gather together five or six credit cards each with a limit of (say) $10,000 … and Hey Presto! they had another $50,000 or $60,000 dollars that could be used as a deposit filler.

4. Personal loans and small second- third- or fourth-mortgages from small lenders (‘loan sharks’ some of them, to be sure) were then, as now, freely available secured against furniture, cars or what-have-you. These were very useful, even at horrendous interest rates. Property is a numbers game. The high interest rates charged were regarded as nuisance-value only as actually buying a home was regarded by far and way, the most important factor. The headlines will make a great song and dance about it, but that’s what happens when markets are interfered with.

5. Solicitors nominee companies (and 2nd tier finance companies) sprang out of the need for ‘top-up’ loans. Business meets market needs. They did an excellent job of providing extra finance without the nonsense of the ‘two-thirds of valuation’ limitations.
Many solicitors nominee companies and finance companies did a first rate job in lending. Sadly, a number of the finance companies over-extended themselves (even scrupulously honest ones) in recent times — with the disastrous results which we all know about.

As Warren Buffett said:
“It’s not until the tide goes out that you find out who’s been swimming naked.”

There are still solicitors nominee lenders around today — so if you, or someone you know, is short of deposit, and if the Reserve Bank gets off the fence and actually imposes LVR limits, a few phone calls to the right people will hopefully soon sort the problem out.

6. Some very dodgy deals were also done to fill the gap, all of them highly illegal, but when there is an unfilled demand they are surely to be expected.
For example, inflating a property’s sale price to get a bigger mortgage was one of them. When it was settled, the vendor would funnel overpaid cash back to the purchaser.
It was particularly common to inflate the ‘value’ of commercial property by ‘hydraulicking’ rental returns and hence increasing paper values for lending purposes. (Don’t try this at home folks, just be aware of it.)

7. Buying a house together with a friend or family member got around the problem very neatly most of the time. A private arrangement would be entered into regarding who would buy the other out and when, or who would live where etc. The goal: own a property.

8. The low deposit house dealer was popular in segments of the market until recent times. Many of these dealers did an honourable job putting people into homes who otherwise couldn’t afford to buy.
It was usually done by way of long a ‘Long Term Agreement for Sale and Purchase’ which was, in effect, an extended settlement with prior access (kind of like Hire Purchase) … and at least part of the ‘rent’ paid down the deposit. (Other names given to this sort of deals include ‘Wraps’ or ‘Rent-to-Buy’).
Generous bank lending has largely removed the need for this type of dealer, but it looks like their ilk will be back in the market sooner rather than later.

9. Other top-up loans were often extended by employers, unions, charitable organisations, churches, lodges, clubs, and cooperative societies. Consider how you could make use of these in your situation if money is short.

10. Often a shortfall can be extracted from a bank using a guarantee from a family member or friend with assets, without the need for them to actually raise a loan. This is a painless form of assistance, the only catch being the need for the guarantor to stump up if a problem arises. (It does happen, so be cautious if you’re asked to act as a guarantor in such an arrangement.) While the property market is buoyant, problems rarely arise since a property can be sold fairly quickly if needs be.

Residential Rents: a Forecast

Rents have been largely stagnant for some years. This is due to several factors

(a) People emigrating to Australia, or elsewhere, leaving empty flats or houses behind.
(b) The huge number of dog-box multi-storey apartment blocks that were built which flooded the market.
(c) The large number of ‘wannabe’ investors who have been concentrating on the cheap rental end of the market and, as a consequence, have over-supplied that cheap rental market to a large extent.

Let me tell you, this is all going to change shortly. Here’s why:

• Emigration out-flow has turned to immigration in-flow. People who left NZ for better jobs and prospects are starting to come back, some of them with a decent bank balance behind them. Slowly but surely, they will put more pressure on the housing market, buying what would have been rentals, or competing with the locals for existing rentals.
(See: New Zealand records biggest monthly net migration gain in four years; house prices could come under more pressure – Interest.co.nz)

• Any change to lending policies (e.g. limiting LVRs) will see a large number of people forced to rent longer. Currently, many renters can scrape together deposit and get into a home of their home. If this door closes they will cling to their rentals for longer. Rents must rise as a consequence as renters resist giving up their home — even if it’s a rented one

Indeed renting for life maybe the last resort for many as is common overseas. It has its advantages but as you don’t even own the letterbox creating a nest egg for the future is going to be neigh on impossible for most.

Furthermore higher LVR’s will push up rents by restricting the supply of rentals as investors who do a mighty job supplying houses will likely be affected as well. Few investors = fewer rentals = higher rents,

• As virtually no more dog-box apartments are being built, the supply is slowly drying up. They are being rented out long term or sold to genuine home owners as their first step onto the property ladder. As the supply of these dry up there’s only way for rents to go: Up!

•  The huge increases in insurance, council rates, and the cost of much higher building standards since the Christchurch earthquake will flow through to rents. It has to. (It does make you wonder what has happened to all the premiums that have been paid for decades without claims, and why the need for the increases but there you are.)
The coming increases have been well flagged already and are coming true as many business and home owners are finding out to their discomfort. (See: Insurance premiums may double next year – Stuff.co.nz)

• Coupled with immigrants and ex-pats coming back home is the steady pressure from Christchurch residents and the surrounding areas, some of whom for all their admirable courage and resilience, are looking to Auckland to move to if given half a chance. (The current shakes in Wellington is not helping either!)

How much for a home overseas?

In my regular trips to Australia, the USA and Europe, I have taken a keen interest in comparing house prices here and in other countries.

The stories you hear about collapsing house prices and giveaway bargains for a handful of of dollars are true enough, but with one exception: They are almost always sited in newly created suburbs in the back of nowhere, or by lakes that only mosquitoes frequent, or along shore-lines swept by hurricane winds a million miles from anywhere.

Go to the main cities and you will be surprised.

In London NZ$1Million will buy you a small apartment. A car park is extra and there is likely no lift. For example and this Or the other extreme.

Likewise in Paris and New York. (By the way, as well as paying extra for lifts and car parks, you are lucky if you get a real kitchen.)

Take a look at this or this or this.

The foregoing are simply a taste. I suggest that you search the internet yourselves and compare. I am sure you will be surprised how expensive property still is in most of the main centres of the world. There appears to be little or no ‘recession’ anywhere in these centres … as can be seen in these prices. My own ‘on the ground’ research backs that up.

In my recent travels through Europe, the UK and the USA, I marvelled at the fact that the streets were full, and shops and restaurants were packed to the rafters everywhere I went. This is not how it has been portrayed in the media, so what gives?

If there is  a recession in Europe, the UK or the USA, then it must be well-hidden in the countryside because I saw little of it in the cities. Yes, I know Auckland and Christchurch aren’t these big cities, but the message is clear: New Zealand house prices are NOT overpriced at all. If anything, they are too cheap (!) and all we are going through is an adjustment — one that had to come – and nothing more.

It will take a while to taper off as such adjustments always do, but the ‘slump’ that is predicted by some, is nowhere on the horizon. Certainly, it will never be felt in the main centres. So my friends, you can buy in confidence in the certain knowledge that values in the main centres are rock solid.

A word of caution

It does not pay to be over-confident and act recklessly with your money. ALWAYS do a proper due diligence, get truly independent advice, and don’t think you are infallible.

Mid-winter, especially the month of July, is one of the worst times to be taking risks. (The other bad months for it are: January, February, March, April, May, June, August, September, October, November and December.)

Over the last fifty years the most frequent frequent question I’ve been asked is: “When is it a good time to buy”?
My answer has always been the same: “Last year”

Olly Newland
July 2013
www.ollynewland.co.nz
© 2013 Olly Newland. All rights reserved. See Olly’s books and audio products.


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Posted in News & Articles | Tagged | 8 Replies

8 thoughts on “How to Avoid the Coming Lending Crunch … or: Will the Cure be Worse than the Disease? (Column)

  1. It scares me how sometimes I agree with everything you say. Great column. Kiwis need to travel and see what the rest of the world offers. That’s why so many of them that do, eventually come back.

  2. Thx Olly and Team , very informative as always, when i”m back in the market i will be in touch..

  3. Thanks Olly & team,
    Really appreciate the tried and proven wisdom & experience of days gone by that you pass on.
    There always is a way to side step the politians smoke screans put up to apease the masses. We all know that the smart polititans invest in property.

  4. Too right about house prices in Europe. I have just got back from France. As always I talk property with anyone I can find. There the house prices are double Auckland’s. Sure they are cheaper away from Paris but who on earth would want to live someone where else the locals say?

  5. Pingback: As predicted, alternative sources of money enter the market … | Olly Newland website

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