Q&A: Is a Depression coming?

Dear Mr. Newland,  
I have read your latest column which has given me hope, however, I have also read Harry S. Dent’s latest book about The Crash Ahead. His information is based on demographics and spending patterns; and the strategies for inflation vs deflation are opposite. How do you think the slow down that he predicts will impact here in New Zealand? If globally, we are entering the start of a depression, what is your prognosis for New Zealand? Thank you for considering my question.  
Sincerely, Bill  

Dear Bill  
I don’t there is the slightest chance of a depression. The most likely scenario is just muddling ahead going now no where for a few years. Just behind that is hyper-inflation which is big risk- because if economies do not improve governments will print their way out of the problem. I have seen this time and again. Inflation is always the lesser evil as compared to deflation or stagflation.  

While Mortgage Rates Are Low – Borrow More! (column)

Olly Newland’s column October 2011

This may seem a little contrary to popular thinking at present but by being counter cyclical you will have a greater chance of profit and wealth creation than when interest rates are high.

A few weeks ago I spoke to a group about investment. I spoke mostly about seizing opportunities when they arise and, with my usual arm-waving, talked about how the volatility in the market is a great chance for all investors and home owners. I probably got a little carried away (as I sometimes do) because I find the volatility in the market very exciting at times.

At the end of the talk someone in the audience asked me if there were any opportunities when you had a mortgage (or mortgages) to deal with.

The common practice used by most is to apply cash to reducing debt — and not save it for investing. There are exceptions, of course, such as KiwiSaver and the like, but the general rule stands that debt should be paid off first before investment begins.

So the person in the audience, feeling a little awkward no doubt, asked me how he should deal with his debt.

Yes I agreed that money is cheap these days — so why not borrow it and then borrow some more at every chance while low interest rates last?

Some stick-in-the-mud advisers (with respect) say differently. They suggest taking the opportunity of low rates to accelerate repayments of principal and interest. After all, they say, when interest rates fall and you keep up the same monthly repayments, it will have the effect of paying off the mortgage more quickly.

When money is cheap it is easy to get carried away and lower repayments as well … so you have more money in your pocket to spend on other things.

The problem is that principal payments make up such a tiny portion of any loan that it’s hardly worth the effort. Even though it’s true that a component of each payment you make is applied to reducing the mortgage it takes years to make any sort of dent in the amount still owing through your regular payments.

Interest rates are down and ‘down for the count’ … and let me go out on a limb here and say I believe that low interest rates are here to stay for the foreseeable future- as has always been the case in most Western economies for decades and especially these days.

One day interest rates will rise … but that day is far-off — UNLESS, of course, we get hyper inflation. If that happened it would not occur overnight and there would be plenty of time to change course (and, indeed, profit mightily as hyper inflation carries all assets up in value as money devalues).

Home buyers and property investors see low interest rates as a great opportunity to trade up to a bigger and better house or investment and — despite what some say — that is how it should be.

Worrying about future interest rate rises is a hiding to nowhere. Should interest rates RISE it means that the economy is improving or inflation is on its way which means higher wages and greater profits which should easily make up any difference.

The opportunity to get cheap money now carries little threat to buying on tick and loading up some debt — if done carefully — and it can bring great rewards.

My advice

My advice is to borrow more and use the money to carefully upgrade your home or investment property. A dollar well spent in upgrading can return up to ten dollars in profits — and it’s a darn easier way to make money than trying to pay down a hopeless debt.

Put another way, increasing the value of your property is the same as decreasing the mortgage. e.g. if you have a $500,000 house with a $250,000 mortgage then your gearing is 50%. Not bad, but it could be better.

If you spend a prudent $50,000 on upgrading the kitchen, bathroom, or whatever and the property ends up being worth (say) $750,000 (this is pretty easy to do. Ask any property investor) then the mortgage — still at $250,000 against a $750,000 house is now only 33% geared.

Extra borrowings, even at the current historically low interest rates are being covered by rising rents (something I predicted over 12 months ago). Look at the latest figures for the Auckland region. Some rents have risen by as much as 40% … and this is just the beginning as the housing shortage deepens:

Crockers September research (click to enlarge)

Crockers latest research

Also: remember paying off a mortgage has to be done with tax paid dollars. Increasing the value of a property is tax free in most cases. Which one, then, is the obvious choice?

Before embarking on any such plan get your friendly Registered Valuer to give you an estimate on what your property is worth as it stands today and what it would be worth when you do the upgrade you are planning.

Be prepared to compromise to get the biggest bang for the bucks as possible. (This is a big subject.  Contact me if you want to learn how.)

Now is the time to increase your mortgage, NOT to buy ‘toys’, but to reinvest into the home or investment through improvements and ultimate tax free capital gain.

This is not the time to fall asleep and forget the opportunities out there. In fact it’s time to wake up and increase the value of your investment as much as possible … and reduce your debt the far easier way.

I have had countless number of clients who have followed my advice and seen their homes or investments climb quickly in value — outpacing the market easily — even in these quieter times.

A few years ago everyone was throwing money at real estate and just wanting values to go up without any effort  on their part. (No wonder so many came to a sticky end.)

Now a relatively few well spent dollars (borrowed or not) can bring the same rewards with minimal effort. The aim for most renovations is to complete them quickly —ideally inside 4 to 6 weeks. With that it is quite possible to get that gain more quickly and more certainly then by blind speculation or naïve hope.

Time is of the essence. Avoid major rebuilds and stick to once-over-lightly makeovers — then you will see your equity increase in leaps and bounds … as your debt ratio reduces.

And one more bit of advice before you rush out to you see your bank manger: Increasing equity (viz. decreasing debt) requires a fair amount of hard work and dedication on your part. There is much to learn if you are not experienced. With the right coaching and right advice virtually anyone can achieve great results. It takes lateral thinking and the will to succeed

From the files – A real life story

Let me give you a real example from my recent files on just how increasing value creates equity and cash profits.
Sue and Brian, with a small loan from their elderly patents  found a very nice looking 3 bedroom plus wash house brick and tile 1970’s home in the suburb of Glenfield on a reasonably level full site of 620M2 more or less.
Brick and tile are always popular as there is no concern over leaks or shoddy workmanship and so is a full site.  These types of houses are in great demand as they tend to be easier to renovate being made of relatively modern materials.

It was for sale in a very shabby run down state  after being rented out for years.  The suggested asking price was $395,000 and with my advice Sue and Brian put in an offer of $340,000 which was rejected but came back with a counter offer of $370,000.

With my advice a registered valuer was employed who valued the property at $380,000 as is, but with the note that similar fully renovated houses in the area were selling in the high $400’s-to mid $500’s. Brian and Sue put in a counter-counter offer of $359,000 and a deal was finally sealed  at $361,500.  A mortgage of $300,000 was arranged and then Brian and Sue moved into the house and got stuck in. Within 6 weeks ( a little longer than anticipated) a new kitchen ( pre made variety) and bathroom were installed, the place repainted inside and out, floors polished or carpeted a double carport erected (always a good move and cheap), plus new lighting, gardening and minor repairs and major scrub up.
They also turned the wash-house into a study — good move.

Total costs $35,000 plus their own labour.  A new valuation was obtained suggesting $525,000 so it looked like around $100,000 equity or profit was created. Brian and Sue listed it for rent on Trademe and were staggered to get 40 replies within 3 days. This sort of response told them that they had created something a little special so they decided to sell it, which they did within 2 weeks achieving  a sale price of $500,000 clear. Not bad for their first effort and I am sure they will do even better next time  – and the time after.
Indeed as I write Brian and Sue are now onto their second property also on the North shore and if they keep this up they will earn enough to effectively double their annual income.

While it is true that doing up a house while you a still living in it  is not easy, the rewards more than make up for it.

Olly Newland
October 2011
© 2011 Olly Newland. All rights reserved. See Olly’s books and audio products.

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Interview: Hard assets are better than stocks…

Olly Newland interviewed by interest.co.nz’s Bernard Hickey about why hard assets such as property are better than ‘paper assets’ in an era of share market volatility and possible hyper-inflation.

from Bernard Hickey’s introduction at interest.co.nz:

“The share market is a den of thieves and is not for the small investor at all,” Newland said. “They’re tired of having their share portfolios messed around with and they’d like to get into something hard that they can see in the morning and is still there and has the same value from one day to the next.”

US Fed – no interest rate rises till 2013

US Fed to keep interest rate at record low

The Federal Reserve has said that it will likely keep interest rates at record lows for the next two years after acknowledging that the US economy is weaker than it had thought and faces increasing risks.

The Fed announced that it expects to keep its key interest rate near zero through mid-2013.

It has been at that record low since December 2008. The Fed had previously only said that it would keep it low for “an extended period.” …

NZ Herald

With this announcement we should be able to kiss goodbye to any more interest rate increases for some time to come. Unless inflation roars into a life (a good possibility, as I discussed here) interest rates are here to stay or even fall.
Already our major banks have a announced mortgage rates cuts, only a few days after putting them up. There’ll be more.
Allan Bollard who threatened to raise interest rates with the next OCR must be staring into his coffee wishing that the earth would swallow him up.
With low, if not zero interest rates being the new norm in much of the western world, there will be a rush to the NZ dollar because our interest rates are “high” by comparison to others. This may be a problem to exporters … but a bonanza to every one else.

This is all good news for property. If you listen very carefully you might just hear, way off in the distance, the first tentative whisperings of the next property boom. Keep listening. I’ll swear it’s getting louder.

Welcome To Hyper Inflation

In several previous articles I have warned readers of the risks of hyper inflation (otherwise known as the “speculators friend”) and here we have a respected author saying the same thing.

Inflation can be a blessing for investors as it increases assets prices and thereby reduces debt proportionally.

But it has to be handled carefully, as greed and fear can take control and make people spend wildly in an attempt to keep up with inflation.

Sure, interest rates might rocket, but who cares if you pay 20% interest but make 100% capital gain? You think I’m joking? Nope.

That’s exactly what happened in the 1980s — and human nature hasn’t changed one little bit since then.

Roger J Kerr challenges RBNZ view on inflation – thinks it is being driven by different factors (www.interest.co.nz)

June 27, 2011 – 12:57pm, Roger J Kerr

There has been much analysis and debate in New Zealand over the last six months as to why this economic recovery out of recession back to positive GDP growth is fundamentally different to all other economic recoveries.

The argument goes that this it is entirely different this time because the pick-up in the economy is not consumer spending-led and therefore the inflation risks stemming from stronger growth are less concerning.

Households still have too much debt on board to go crazy buying new fizz-boats, TV’s and holidays homes.

Therefore there is a valid argument that RBNZ can delay increasing the OCR as the inflation risks are different.

I don’t agree with this thinking at all.

The RBNZ gurus like this line of reasoning as they have always seen our inflation risks coming from the demand side of the economy with excessive consumer demand fuelled by housing prices/credit expansion. For this reason the RBNZ are not likely to lift the OCR and return monetary policy settings from ‘super loose’ to ‘neutral’ until they see retail sales, house prices and credit growth increasing significantly.

They don’t see the inflation risks occurring until the demand side increases.

The reality of the NZ economy is that most of the inflation comes from the supply side of the equation, be it commodity prices, oil, rents, electricity or building costs.

Price increases from these sources can still push annual inflation above the RBNZ’s limit of 3.0%.

However, the big question is whether pushing interest rates upwards to slow consumer demand will have any impact on these supply-side sourced inflationary pressures.

Probably not.

Herein lays the dilemma of only relying on monetary policy (interest rate changes) as the sole controller of inflation in New Zealand.

The core funding ratio regulation on bank borrowing does provide another lever for the RBNZ to pull, however again this is all about restricting credit growth to the feared residential property sector.

What is the RBNZ doing about the supply-side inflation risks that will potentially cause them to breach their 3.0% inflation ceiling next year?

The answer is sweet bugger all!

The RBNZ are mandated by the Government of the day to control inflation between 1% and 3%, however they seem to think it is someone else’s responsibility to push for proper competition policies and control public sector price increases. Most of our inflation continues to come from these two sources, but you never read about this reality in the RBNZ’s Monetary Policy Statements. Their view of the sources of inflation and how you address those pressures remains far too narrow in my opinion.

Until we have a wider inflation control mandate for the RBNZ to highlight the true sources and prompt change we will have sub-optimal management of inflation in this economy.

If I was the Governor of the RBNZ, I would currently be worried about the following sources of inflationary pressures outside the obvious food and petrol price increases:-

- Inflationary expectations increasing from the high headline inflations rates of late.
- For the last 10 years China has exported deflation to New Zealand with price decreases on imported consumer goods. Massive wage increases in China has now ended this deflationary phenomena.
- Wage demands and settlements will be sharply higher over the coming 12 months as workers seek a catch-up on the zero increases of recent years.
- Building costs have to increase as local construction industry resources cannot meet the Christchurch rebuild demand.
- Rents are also likely to continue increasing as wages lift and residential property construction remains well below historical averages - that is, housing shortages.
- Current low capacity utilisation in the economy will not last much longer as production is ramped-up by agriculture exporters and manufacturing exporters selling into Australia.

Add on constantly rising electricity prices and local body rates and the end-conclusion is elevated inflation risks.

I re-read the 9 June RBNZ Monetary Policy Statement and did not get the impression that these aforementioned inflations risks are well recognised and understood.