Beware The Greater Fool
Early in my investing career I was told a story that illustrated the concept of ‘the greater fool‘. It’s remained front and centre in my mind ever since and given the irrational behaviour of the Aussie property market, I feel it’s prudent to tell you about it as forewarned is forearmed.
The story told to me is an account of how, in the midst of the roaring (19) 20’s, a stockbroker left his desk in a stockbroking firm on Wall Street and caught the lift to the ground floor, possibly to make a lunch appointment with a colleague.
As he got into the lift he overheard two busboys, lower paid young men whose job it was to operate the lift, talking about how they had invested in stocks and made quick profits.
After hearing the tales of easy money and gossip of hot stocks, he immediately went back to his desk and sold down his share portfolio.
For many months later his peers scoffed at him for selling too early and missing out on higher profits as the market went higher and higher still.
But then the crash came, and with it much wealth evaporated.
When asked later how he managed to exit before the crash that sparked the Great Depression unfolded, the broker said that when he heard the busboys talking he realised that instead of operating on the back of solid economic fundamentals, the stock market was being bid up by irrational speculators.
Without understanding what they were doing, or exactly how the company they were investing in was going to make money, fool investors relied on another (greater) fool to come along and bid up the stock in order to drive the price higher.
The market peaks when the greatest fool buys. That is, there is no greater fool willing to pay a higher price than the fool who had just bought. Once that happens a crash is imminent.
(If you want to learn more about this concept then Google ‘greater fool theory’.)
The reason I’m retelling this story now is that I’m becoming more and more concerned with what I’m reading in the papers about record property prices and irrational behaviour at auctions.
Bluntly, how many greater fools can there be?
These record prices are not supported by the current or expected performance of our economy, job prospects, or rental yields. Surely we are in fool territory where values are being bid up on the belief that prices cannot, and will not, fall. This is simply wrong.
Consider Moranbah in Queensland. Rents for a 3 bedroom home in March 2012 were a whopping $2,000 a week. Attracted by high returns, median house prices rocketed up to $710,000 as investors outbid each other to get a slice of the positive cash flow action (median house prices in March 2009 were $176,435). It was happy days indeed.
Then the mining boom ended, and as jobs were shed, rents fell as housing supply exceeded demand. Prices followed and today a 4 bedroom home rents for $340 a week and the median house price is $372,000.
The principle here is that any housing market characterised by more investors than home owners runs the risk of a sudden price collapse when the reason for investors being attracted to that property ends causing them to need to exit quickly.
That is, if investors cannot afford to hold the property then supply can suddenly increase as properties are offloaded, and if there are not a sufficient number of buyers (which there won’t be if the majority of buyers were investors in the first place), then price can fall, fast as sellers compete to exit by slashing prices.
In respect to Moranbah it was the high rents that ended as the job market softened and vacancies increased, but the same holds true in respect to the removal of tax incentives (beware NRAS investors), or the removal of tax concessions (beware heavily negatively geared investors)..
Rarely do you see the reason for the change in conditions coming, but you will certainly feel the nasty effects of being caught up in a whirlwind downturn.
(As a side note I have to note that several prominent hot spotting sprinklers advocated buying in towns like Moranbah and have quickly moved on to other areas and have hushed up their failed projections, whereas investors who followed their advice are left with the nasty consequences.)
So the message is simple…
Don’t be fooled by the record prices being reported in the papers. Without the required economic strength to back it up, it’s shaping up to be more mania than genuine money making opportunity.
As I have said before, it is always a great time to buy a great property, but it’s fast becoming an awful time to buy a dud. Let the buyer beware.
So, enough from me… what do you think will happen to property prices over the next 12 months? Share your thoughts by leaving a comment below. I’d also love to hear the good, bad, and the ugly if you went to a seminar and were advised to purchase in mining areas.
And now for something a little more lighthearted…
A central banker walks into an Italian restaurant to order a pizza.
When the pizza is done, he goes up to the counter to get it. There the shop owner asks him: “Should I cut it into six or eight pieces?”
The central banker replies: “I’m feeling rather hungry right now. You’d better cut it into eight pieces.“
I’m off on a short vacation in Tassie. Until we speak again, stay safe and remember that success comes from doing things differently.
Steve
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“hot spotting sprinklers advocated buying in towns like Moranbah and have”
=> hot spotting spruikers advocated buying in towns like Moranbah [and somewhere else] have”
Still buying, but income/cashflow investing instead of CG investing (or speculating), in the suburbs of state capitals.
If it costs nothing to hold, or makes money, I’m able to hold it until the right time for the market to move comes. In the meantime, capital growth is less consideration but can be manufactured instead of organic growth.
Thanks for commenting.
I’m not saying don’t buy or invest, just be smarter and more strategic about your decisions, and don’t expect the rapid growth experienced in some cities to continue on a linear basis.
All the best,
Steve
Hi Steve thanks for your reminder. You have a big heart.
My view for the property market for the next 12 months is that it will go flat for majority of the capital cities. I don’t know enough about the regional towns to make a comment. But definitely with the biggest capex cliff and national income growth stagnant, this likely to put a cap on the housing capital growth. The government policy tighten up will certain see lower end of the market doing relatively better than the mid / high end.
I think a property is ok to hold for neutrally cashflow provided it may / may not give you an upside potential of growth. But not so good if holding negatively cashflowed for the hope of capital growth. As you are trading in a sure loss for a unsure gain. Also the rental yield can be bought and also made. For example, granny flat option for dual income and subdivision-build or subdivision then sold the land pay down debt to increase cashflow in that way , But those strategies requires multi skill sets to be succeed.
I don’t know how the market is going to move, it’s not likely a big dropping like some of the economist warned out there, because firstly I think the interest rate may not be easily increase in the near term ( not because to prompt a easy credit fiat money environment but more on preventing a debt deleveraging type of scenario) , secondly aussie dollar depreciate will help support the falling mining sector., hence support part of the loss of the national wealth through mining sector . but that is more on the macro side.. each suburb has it’s own micro side, in which if you are an local expert, you can take advantage and still making money in a downside market.
Good post! Thanks for making it. Steve
Thank you for a timely article Steve. Many people with cash burning holes in their pockets and desperate to invest. Sometimes much better to sit on the sidelines and wait for opportunities.
Google Moranbah and got this article from 2012 http://www.apimagazine.com.au/api-online/news/2012/04/property-bubble-bursts-in-moranbah-but-for-how-long
Ouch. Things have gotten much worse since that article, with rents and prices falling sharply.
I have heard reports of people who want to sell but can’t because they can’t afford to exit at market as there is a large shortfall on what is owed on the mortgage.
It is wise to remember that real life investing uses real life money. Losses hurt.
Steve
I disagree with the statement the irrational behaviour of the Australian property market. I believe the Australian property market is rational. Record low interest rates, borrowing capacity of self managed super funds, and a lack of housing supply all contribute to favourite conditions to invest in.
In reference to the comment “risk of a sudden price collapse when the reason for investors being attracted to that property ends causing them to need to exit quickly”, there must be a major political or socio economical shock for this to happen. Something irrational that nobody foresees for this to happen. It won’t just happen on it’s own.
I’m not sure what will happen over the next 12 months. Over the next 5-10 years I believe properties will have periods of growth and decline but overall properties will continue to rise. There is no bubble!
Thanks Nathan. It is good to have a variety of opinions, so disagreement is welcome!
In fact, I agree with your disagreement!
The thing about economic shocks is they only make sense in hindsight, although there were warning signs that went ignored. The tech wreck is a good example as earnings multiples went to ridiculous levels and we coined the term ‘new economy’ to justify it.
Of course that was silly as no business can sustain an unfounded loss beyond its savings and reserves.
There was a plausible story in Florida in circa 2006 about how there was going to be a flood of immigrants moving to the warmer climate, backed by demographics and trend analysis. Property prices were bid up accordingly, but it never happened and instead the huge foreclosures of the Great Recession triggered a price collapse.
I hope Aussie prices hold up well, but markets do tend to overshoot on the upside and downside and hence are prone to corrections at the extremes.
Perhaps let’s agree on the middle ground… that it is timely for all investors to reconsider their investing positions to ensure they remain congruent with their expectation of market performance and their time, money, skill and risk profiles.
Steve
Hi Steve
I met you the first time over 10 years ago in one of your
seminars.I’ll like to say thanks for your help and for always being
honest to your word. I don’t think I have ever seen you write something
like this before thou. But as a successful investor and having a huge following
I think it takes courage particularly in the business you are in.
As for me being a small time investor and following some of your simple techniques i do believe what you are saying is true. So I am selling a few house just in case and I’ll keep on doing things different.
Cheers
Thanks for your kind words.
Remember the time to sell is when you can do something that will make more money, sooner, with less risk and lower aggravation.
As I have written previously, properties that have not performed well recently should be closely scrutinised as if they didn’t do well in the good times, how much worse will they perform if the market slows?
Steve
The influence on the market are:
1.Interest rates
The RBA is stuck between a rock and a hard place. Hold, drop or increase?
If the RBA had any policy they would implement it. The key is the dollar exchange rate. Once the dollar is low enough it will allow the RBA to increase rates to offset the ‘bubble’ they now accept is developing. At the moment they cannot disconnect the economy (read everything other than property) from the property market. Prognosis rates will increase. Factor in the US rates, likely to go up.
2.Employment
The fudged figures say we are uncertain of the current situation, rule of thumb says unemployment is rising even with low interest rates. Increased rates will push up unemployment. Both investors and home buyers will feel the impact. Result demand slows. Prices and returns under pressure.
3.Investor profile
SMSF (SMURFS)are buying because they are long term and don’t see a risk to the property values, in the short term they are pushing up demand. Downside is they are connected to interest rats/returns/unemployment. If they are over exposed, then they will suffer in the short term. To much demand in too short a time period has created the impending bubble.
4.Other buyers
1st home buyers are squeezed even with such low rates, Market dynamics disconnect from 2nd home buyers, demand shrinks, long term prognosis is they will continue to diminish as active property buyers.
5.Returns
Are not huge, costs will increase as the rates go up. Pressure on prices. Market slows to stagnation, then possible run on devaluation.
6. Government policy
There is a stand off between the government and the RBA, there is a risk it will spill into the property market as both dig in their heels, Government “no property bubble” RBA ‘property bubble exists’ We are in risky waters with the Captain and the Navigator disagreeing on the bridge!
This is as good as it gets folks………..remember we can’t all be rich……….but we all can be poor!
Great analysis! Thanks for contributing.
Steve
“….holds true in respect to the removal of tax incentives (beware NRAS investors),….” Why would an NRAS tax incentive be suddenly removed during a downturn? Or am I just misinterpreting the statement?
Pls see my earlier blog on NRAS in the archives.
Steve
Great article as it provides food for THOUGHT. Thinking we don’t do enough of. Whilst some great comments supported by some good insights, I take the simple approach that when properties sell in under 2 weeks on a consistent basis – then the market is too hot which over-inflates prices. That cannot be sustainable. So the outcome is prices need to correct (be that drop or stabilise whilst CPI or whatever you want to call it catches up). Whilst not every city and suburb I see a lot of it esp in NSW (and Sydney) and took advantage and sold my Sydney property (you don’t have to sell at the top but you don’t want to sell on the way down!)
Interesting one of my catch phrases is perception is 9/10ths reality
Tonight on the news is that the Sydney market has over-cooked and prices will drop.
I believe the media (TV especially) is the busboys of the 1920’s.
Be good to review this in 6-12 months time and see who is right :-)
Thanks for commenting. Steve
I agree wholeheartedly Steve! We don’t think this can be sustained and in the area of Mt Waverley in Melbourne the prices being offered are well above what we would expect. As a consequence we put a plan in place three months ago and just this week we have sold three of our development properties that we have bee holding onto for three years. We have broken the $1M mark for a townhouse – can you believe it!! Now we just have to decide what to do next in our investing careers.
Excellent article Steve. Well put together.. I recall the older days when gold hit $800 from a miserable $300-ish in a rapid growth sessions and every fool and his dog dipped in to but an ounce or more and then the crash came. Is the market hot in Melbourne and Sydney today because the Asian buyers don’t need to borrow and are offloading bundles of cash into safe havens like Australia. That is my feeling seeing how many planning permits we get for Asian buyers on a weekly basis. Its crazy to say the least. They pay 20% more than market value to offload cash without doing a feasibility And when we do the permits and numbers their smiling faces turn to disappointment. Buyer Beware.
Thanks for the regular blogs these days Steve. I have never heard of this town you mentioned, “Moranbah in Queensland”. Could you please clarify a point thought. Are you saying don’t buy property now in Australia as it is over inflated in price generally and across the board are you saying that certain locations which do not have what I like to broadly call “good fundamentals” should be avoided. As for auctions i think they should be avoided at all times. I can’t see how auctions benefit buyers at all.