The trouble with these sort of cycles is that, much as we economists may warn about falling prices and display graphs showing this happening in the past, people cannot relate such pain to current or prospective circumstances.
They either believes prices won't fall or if they do they will be able to handle it. The former problem we can put down to stupidity. But the second is a well-known factor psychologists have delved into along with economists in the past.
When an asset price is rising, even if we accept the price may fall for a while in the future, we fail to accurately assess how we will react when it happens. At the time of purchase we overestimate our ability to take a paper loss through tenant income, and we completely over-estimate our true risk tolerance.
The previously booming sharemarket provides the most recent widespread example of this. We all saw the graphs showing the Dow Jones Index trending strongly upward over time, but overestimated our ability to ride through the inevitable rough patch.
Just look at the reef fish who sold out earlier this year and have missed out on around 30 per cent recoveries since.
This is what will happen this housing cycle. People will currently be overestimating their ability to weather the period of falling prices when it comes.
Some other commentators are couching this in terms of net equity positions. But the big killer is one's sleeping position.
Bolt upright in bed afraid of further paper losses is what causes a market correction to turn into a rout. We don't see a rout coming by any means. But some over-optimistic individuals are going to get burned.
Can we illustrate for the last-gasp buyers out there what can go wrong in housing with real life examples?
My challenge to you is to email me your story (if it happened) showing how you got caught out one way or the other by the last housing cycle or the one before that.
My own story is one of borrowing 80 per cent of the value of a house with the 20 per cent deposit raised entirely on four credit cards, and sleeping the first six months on a couch for want of any spare cash to buy a bed.
What is the sad part? I bought in September 1987 - one month before the biggest sharemarket crash since 1929.
I recall weeks of looking in real estate windows and buying the property on its first day on the market. I sold six years later for 3 per cent more than the purchase price, after adjusting for inflation, and along the way paid interest rates over 15 per cent.
A. Ever noticed how people love to tell stories of how the property or share they bought tripled overnight?
They must have also had some losses, but they are curiously silent about those.
The trouble is that we end up with a distorted view of how easy it is to invest successfully. Let's try to create a more accurate picture. Send your sad tales to
Tony.Alexander@bnz.co.nz
.
He's promised to let me run a selection of them in this column.
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Q. We were intrigued by your response a couple of weeks ago to the couple with a freehold lifestyle block and $100,000 of investment funds.
An alternative to trading down - selling an existing property and purchasing a less expensive property and investing any surplus funds - would be to enter into a home equity conversion or a reverse mortgage.
This alternative is widely used abroad, particularly in the United States, Canada and Britain.
Retail banks in Australia have moved to offer the product and we, Save and Invest, offer it here in New Zealand.
Indeed, our Finance Minister, Dr Michael Cullen, recently referred to reverse mortgages during his speech to the Retirement Commissioner's Savings Symposium in June.
The product works with owners borrowing against the equity they have in their property. The maturity date of the borrowing is deferred until the house is vacated and sold or the death of the owners. The owners retain the title to the property, we merely take a charge (i.e. a mortgage) against it.
The owners benefit from any gain in property value as this could increase the amount they may borrow. The product allows the owners to take a lifetime annuity, a set-term annuity or a single lump sum payment.
These mortgages are suitable as a means of improving retired couples' cash flows.
They can be drawn against properties held in family trusts, or against rental properties, enhancing the potential rental yield. And they may be used to repay existing mortgages with banks.
This product could also be used to finance larger spends (e.g. elective surgery, medical, mobility vehicles) without necessitating the sale of the homes or enduring lengthy and stressful waits.
There are many advantages of this style of product as opposed to trading down. These include:
* By staying in the existing home there is no need to change social clubs, doctors, churches, phone numbers, or lose contact with existing neighbours.
* Reduced costs (selling and relocating costs including conveyancing and real estate fees, utilities connection fees and fund manager charges when investing any surplus).
* Peace of mind as the owners are not investing into something that they are not already familiar with, or that is outside their normal risk profile.
* Comfort of continuity of the family heritage. The family may not be in a position to purchase the property today, but they may be at the maturity of the reverse mortgage.
Obviously there are terms and conditions, and these are included within our prospectus and investment statement. These are available from Save and Invest, free phone 0800 951122.
A. Thanks for the info.
This correspondent, and the following one, who is about to start offering a somewhat similar product, got in touch with me after reading recent letters about reverse mortgages or home equity conversions (HECs) or home equity releases (HERs) - we do need to agree on a name!
I asked both to give me some details about their products, and I've published their letters here.
Why am I offering these free ads?
I've been keen on the idea of reverse mortgages for years. There's a crying need for them, particularly in New Zealand where we tend to put much of our wealth into our houses.
As one typical reader wrote to me recently: "I would be a starter if such a scheme was on offer. It would suit our circumstances ideally".
It's important to note, though, that I don't know enough about either company's offerings to judge whether they are a good deal. They are often complex products, not easy to assess at a glance.
And while some people might baulk at, for instance, relatively high interest rates on the loans, others might be prepared to pay that price to get what they want.
I decided to let readers judge for themselves - perhaps with the help of a financial adviser, lawyer or accountant.
Here's the other provider - or rather soon-to-be provider.
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Q. I read a reader's letter included in your Herald column of October 18 with interest.
I have had a strong interest in home equity release products since I, as a young actuary, designed one for a client in London in the early 1970s.
It is very clear that a large proportion of the retired population in New Zealand have considerable assets in their homes, but are not enjoying the lifestyle that they could because of low levels of cash income.
Over the past two years I and a group of people have been researching the possibility of providing this product in New Zealand.
There have been quite a number of these schemes emerging around the world recently, particularly in Britain. The only ones that have been successful, in terms of sales, have been those that are simple and provide good value for money.
There are quite a number of extremely good products that are too complex and have failed because of that. There are also a number of schemes that are easy to understand but are expensive, reflecting the high costs suffered in turn by the provider. There are also some real horrors!
Although a good product should look simple on the outside it is usually very complex underneath. The key to being able to provide good value is through some very complex securitisation and risk-reinsurance structures.
We are very advanced in preparing to launch a home equity release product, but there is still a substantial amount of work to be done.
We are preparing to launch our company before Christmas, or in the new year.
A. This company doesn't want its name released just yet, but I will include contact details in this column when they are available.
Obviously, interested readers would be wise to wait until then, so they have two products to compare before making a decision.
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