Q. I was wondering if you had read the Economist magazine's survey of the global property markets. The broad thesis is that sooner or later the property bubble, found in many residential markets worldwide, will burst, as all bubbles inevitably do.
Knowing your views on property, to what extent would you agree a similar situation exists in Auckland?
I have lost out twice in the past few months in the search for a rental property when I was not prepared to chase prices that did not justify the return.
Indeed, so similar are your views that I cannot help wonder whether you and Pam Woodall, the Economist's economics editor, are not one and the same?
A. My cover has been blown! In between assignments all over the world for the Economist, I slip back to Auckland once a week to pursue my real passion, Money Matters.
Seriously, though, that's perhaps why I thought Pam Woodall's articles on the housing bubble were really good. We're on the same wavelength. And her articles are worrying.
Comforting assurances that land is in fixed supply and so its value must rise, and that "bricks and mortar are something tangible", don't amount to much if prices rise too fast, she says.
"Housing is just as prone to irrational exuberance as is the stock market. The latest housing boom has inflated bubbles in several countries, notably America, Australia, Britain, Ireland, the Netherlands and Spain.
"Within the next year or so those bubbles are likely to burst, leading to falls in average real house prices of 15 to 20 per cent in America and 30 per cent or more elsewhere over the next few years."
Note that she writes of "real" house prices, which means they are adjusted for inflation. In the high-inflation past, when a housing bubble burst, unadjusted prices fell only a little, if at all.
"This time, however, with inflation so low, house prices will fall more sharply in money terms."
In Britain, she predicts, "significant numbers of owners may be left with homes worth less than their mortgages".
That's happened before in several Western countries, and it can get pretty ugly.
The survey didn't include New Zealand. So how should we react? There's no need to panic.
BNZ chief economist Tony Alexander is fairly comforting. He points out that house price inflation was considerably slower than general inflation in the late 90s and through 2000.
In the past couple of years it's been faster, but for a while it was just playing catch-up. Even today, it's not nearly as far above general inflation as it was in the mid 70s and mid 90s.
"Those calling for a big weakening in the housing market are still missing the ball," he says in a newsletter. "There is good underpinning to activity from low interest rates, migration gains, price momentum and a lack of alternatives attracting investors at the moment."
He expects immigration and economic growth to slow next year. "The housing market will also naturally be looking for some correction then. But at this stage we expect it to appear in the form of prices flattening rather than going down as such."
At first, Jason Wong of First NZ Capital - who studied the local housing market in response to the Economist articles - seems to be more alarmist.
He acknowledges that growth in real house prices here has been lower than the global average over the past seven years. "We're not in a housing bubble," he told the Business Herald's Anne Gibson.
But, he says, "house prices have got ahead of themselves in terms of rent and income".
After looking at migration, economic growth and house building, he predicts that real house prices in New Zealand will fall just under 10 per cent in the next five years.
Again, though, note that he's talking about prices that are adjusted for inflation.
If inflation stays roughly constant, under Wong's prediction nominal prices probably won't fall, although they won't rise much either.
One more view, from Paul Dyer of AMP Henderson Global Investors.
"To the extent that low US interest rates will drive continuing low (and maybe even lower) fixed and floating mortgage rates in New Zealand, the fuel driving the strength in house prices will remain in place," he says.
"However, investors should nevertheless exercise caution, as signs of excess are clearly evident in the form of high house price/income ratios, falling rental yields, surging mortgage debt levels and the increasing role played by investors/speculators".
Alexander also notes investors' growing interest.
A Westpac McDermott Miller Confidence survey showed a big increase in the proportion of people saying they would invest a $5000 windfall in real estate, he says.
"It does make one pause for thought a bit. If the investors are increasingly getting active in the market, perhaps this is a warning signal that there will emerge an imbalance between properties being offered for rent and the tenants coming forward."
Where does all this leave you, as somebody looking to buy rental property?
Let's assume that you're convinced this is the right type of investment for you - despite all my usual objections about lack of diversification, the hassles of being a landlord and the fact that average returns tend to be lower than on shares.
Picture your property value dropping and ask yourself whether you could weather that storm.
As long as you continue to be picky about what you buy, and you're prepared to stay in for the long haul, you probably won't come a cropper.
But if you're expecting to make a quick gain - or perhaps a bigger gain over the long term - perhaps you should look elsewhere.
The very fact that, as Alexander points out, other investments aren't particularly attractive at the moment suggests they might be better buys than property.
Buying what everybody else hates is certainly not a sure path to success. But it tends to be better than buying what everybody else loves.
* * *
Q. Your responses last week included a comment that it is safer to stick to a finance company name that has been around for years.
Perhaps, but ask for a copy of the prospectus (not just the investment statement) and check who now owns the familiar "name" and where it is lending your money before you invest.
Consider names like Nathans, Marac and Elders, all long-standing finance company names that have been around for years.
If you check, I think that you will find that they are now owned respectively by Vending Technologies, Pyne Gould Corporation and Eric Watson's Hanover finance group. I am not commenting on the suitability of these entities as owners, simply suggesting that investors make sure that they know who they are giving their money to.
A. Good point. So good, in fact, that another reader said much the same thing, only his list also included Broadlands.
Companies can change quite radically under new ownership.
In the past, when I made a similar comment, I got a rather angry response from a new finance company executive saying that old isn't necessarily good and new isn't necessarily bad. He's quite right, of course.
Still, while it's true that past performance is no guide to future performance for shares, property and most managed funds, a good track record certainly counts for something in the fixed-interest world.
* * *
Q. I noticed the 2.5 per cent "risk of losing your capital figure" in your column two weeks ago, too.
I think your correspondent last weekend is correct when he says that a BBB rating means a 2.5 per cent risk of default, but there is an average 30 per cent recovery of defaulted issues. Thus the risk of actual loss is somewhat lower.
In a note from S&P as at March 6, 2003, it says that the average likelihood of default over five years on investment grade bonds (AAA to BBB) is 1.2 per cent. On speculative grades (BB to C) the probability of default is 21 per cent.
Remember, though, the data refers to probability of default. Actual loss will be less due to some recovery of defaulted issues.
A. Thanks. All of this is probably sounding rather technical to many readers. But it's pretty important that those who venture into fixed-interest investments understand at least the basics.
Standard & Poor's credit ratings are well worth taking notice of. And a low rating is quite a worry.
Many corporate bonds and similar instruments get S&P ratings. AAA is the highest, then AA, A, BBB, BB, B and CCC.
When I looked at the report you're quoting, I was struck by how much more likely it is that a lower grade investment will go into default.
In the recent past, 3.2 per cent of BBBs went into default within five years. For BB, it was 12 per cent; for B, 27 per cent, and for C, 50 per cent. Half the C rated investments go bad. Horrors!
You're quite right that default doesn't necessarily mean you've lost all your money. But it's still pretty unnerving.
You can get information on ratings from www.interest.co.nz, stockbrokers or good financial advisers. Fixed-interest investments that don't have S&P ratings tend to be riskier than S&P's investment grade (AAA to BBB, as you say).
Some of them have Bondwatch ratings. But, as I've said before, those ratings are not as reliable, partly because Bondwatch uses only publicly available documents, whereas S&P probes more deeply.
* * *
Or post it to:
PO Box 32, Auckland