Keep INVESTING Simple and Safe (KISS)
****Investment Philosophy, Strategy and various Valuation Methods****
The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
In the UK after a breathtaking boom, property owners have watched prices fall 10 per cent since the third quarter of 2007. Those less fortunate have experienced declines of 20 per cent or more (especially in the north).
Swingeing government budget cuts are yet to hit an economy already lacking confidence and there’s no shortage of fear-inspiring newspaper articles. Gloomy times indeed.
“North may never escape negative equity,” shouted one headline in The Times earlier this month. The paper cited a study by Standard and Poor’s that showed, “One in ten homeowners in the North West is in negative equity, trapped in properties worth less than the amount they owe and vulnerable to repossession as the public sector sheds jobs.”
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But what really caught my eye, particularly in light of my April column, Property valued properly, was the following (italics are mine):
“Savills, the estate agency, argues that in a new era where mortgage finance remains perhaps permanently constrained, some low-grade properties in the North may never recover, whatever the direction of prices elsewhere. Such dwellings may be valued only on the rental income they offer to landlords, as the would-be owner-occupiers of such homes will be denied finance.”
The notion that properties may be valued “only on the rental income they offer” is presented as something of a revelation. To me, this is indicative of an asset class where prices have (or had) broken free of economic reality. Now they are returning to it.
At universities all over the world, finance students are taught that the value of any asset is the stream of future income it will provide, discounted back into today’s dollars. Most professional sharemarket and bond investors would concur with this rule.
Even industrial and commercial property investors recognise that the income stream is of supreme importance. But when it comes to residential property, the same rules seem not to apply.
Without rehashing the arguments for and against Australian residential property being an exception to the laws of finance, to me the UK provides an interesting case study. Three and a half years ago, many Britons were as adamant as Australians are today that “property never falls”.
On a recent trip I was assured that “property in the south-eastnever falls” (my italics); an illustration of how hard it is to escape from dogma once it becomes entrenched in people’s minds.
The Australian property price debate is divisive and emotionally-charged but, whatever your view, it’s foolhardy not to acknowledge the possibility that capital gains may not always be counted on to bridge the gap between the rental income (or rent saved) and a fair return on your capital.
In many cases, those who bought during the UK boom, accepting low yields in the hope of future capital growth, are now living with the consequences of “negative gearing” and nasty capital losses. It’s not a pleasant combination.
My advice is not necessarily to avoid the property market altogether but to ensure that any debt you take on (as an owner-occupier or investor) can be easily serviced should economic conditions deteriorate. As my old scoutmaster used to say, it’s best to “be prepared”.
This article contains general investment advice only (under AFSL 282288).
Greg Hoffman is research director of The Intelligent Investor. For more Intelligent Investor articlesclick here.