Sunday, February 7, 2016

The gorilla in the investment house.

I've had so many people over the years tell me houses only go up in value. These same people often listen to investment advisors that tell them how to leverage their real estate investment to the max and end up with a string of investment properties, with each property paying itself off.
For the past thirty years of so, this has largely worked. I personally know people who had very little and started buying up country real estate using this investment model. Last I heard, they have over thirty properties.

The question to be asked though is not "what happens if it all goes well?". The investment advisors, who make commissions on lending, will tell you all about what will happen if it goes well. No, the question to ask is like the gorilla in the room. Some people know it's there. Some people are worried it could be there. Some people have really nice rose coloured glasses from reading investment books and pumping up their expectations at seminars, and barely acknowledge it could be there at all. But it's there alright. Risk always is there. And this time, it looks like the gorilla could cause a bit of distress; perhaps even wreckage.

Before you read the attached stories for a quick survey of what some pundits are saying, think with me a moment. Let's consider a scenario...

   You bought your first home and we're paying it off happily when someone convinced you to invest using equity of that home. Let's say you left 10% equity in your home so you could get the investment property you wanted.
  Let's suppose that over the next three years you managed to procure three more properties, each with just ten percent equity.
   Then two years ago, when you saw some bargains, you thought carefully and stretched for one more property, thinking "This is my last!", and "I've got all I needed now". You were satisfied knowing you had a sustainable investment strategy with brick and mortar investments you could control.
All is good in the land of perpetual gains.
Think a bit further on the scenario though. How much would it take to collapse the whole thing? I'm not talking about a drop in wages or unemployment. Maybe just a call from the bank to say you're a bit over-exposed due to a drop in prices.
Let's say you experience a five percent fall in property values. That would leave you with only five percent equity. If the bank wants you back up to ten percent, (or heaven forbid twenty percent) you would need to sell half of your houses. And that pre-supposes you get market value for them on what maybe perceived so now being a falling market.
Now let's consider a ten percent drop. This would remove ALL EQUITY from ALL YOUR HOUSES. You would absolutely be back to square one. Our maybe worse. I can tell you as someone who has suffered loss due to a bad neck injury, that when you have lost the family home, it's not easy to get back in the market. Prices are now gastronomically high, and having a family to support makes it so much more difficult that when you were first married. Do you think you could negotiate or sell your way into keeping the family home? I hope so.
Go back to that five percent drop, but consider the bank could ask you to find twenty percent equity in your family home, and maybe one investment home. Just for safety. You would be very lucky indeed to keep the family home and one investment property in this scenario.

I hope I haven't scared you too much. It's just that the USA owed so many trillions of dollars to the global banks that it never repay them, and many experts are saying the 'fiat currency system' of the petro-dollar WILL totally collapse. China is the same, but instead of spending the money on entertainment, holidays and new cars, the Chinese have spent it on infrastructure. The truth is, there are only two countries left in the world without a central bank at this stage, which means we're all in the same boat. Argentina is in a horrible mess, as are some other South American countries. Africa is a basket case. Europe has shocked everyone, making front page news with its financial mess, and even the Saudis seem to be in trouble too.

What's the point? The point is we've never been here before. The point is we're looking worse on a global basis than any other time in modern history. It's bad for the governments. It's bad for corporations and retailers. It's a real squeeze for dad's and mums. Canada, which from memory is a first world country, is getting really messy, and food prices are going up. We in Australia can probably expect the same.
If a fall in house prices is accompanied by a hiccup like adverse weather, or (God forbid) a storm in the financial world, people who are heavily leveraged will be up to their armpits in dung and without a space to dig themselves out.

So read the articles below, even if briefly, and if you are 'heavily leveraged', think really seriously about reducing your exposure so you can cope with 'adverse events'. I'd rather be remembered as the guy who wrote a warning than the guy you ignored and lost everything. And I'd rather be disagreed with our even poked fun at than not say anything when the signs are so clear.
Lastly, it may take a few years yet before the global financial system makes a larger adjustment than we've ever seen. This will be due to the collapse or complete reengineering of the USA and world trading system,  but any expert without their head in the sand (or stuck somewhere else unpleasant) will tell you there's probably no way to avoid a global restart at this stage. The only question is WHEN. Perhaps this magazine cover from some years ago could be a clue?