Monday, June 24, 2013

The End of "Always Buy, Never Sell Property"?

Let me start off this post with a paragraph reflecting on the latest chatter before I lead into the main subject of this post. The year so far hasn't deviated too far from how I thought it would end up. The USA has been talked up to recover faster than the expectations of lots of people and the EU is still around. Where I've been wrong is the underperformance of emerging markets. I had thought that a recovery in the USA would pull along the rest of the global economy in tandem. That however, has not occurred as China remains soft, pulling lower commodity prices, and together pulling lower other emerging markets so dependent on commodities like Brazil, Indonesia, South Africa. In addition, the latest volatility in the market has arisen due to the sudden spike in treasury yields due to just a few words from Bernanke in reference to the end of QE3.

I've been wary of the end of low interest rates for as long as 2-3 years ago (I have so many posts on this) so this speech was of no surprise to me. What did surprise me was the reaction of emerging markets. For example, the Philippines, Thailand, Turkey and China have all been in free-fall. China itself is a bit of a domestic issue due to its financial markets still being largely closed, while Turkey is due to some domesetic unrest. However, I didn't foresee the interest rates being the real killer for the other emerging markets. I didn't realize some punters have been borrowing on low-US interest rates and investing in these booming emerging markets. In a sense it's a carry trade of some sorts and an idea that just slipped my mind in analyzing some of these smaller emerging markets.

This has really lead me to think even further on this issue of interest rates which are so critical. Asia property has risen to new and newer heights on the back of low interest rates (see my post on HK property in 2009). When I compare property in Asia to such established places like London and New York, the alarming closeness in prices is, well, alarming! Fundamentally speaking Asia property shouldn't be per square feet as expensive since GDP/capita really isn't quite there yet. You can certainly debate all day with me on this. Nonetheless, this relative overvalue of Asian property actually isn't what I really want to talk about in this post.

Rather, it's that property as an entire asset class should fall or stall over the next decade. My attack is on the conventional wisdom of "Always Buy, Never Sell Property". And it's entirely predicated on the contents and trends of this chart below:

Source: Yahoo! Finance

This is the chart of the 10 year treasury yield over the last 50 years. The thing to take from this chart is that it's been on a downward trend for the last 30 years. Most of the people alive today  giving you the advice to "buy and never sell property" have been living in a generation where the interest rates have continued to fall. With expectations that interest rates will keep dropping steadily it makes complete sense to buy property. Easier credit = easier to borrow money to buy property = higher housing prices = more inflation. This cycle more or less continues as interest rates continue to fall. I guess some places like Japan (prior to Abe-nomics) refute this logic, but for the most part it's generally true.

And then if the reverse happens, as the market is now slowly starting to expect (i.e. tougher credit coming in the form of higher interest rates), property prices should have a tough time climbing. The path of least resistance for property prices would be on the downside in that circumstance. I was surprised at the market's volatility and reaction of late to Bernanke's comments - I thought everyone knew that interest rates would come up. The enormous positions entwined in the low interest rate environment is certainly deep. Housing as an asset class is one of them.

This idea that real estate prices could have a persistent bear market is a challenge to conventional wisdom and there are certainly plentiful of counterarguments to this challenge. For example, reasons why real estate markets will always rise are usually due to people always needing to live somewhere, people continue to urbanize, etc.

My take against the  conventional wisdom is that credit markets are so key to all of this. Low interest rates lead to a lot more people participating in borrowing money to buy property. The reverse would lead to the exit of these buyers unable to buy with cash, which is in fact a lot of people in the world, and especially in emerging markets. In a world with no credit, housing prices should go to a level where cash buyers can afford to buy. And looking at today's Asian property prices, they are a long, long, long way from a level where cash buyers can afford to buy. The implications for the Asian markets are far and wide as most of Asian wealth created over the last decade has come from property.

Lately the treasury yields have spiked and people are rushing to the exits already of all easy-money related trades. I'm sold on the idea that yields will come up over the longer term. However, I actually don't think in the short term they should come up all that much so fast because the Fed is still pumping money into the system. The American recovery has been a bit over hyped (I believed in it too but at this point I think the media has exaggerated it too much). Fundamentally I do believe that this is a preview to the start of an eventual upward trend of treasury yields. The implication to global markets are far reaching and highly impactful. Buyers beware!

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