The anatomy of a property crash

Bubble bubble toil and trouble. Every Kiwi who owns a home, or wants to buy one ought to understand the mechanics of a property crash.

Virtually no-one is predicting a property crash for Auckland or New Zealand. Supply of housing is far too tight for the numbers of people wanting to buy, the economists say.

But when it comes to financial markets, never say never. For hundreds of years investment markets have followed the same cycle of boom, slump and recovery, followed by boom, slump and recovery. No-one can predict how long the booms go on, or how sharp the slumps will be. Eventually, however, markets that have lost touch with the underlying economy will come crashing back to reality.

One common element about financial crashes is that most people, even the experts, don’t see it coming. That’s exactly what happened in the United States and resulted in the Global Financial Crisis. America’s banks, regulators and investments were blind to one of the biggest financial crises ever, which was thundering their way.

Whether it’s our property, or our investments including KiwiSaver, everyone who holds investments will eventually go through a crash and be spat out the other side. Surviving is all that matters.

Property speculation and property booms

The concept of property prices falling is often beyond the average Kiwi’s conception. Most of the time our housing markets rise steady as she goes. When things go wrong is where property markets hit “irrational exuberance”. When that happens, buyers start behaving speculatively, believing whatever they buy can only go up in value.

Housing market collapse

What makes a housing boom pop

Housing and share market booms often go onwards and upwards for far longer than most expect and prices rise far higher than anyone thinks possible.

Eventually it must come to an end and prices revert to the long term average. It’s a bit like gravity. You can only throw a ball so high before it comes back down to earth.

Supply and demand drives property market. Prices rise when there’s limited supply, or increased demand. Conversely if there’s an oversupply or a lack of demand prices fall.

That can happen in more than one way. Sometimes years of stagnating prices can do the deed. In that case prices revert to a more realistic level slowly, not suddenly.

Bubbles do sometimes pop unexpectedly. Just ask Americans about the GFC. The cause of that collapse was caused by a large number of owners being unable to pay their mortgages when their low introductory-rate mortgages reverted to regular interest rates.

We don’t have introductory-rate mortgages here in New Zealand. None-the-less a sudden or large increase in interest rates can be the pin that pricks the bubble. Other factors that can halt the exuberance include a tightening of mortgage credit, new government controls on borrowers, a sudden or drastic drop in demand, or adverse economic conditions leading to widespread unemployment and the inability to make mortgage payments. Some economists argue that changing economic conditions overseas could dampen demand here and have an adverse effect on our property market.

Compare Home Loan Interest Rates

Property: Why this time’s different

Never believe anyone who tells you we’re living in a new paradigm and this time’s different. It’s never true and eventually the market comes back to bite anyone that believes in new paradigms. The tech stock boom of the late 1990s was a classic case of this. Everyone said technology stocks were somehow different to other stocks. Those who believed the rhetoric lost money.

When a property bubble bursts…

There’s no reason why when a property bubble bursts you can’t just keep paying the mortgage. Most people do. The problem with a property crash is that the economy is often affected and people lose their jobs.

So one of the best ways to protect yourself is pay down your mortgage as hard and fast as you can. It gives you breathing space if your income vanishes. If the bank comes calling after a crash they’ll be after the people who can’t pay first and those with loan to value (LVR) ratios of over 70/80 per cent. If you’re paying interest only, or regularly topping up your mortgage to pay off the credit card or buy consumer goods such as cars, you’re at a greater risk in a downturn.

The other way to protect yourself is to become a contrarian. That’s someone who doesn’t follow the herd and thinks for themselves.

Finally, the more you can increase your financial literacy, the less at risk you are of everything from scams to property bubbles.

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