Sydney and Melbourne: ticking time bombs

GUEST OBSERVATION

In my time of investing and purchasing for investors, I have the luxury of knowing that this current market movement is not normal, nor an accurate prediction of what they next five years will be like.

In fact, if anything, I am more bearish now about property than I have been for some six years, seeing that affordability and irrational exuberance have taken over rational thinking and sensible wealth planning.

But I have never actually been called a property bear - until now, that is.

I copped the comment last week at a luncheon, replete with bankers and wankers. I might also add that my fellow lunchers included people who exclusively made their money from giving obscene levels of credit to suckers (otherwise known as consumers) to go and buy more residential property.

After I gave someone a response that they clearly didn't want to hear, of course I was howled down. In their minds, there are so many people out there buying right now. The masses clearly can't be that wrong.

Can't they? Have they ever been that wrong before?

You bet they have. In fact, history demonstrates this repeatedly. I cite below one of the most extraordinary examples of irrational exuberance ever to present itself to an investor market.

Tulip Mania

The Tulip Craze of Holland truly demonstrates not only what a human mind can conjure up to consider an investment, but how obsession and irrational exuberance can take over even the most logical of minds.

The flower Semper Augustus was judged to be the most valuable flower in the Tulip family in the 1600s. So much so that in 1630 one person paid 3,000 guilders for one tulip bulb.

Do you know what the value of a guilder was in 1630s? Well, me either - but I can tell you that three months later, a Rembrandt painting sold for 1,500 guilders. Importantly, Rembrandt (1606-1669) was not one of those artists who were popular only after he died!

Moving on to 1633, records show that one investor swapped traded three tulip bulbs for a whole property. In the ensuing years (1634-1673) the value of tulips then ran up by another 1000%.

Then, one day, at a non-descript tulip auction, one large buyer didn't turn up to claim his prized tulip trade. Upon witnessing this, other buyers baulked. The ensuing panic saw the value of tulips return to their intrinsic value in less than a week: zero (or at least, the nominal value of just a beautiful flower).

The government of the day agreed to protect people's bad investments to the value of 10%, a story that is repeating itself now. That is: privatise the gains, but socialise the losses. Sometimes, we never learn!

Now, in the above examples it is true to say that there was profit to be made from the trade at every stage except for the when the last investors jumped in.

There is no denying that many of you already have and still will make money from property in 2014-15 in particular segments of the market. But as time passes the risk increases that you may just be the one holding the bomb when the fuse runs out.

I also understand that tulips aren't property. Of course, property has a utility value of some considerable price (a roof over someone's head), but we still need to keep in mind that it is the same "animal spirits" brought out tulip mania that are playing itself in our property market.

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Investors keep bidding the prices of property up, so much so that they can reflect far more than the actual value of the property.

I find it almost strange that I am writing this article at the time when my past simple calculations (see paragraph 6) have come about, with average Sydney prices now coming in at $800,000; only $500 off my prediction.

With an interest rate decrease given to consumers last August '13, it is true to say that the potential to bid homes even higher is likely. But not by much. Ask yourself how much more that $40-$50 per month can add to a house price. Very little, I would imagine.

But keep in mind, my calculations used a logical and arithmetic method to it. Logic and arithmetic don't come into the equation when "animal spirits" take over.

And that's why I think property is going to go higher, and produce a lot of pain for those latecomers (still) piling into the Sydney and Melbourne property markets right now.

I am not happy about it, but it seems the inevitable next step for the market to take. Call it irrational exuberance.

The fact remains that the greatest risk always presents itself when the the most people are in the same trade - all expecting it to go up in perpetuity.

Any decrease in this demand in the future can only decrease price expectations.

Is there still opportunity?

The only opportunities I see (at all) for real capital growth are north of the New South Wales border. In the same article mentioned above, I observered that Brisbane and the Gold Coast presented real buying opportunities over 12 months ago. In fact, they were perfect buying then. It's true that some of the gains have been lost to modest capital growth since then, but opportunity still abounds while so much attention is focussed on the overbid Sydney and Melbourne markets.

And for those who still carry that foolish notion, "I want to live near my investment property, so I can check on it", may I ask how you might feel in 2016/17 if you had to drive by that same property to be reminded that you were in a negative equity position. Wouldn't that be ironic?

Brisbane - I still love it. As Australia's fastest growing capital city (yes, it has overtaken Perth some time ago now!) and Australia's 3rd largest city, for me still stands out as a bastion of value.

For Gold Coast, I don't deny the volatility that this presents over a long term investment period. All the same, for those that can avoid the high rise district and cope with this long term volatility, the seachange effect is something that I expect is occurring in earnest now.

Don't forget, in 2001-04, when prices doubled in the southern states (especially Sydney and Melbourne), the Gold Coast (and less so Brisbane) became a beneficiary of this as migration led by affordable housing made the move north a rational decision. As the sunny state hit prices only 10% below Sydney/Melbourne leading up to 2007, the rationale for a 'seachange' diminished.

With southern states house prices edging $800k and $700k respectively now, yet with Brisbane and Gold Coast at just over half of that, are you telling me that history is not about to repeat itself?

I'd at least put down a few tulip bulbs to bet that it will.

Sydney and Melbourne at record highs, or the northern cities on the way up. What side of this trade are you going to get caught on?

Oh, one more tip. If you think that something like Tulip Mania can't strike again, I have two words for you. Bit. Coin.

Gavin McPherson is the chief executive of Oasis Property Group. His book, 'Value Investing in Property - What would Warren Buffet do if he was buying property in Australia?', takes aim at the get rich quick property experts and explains instead the sturdy path to wealth through value investing in property.