How to spot a housing bubble: Bill Moss
Long-term strategic planning has always been one of my passions. To me, thinking ahead, being observant, asking questions and working out where the world is going, whether it be economically or socially, are basic, vital skills.
Take Dubai for instance. I first went there in the early 1990s and driving around at night, the first observation I made and the first question I asked myself was: “Why are only 20% of the lights on in all the residential buildings?” Talking to people who lived there, I soon discovered most residential properties were empty because they had been bought as second homes by wealthy people who lived in other parts of the Arab world in case of problems in their own countries, as a hedge against revolution, or as a place to keep a mistress. I left without wanting to invest in Dubai.
I have always believed that no one should ever invest in anything unless the fundamentals are right. If the people who pay the rent or borrow the money to purchase a property cannot afford to keep up repayments, then a property investment fails. After a global financial crisis, the concept of keeping vacant real estate as an inventory item, as the sheiks of Dubai did or as the Chinese and Russians tried to do, is doomed to end in tears.
In the mid-2000s, a decade after my first visit there, Dubai was obviously becoming really powerful as an international growth centre; a destination with a low tax rate that was attractive to wealthy Westerners, Russians, Indians and Middle Easterners alike. If you came from a country that was politically unstable, Dubai was potentially a future safe place to call home, and there were plenty of wealthy people from Iraq, Iran, Pakistan, Sri Lanka, Georgia – the list goes on and on – keen to purchase real estate there. Dubai was seen as a safe haven within the Middle East and appeared to be safe from terrorists. It had a world-class airline and had become a major global strategic and business hub. But as I watched Dubai grow and grow, I realised within a few years it was all a giant bubble that one day, sooner or later, was going to burst. And the reason it was always going to burst was because when you analysed what was going on, the situation in the early 2000s was no different from the early 1990s; the majority of residential properties were unoccupied. Whole projects were being purchased by absentee foreign owners, then locked up and left vacant. The outlandish boom in real estate prices could not possibly last as there was nowhere near enough demand either locally, or eventually internationally, to keep it going.
The model widely used in Dubai to create value was a pyramid scheme. The owners of a piece of land, who invariably had government connections, would design the largest, flashiest apartment building they could and sell a percentage of the units off the plan at a perceived below-market price to associates, who were effectively sub-underwriters. Everyone was told the second release of sales once the building was finished would be at a higher price, to create the panicky sense of “I must buy now”. The first round of purchasers would then sell out some of their stock at a higher price than they had paid, but below the next release price, and so it went on. Foreigners would end up owning some of the apartments but the rich local families held most of the stock as inventory at inflated prices. But real estate should never be held vacant as inventory, because vacant property depreciates and costs money to hold, particularly when you borrow against it to buy shares that ultimately collapse, as many of the wealthy in Dubai found out in the GFC. Ultimately the Dubai boom, like so many others, was predicated on nothing more than hot air; people just talking the market up and up and up. All the apartments and houses were getting dearer and dearer, but there were no tenants to give investors an economic return. The result was that in the last purchasing wave, just before the GFC hit, Dubai was turned into a virtual investment ghost town, the only people who could still afford to buy there being a shrinking pool of Russian and Middle Eastern billionaires.
Realising 10 years ago that Dubai would eventually collapse, I continually warned my more eager colleagues not to invest there. But a lot of people who should know better – not least because they are responsible for investing other people’s money – simply do not understand basic market fundamentals. They just read analysts’ reports or, even worse, newspapers, and believe the hype. They simply believe what they are told. When it came to investing in Dubai’s thousands of new apartments, they never checked who was living in or renting them. It is a bit of economics, but mainly it is a lot of common sense. Succeeding in business ultimately comes down to asking oneself one simple question: “Why is this so?” — because everything works on fundamentals of supply, demand and access to debt. You can distort the fundamentals for 10 or 20 years but ultimately, everything works on fundamentals.
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I have seen many real estate bubbles in my 30-year real estate career. Excluding the current disasters in Ireland and Spain, the worrying overbuilding in China and the USA’s sub-prime debt-driven disaster, the two classic collapses are Japan in the 1990s and Dubai post the GFC.
Japan’s collapse is staggering. I can recall in my many trips to Japan in the late 1980s, while being continually reminded of the Japanese superiority in all aspects of life, including real estate, that the value of real estate in Tokyo alone was worth more than all the real estate in the USA. This is most certainly not the case today, even in the post-GFC quagmire US real estate finds itself in. The Japanese market had bubbled to such extent that purchasers would eagerly take 100-year mortgages, to be paid off over three generations, to buy a basic property. Sustainable? The Japanese thought they were just smarter than the rest of the world because they were worth more; a classic case of hubris, or pride coming before a fall.
One of the golden rules of life is: “There is no correlation between wealth and being smart. If you are wealthy and you think that is because you are just smarter than everyone else, look out.” For the Japanese, it seemed as though values would never stop rising, as they had done ever since that country’s reconstruction by the US after the end of World War II. Debt was cheap, and values always went up. The Japanese had a similar philosophy to a few of my well-known associates at Macquarie who, pre-GFC, and with debt so cheap, made famous the phrase: “Let’s gear the bejesus out of it”.
The Japanese bubble burst in the late 1980s with tremendous consequences. Real estate values fell 60%, and 20 years later are still down 60%. There is no longer a belief in Japan that everything goes up in value; rather a fear values will fall even further. The Japanese collapse coincided with an ageing population, a demographic trend that initially boosted consumer confidence as spending peaked. Few foresaw the economic stagnation that an aged population would eventually bring.
The Japanese fear of permitting immigration has created many economic problems, although it has at least helped the many elderly citizens of that country who need jobs and continue to have to work well into their old age to pay off mortgages on houses worth less than the debt on them.
I can recall in the 1970s that the Asian language Australians were all being advised to learn was not Chinese or Korean but Japanese. Japan, we were all told, would be the dominant force in our region during our working lives.
Learning Chinese was not on anyone’s radar at that time. In fact, learning to speak Chinese was about as popular an option for most Australians as becoming a banker.
My first desire to use a walking stick occurred in Japan. One evening I was drinking with a few Japanese friends, quaffing sake in rather large quantities. When I woke the next morning, I had great difficulty in moving my legs as freely as the day before. As the alcohol left my body, the loss of mobility did not. I struggled along unaided for a few days until I returned home and purchased my first walking stick. At first I did not use it every day, but always took it with me on my frequent travels.
I found travelling with a disability in Japan a mixture of goodwill and bad design. The people were wonderful, always wanting to help, and the transport system worked very well, but the infrastructure and building design failed miserably. Supposedly disabled-access hotel rooms with a step or two were not uncommon. In my early visits to Japan with Macquarie associates, travelling without a translator, we would often sit in meetings that were scheduled to be in English. My fellow travelling companion at the time, Gus Kuiters, noted after a series of meetings how rude the Japanese were as they would talk for 10 minutes or so amongst themselves in Japanese as if we were not in the room before finally returning to the conversation in English. We talked about this to a Canadian associate who spoke French. He told us that when he and some other French-speaking Canadians travelled to Japan, the same thing happened. So, as the Japanese spoke amongst themselves in Japanese, they would speak French amongst themselves. He said this would enrage the Japanese, who would demand to know what was being said.
These trips were long and tedious, knocking on the doors of companies investing in or thinking of investing in Australia. On a subsequent trip with Gus, we encountered the same rudeness. So I said to Gus: “Let’s speak another language”, to which the obvious response was: “We don’t know another language.” To which I replied (with retrospective apologies to Aboriginal brothers and sisters): “Yes we do, we know Aboriginal”. So we decided that the next time we were confronted with this treatment, we would speak ‘Aboriginal’. The conversation went something like this.
I would say: “Cabramatta Wagga Wagga Coolangatta Kakadu”, to which Gus would reply: “Jabiru Gunnedah Gundagai”. We had compiled a list of about 100 Australian towns and places with Aboriginal names. These names, strung together, sound very fluent. We had a lot of fun with this. The Japanese would stop talking and start listening, and as usual begin writing down every word that was said — or tried to in this case. Then they would ask what language we were speaking and we would say Aboriginal. I had visions of some poor Japanese analyst being given the job of researching ‘Aboriginal language’ after this meeting. We really did come from the land Down Under.
The Japanese and Koreans made more bad international real estate business decisions than I have seen anywhere else in my career. The size of their losses in Australia in the early 1990s was unbelievable, developing complex projects in obscure locations and with overcapitalisation on an absurd scale. All justified by so-called ‘long term vision’: a vision to spread their capital around the world and build icons that would not provide a meaningful return on capital for 20 years. At first I thought these were just stupid business decisions. I was perplexed as to why, after financing building projects that in retrospect were worth 10% of their original cost, the ‘80 still walking Japanese banks would appoint the same consultants who presided over this mess in the first place to work them out of the problem. The pieces of this puzzle were only to fall into place when assets began changing hands.
We had financed an Australian company that had purchased one of many distressed Japanese-built assets in Queensland. The head of this company told me that when they took possession of the property, they had found boxes and boxes of documents relating to its construction, among which were many interesting invoices. He drew my attention to the pavers we were standing on; good-quality Queensland pavers worth about $10 a metre at the time. He told me they found an invoice for six times this amount on a letterhead of an agent based in another state, supposedly to import these tiles from Europe. I asked more questions and found more and more examples of this sort of thing. They were not stupid, just corrupt.
I discussed this with a senior executive of one of the Japanese real estate financing banks who had realised there was no future in working in the real estate area for a Japanese bank for the next 20 years and had decided to venture out on his own. He told me very frankly that levels of corruption in project financing were so widespread that we would all have to wait at least two decades, until the senior management of that era retired, before there could be any reform.
Two decades on, real estate in Japan is still bleak and would be even bleaker if real values were reflected in company balance sheets. But in this case, as in any country where more people die each year than are born or immigrate, there are many other pressing issues. Simply, as cities shrink, values fall.
Bill Moss is a former executive director of Macquarie Bank. He has written a book about his life with muscular dystrophy called Still Walking, of which this is an excerpt. All proceeds from sales of the book go to the FSHD Global Research Foundation and Fighting Chance.