Is the investment property boom the next dotcom bubble?

I remember reading somewhere that an American multimillionaire (can't for the life of me remember his name) sold all his shares just before the great depression. He was inspired to do this when a bellboy or lift operator or chauffeur asked for advice about his share portfolio....the millionaire figured that if everyone was getting into shares, it must be the time for him to get out.

I have thought the same thing about property investments recently and today I read this [broken link removed] so obviously I'm not alone. Loads of people from all walks of life seem to be trying out life as a landlord... even people who don't yet have a home of their own.

Any opinions?

tedd

Hi Tedd

No - I don't agree with you or with the Motley Fool correspondent.

As I understand it, a bubble is a situation where the values become totally disconnected with reality. During the dotcom bubble, people changed their valuation model from a multiple of EPS to a multiple of turnover. That is insofar as they had any model at all. Consequently valuations became completely disconnectd with reality. Tulipmania had the same problem - there was no logical valuation model.

It's very difficult to do this with property. Anyone I know who has even considered investing in property, did a very simple sum: Estimated rental income less estimated mortgage interest = profit. It's a very simple model and if most people stick to this model, the property market won't bubble out of control.

I am not saying that property is not overvalued. I don't know whether it is or not. But it is not so grossly overvalued that it will drop by 80%.

Brendan

My personal opinion is that people are stretching themselves a lot to purchase an investment property and are totally reliant on rental income to make their payments each month. So in the event of a down-turn in the rental market, affording the mortgage becomes a real problem. The impact of one or two months vacant occupation or perhaps one bad tenant who leaves bills and repairs in excess of their deposit is underestimated by prospective investors, I believe.

Furthermore I think that, in general, people have less discrimination in buying a property to let than one they would live in themselves. It won't matter much in a booming rental market, but it certainly will if things slow down and renters become fussy. It would also be very important if they needed to sell in a hurry.

In short, if someone was going to invest 15,000 or 20,000 in shares they would be told to only invest money they could afford to lose. But property investors part with this kind of money upfront and undertake to service a large mortgage, usually with their own home as security. I've never heard anyone advising a property investor to only invest money they can afford to lose.

Hi tedd,

While I would’nt go so far as to say that the investment property boom could be the next dotcom bubble but what does concern me lately (ever since the Budget) is that there has been an awful lot of publicity saying, more or less, that property is a great investment at the moment. It is certainly “flavour of the month” right now.

For example, much of yesterday’s <!--EZCODE ITALIC START--> Irish Times <!--EZCODE ITALIC END--> Property supplement was devoted to property investment with headlines (on the front page of the main paper) like “How to do it…and win” and “Where to do it…and why”(?) . I am not singling out the <!--EZCODE ITALIC START--> Irish Times <!--EZCODE ITALIC END--> specifically, you can see similar examples elsewhere also.

Of course, property <!--EZCODE BOLD START--> does <!--EZCODE BOLD END--> seem to be very attractive at present. All I’m saying is that people should’nt discard their critical faculties and should view property as just one of the many investment opportunities that are available out there.

BTW, tedd, the multimillionaire that you refer to in your first post is, as far as I know, Joseph P. Kennedy, patriarch of the famous Kennedy clan.

Brendan's bubble definition

Property values don't have to move too far from reality for a bubble to develop. As most investors are geared, their sensitivity to price movements is exaggerated. Somone who has borrowed 90% of the value of the property would only need an 8% price drop to lose 80% of their investment (more, if you count expenses). This might not technically be a bubble, but it's effect would be the same.

PH

Negative equity

Whatever about the effects of property values falling on any eventual capital gain when an investor disposes of the property, surely as long as the investor can secure tenants and rental income sufficient to service the investment loan/expenses then s/he is no worse off?

Some of this discussion reminds me of the scaremongering about "negative equity" in the context of private home owners whereas "negative equity" is of academic interest if (a) one can service any outstanding loan on the property and (b) one has no plans to move house in the immediate future.

Re: Negative equity

I didn't bring the subject up to be a scaremongerer and I apologise if it is perceived in that light.

<!--EZCODE ITALIC START--> surely as long as the investor can secure tenants and rental income sufficient to service the investment loan/expenses then s/he is no worse off<!--EZCODE ITALIC END-->

That's my point. Secure tenants and sufficient rental income are not guaranteed. A monthly mortgage payment, on the other hand, IS a guarantee. For some investors, two months without a tenant or a repair bill of 1000 can be met without much trouble out of their personal cashflow. For people like this, property is a relatively low risk investment.

But I have the impression that a lot of new or aspiring entrants to the investment property sector are really stretching themselves to get together the 10% deposit and all the associated start-up fees. If it all runs smoothly, then they have no problem and property is a great investment. But if, on top of this the place is vacant for two months or a reasonably expensive repair is needed, there is a major cashflow problem that has nothing to do with "negative equity".

regards,
tedd

Scaremongering

<!--EZCODE BOLD START--> I didn't bring the subject up to be a scaremongerer and I apologise if it is perceived in that light.<!--EZCODE BOLD END-->

Sorry! That wasn't directed at anybody here - I just had in mind newspaper headlines screaming "Property prices fall by x%" and then extrapolating to people suffering from "negative equity" when this is only relevant to somebody who has to sell for one reason or another (e.g. can't keep up with mortgage repayments for some reason unrelated to property price falls or has to move house for some reason).

As for your general points on this issue - I too would certainly wonder if there is a bit of a rush into the investment property market by people judging by things one overhears and, for example, the number of investment property related queries posted here on AAM since the budget. It seems odd to me that people would do this now but not before the budget and, it seems to me, suggests that some people may not be weighing up the investment on its own merits but could be rushing in because of the tax treatment which could so easily change again in the forseeable future.

Re: Scaremongering

"It seems odd to me that people would do this now but not before the budget and, it seems to me, suggests that some people may not be weighing up the investment on its own merits but could be rushing in because of the tax treatment which could so easily change again in the forseeable future. "

Because of the threat of litigation, it's very difficult for the State to change the tax treatment of existing property investors. None of the Bacon changes affected existing property investments, only new ones. So it is reasonable to a rely on the continued existence of the current tax regime for an investment made under that regime.

Re: Scaremongering

IS the threat of litigation enough to preserve the existing tax laws? I would be interested to hear other views on this.

Personally, I do not think this is the case. There are lots of decisions we make which you could argue were based partially on existing taxation or benefits. For example if the government stops the children's allowance, can I sue because I never would have bothered if I wasn't getting the few bob every month? If I have just bought an enormous car and car taxation alters to an emission-based system, can I sue because I would have bought another car and now my new car has a lower resale value?

What do others think?

tedd

Threat of litigation

Tedd is right. I don't think there is any legal right to the preservation of the financial status quo. I couldn't sue when mortgage relief was removed. The taxi drivers couldn't sue when the value of their plates was removed by deregulation.

I would agree with tedd and d53 on the litigation issue...

However, I still can't see a finance minister re-introducing restrictions along the lines of Bacon and making it retrospective. It would be political suicide.

I feel that if a finance minister were to remove the allowance of rent against interest he would do it form a specified date onwards as happened last time.

When the Bacon restrictions were introduced it was for investment property bought from April 1998 onwards. Any property bought prior to that still qualified. If Bacon restrictions were to be re-introduced I think this is a more likely scenario than any investment property ever bought to have the allowance removed.