All Topics / General Property / Useful Buffett Insight

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  • Profile photo of Steve McKnightSteve McKnight
    Join Date: 2001
    Post Count: 1,763

    Fellow investors,

    I’d be interested in your thoughts, comments and observations about the following matter:

    Last Friday, the Financial Crisis Inquiry Committee – the US body established by Congress to examine the causes of the financial crisis – released several hours of audio interview relating to when Warren Buffett was called before them to testify.

    By way of background, Warren Buffet is regarded as one of the most successful investors in the world. He was ranked the world’s third richest person in 2010.

    As you can imagine, Buffett said a lot over two hours, however one snippet that was reported caught my attention. It was his thoughts about the origins of the property bubble.

    Again, by way of background, USA property prices rose rapidly in in 2006 and 2007. This new equity was refinanced and used to buy more property… and so on it went while prices kept rising. However, as values peaked and fell, mortgages foreclosures increased and the bubble deflated. Today, prices are down by as much as 80% (from the peak) in some areas .

    Anyway, back to Buffett’s quote:

    "An original sound premise becomes distorted as time passes and people forget the original sound premise and start focusing solely on price action. So everyone – the media, investors, mortgage bankers, the American public, me, my neighbour, rating agencies, Congress, you name it – people overwhelmingly came to believe that house prices could not fall significantly. And since it was the biggest asset class in the country and the easiest asset class to borrow against, it created probably the biggest bubble in our history. It will be remembered along with the South Sea bubble and the tulip bubble."

    Now go back and substitute ‘American public’ for ‘Australian’ public, and ‘Congress’ for ‘Federal Government’, and I wonder… could the same also be said for the Australian property market?

    Last night, a friend asked me whether I thought the Australian property market could crash like the US has. I think he was genuinely surprised when I said ‘Yes’.

    Although we have sound economics, a housing shortage etc. etc., the simple truth of the matter is that a large portion of property value is perceived, not intrinsic. In other words, a house is only worth as much as the nails, wood, plaster etc and the land that it sits on. The extra above it is the ‘perceived value’. Because of this, if the majority of people believe in an outcome (such as property values going up), then values will adjust to that outcome.

    We saw that with stock prices adjusting as the GFC unfolded. Those same companies whose prices halved (or worse) have today regained a lot of their value. Is it because they have new markets, higher profits etc? Well, yes – partly. But even more so it is because investors perceive the GFC threat to have somewhat passed and are now rethinking their value proposition.

    In summary, although property prices can crash, before this can happen there must be an event that has owners and investors question value. Examples include: escalating interest rates, higher mortgage foreclosures, unaffordability, change in legislation that provide a disincentive to invest in property etc.

    Until then, property prices are likely to continue their predictable patterns (because this is what people expect) of flat periods followed by increases.

    If you’ve enjoyed this discussion and want to know more about what I think is going to happen to the property market in 2011, and how I think you should prepare, then I recommend attending my upcoming live market updates.

    I only do them twice a year, and considering the recent floods etc, there is a lot to update you on. I hope to see you there:

    Please post your thoughts and comments about Buffett’s comments above and let’s start a discussion.

    Steve McKnight | Pty Ltd | CEO

    Success comes from doing things differently

    Profile photo of Wealth AccumulatorWealth Accumulator
    Join Date: 2008
    Post Count: 67

    It will be interesting to see what happens post the floods in Brisbane.  I have heard some talk about a change in what they rank as important.  Will this include devaluing the "materialism" value that you talk about.

    The perceived value you talk about is not just about the physical construction.  What has affected us at Graceville after the floods is the mess that the community spaces are, eg, parks, walk tracks etc which all adds to the perceived value of a location.  This certainly is a constant reminder of what happended and could happen again.

    The other issue that will start to affect things is the new responsible lending requirements under the NCCP.  Upgraders may face age issues, proovable income is focused on much more, etc.  Is the purchase a "reasonable thing" for the borrower to do?  How can you objectively answer that?

    The other issue still holds – that income growth is not keeping up with property value increases.  We will become more and more like Europe where there are fewer land owners and more renters.

    We have seen property listings in our area reduce.  That is one thing we tend to do in OZ.  If we don't like what the market tells us we generally delist and bunker down till things look better.  We haven't had the same toxic lending that America had.

    We are looking at renovating at the moment – it is much cheaper to renovate the house we have than buy a finished job as we bought about 6 years ago.  Most houses comparable would cost an extra $300,000 on top of the construction of our renovations.

    I wouldn't be surprised in seeing some stagnation for a while.  Mammoth drops – not really as the cost of land and construction is still high.

    Profile photo of DHCPDHCP
    Join Date: 2010
    Post Count: 190

    Hello Steve,

    One thing that differentiate the Americans and Aussies, is that they take on too much risk which is driven primarily by corporate greedy. Regardless, if we discuss the share market or the real estate market, American executives are primarily driven by short term profit hence greed. If we look back from the last decade, we saw  massive US corporate collapses (e.g., Enron, Arthur Anderson etc). Enough was never enough. Then, came the GFC, again, the catalyst for this world economic crisis is, driven again by corporations wanting more, and more profit, hence taking risk too much become the norm. In the end, their greed is under undoing.

    Unlike them, we Aussie tend to be a little conservative and don't like too much risk.  I'm we have some of our local problem (e.g., HIH collapse etc)., but this is small in comparison with what had happened.

    Either it is in the share market or real estate market………the bottom line is American corporation take risk to an extreme level primarily driven by their greed hence their undoing.

    Profile photo of PQPQ
    Join Date: 2009
    Post Count: 18

    Dont be silly Leo, Australians are just as greedy as Americans and everyone else in the world for that matter – its a basic human trait to want a reward for no effort!

    I think there will need to be a significant drop in employment before there is an American-style crash in Australian property prices. Plus there is still the matter of low supply in Australia – America had a glut of properties prior to the GFC and the foreclosures added to the supply.

    Profile photo of DHCPDHCP
    Join Date: 2010
    Post Count: 190

    I agree to some degree BUT as said they take too much risk, in the end, even their premier rating agency (e.g. Standard & Poor) who supposed to be brilliant on rating those sub prime lending package, become clueless to the point it went downward spiral creating the GFC.

    Look, The Australian market rides on the back of the Chinese strong appetite to our natural resource (e.g. coal). Unlike the British and European market are pegged strongly to the North American market. The collapse of the housing market in the US naturally affected those countries strongly reliant on the US market.

    Thanks to China's strong appetite from our natural resource, The Australian market was shelled out from the major impact of GFC including our real estate market.

    Profile photo of thecrestthecrest
    Join Date: 2004
    Post Count: 992

    Hi Steve.
    Unlike the US situation where many Americans had "walk away" mortgages and the Banks copped heaps of "jingle mail",  Australians are and feel accountable for their housing debt, even when values fall, a bit like "for richer for poorer" , and they'll back it with continued hard work to dig it out of a hole.  They know the values will return. This refers to the majority of good solid Australians, the backbone of our country and national character, and excludes the slick types who file for bankruptcy.

    USA went out on a limb and when the cracks started, no one was accountable or held firm, and with a walk away mortgage they didn't  have to hold anything. It's not bankruptcy for them.


    thecrest | Tony Neale - Statewide Motel Brokers
    Email Me | Phone Me

    selling motels in NSW

    Profile photo of luismanluisman
    Join Date: 2004
    Post Count: 3

    Hi Steve,

    In the RESULTS program last year I challenged your perception that median house prices in Australia could reach the $1M mark by 2019.

    You promised to invite me for dinner if that doesn't eventuate. I will be looking you up then.


    Profile photo of Blank FrankBlank Frank
    Join Date: 2011
    Post Count: 22
    PQ wrote:
    Dont be silly Leo, Australians are just as greedy as Americans and everyone else in the world for that matter – its a basic human trait to want a reward for no effort!

    I think there will need to be a significant drop in employment before there is an American-style crash in Australian property prices. Plus there is still the matter of low supply in Australia – America had a glut of properties prior to the GFC and the foreclosures added to the supply.

    Yes, we have the greed, but Leo is right in saying we do not show the same hubris. Our actions are more tempered by a conservative streak, and a kind of wariness: "Things have gone wrong before!". This is hardly likely to be forgotten given recent events.

    The only people I see with unbridled hubris would be the Chinese 'Players' and people who have just come out of property investing seminars! You know the ones I mean.

    Profile photo of InvestorMickInvestorMick
    Join Date: 2008
    Post Count: 55

    Some interesting thoughts! Having just arrived back from 7 weeks in the USA and doing some property deals it is obvious that nothing is impossible. Most American home owners would not believe the bubble could burst up until the day it did. We asked people about this!
    The major differences between us and the USA are the resources boom (I thank God for it everyday) and the madness of loans that people could walk away from with such ease (USA). Also, generally speaking, Aussie wages are higher than Americans, as is our cost of living. Petrol for one is $3 a gallon compared to our $5.20+, electricity is 10cents a kw compared to our 20cents, etc. Our housing prices are simply a reflection again of our cost of living. Can this cost of living continue as we become more and more a global community? Hmm!
    In saying this, I certainly don’t believe our bubble is about to burst! Our banking system isn’t about to fall over, our population continues to increase, we don’t have enough building going on and our resource boom keeps going from strength to strength. We don’t just sell to China, they are simply our biggest customers. India, Korea, Japan and so many other countries need and want our resources, unless of course some silly government taxes them out of competitiveness and gives the competition a leg up.

    Profile photo of Steve McKnightSteve McKnight
    Join Date: 2001
    Post Count: 1,763

    Thanks for the discussion so far.

    Be careful not to make this an 'Australian vs US' issue. It's not, and that's the point Buffett is making. No one saw it coming because there was no concept that it could happen.

    We tell ourselves the same things in Australia and argue how and why we are different. The simple truth is that it could, but that until some event happens (which does not currently exist), in all likelihood it won't. Instead, the expectations of people will mean that property prices will keep going up.

    Let me tell you a story of a situation that proved me awfully wrong. Driving home some years ago, it struck me that the stock market couldn't ever crash again. Why? Because each month there will billions of dollars that had to be placed 'in the market' via superannuation contributions. In other words, there was mandated government supply of new money into financial markets that had to keep flowing in, and so long as more money came in than went out, prices had to increase.

    Clearly, I was wrong. But why? It's true that more money keeps coming in, but values dipped suddenly. This was not because of economic factors. It was because of psychological factors.

    So the same point could be made for the property market. The economics of a housing shortage, strong Asian demand, etc. all point to a continued strong market. But… if people no longer perceive value, then it doesn't matter a cracker about the economics, prices will drop.

    In many ways, that's the state of play with the Aussie market now. Without the psychological drivers in full force, values have stagnated.

    I guess what I am saying is that the economics are used to justify the outcome, but because people are random rather than predictable, the future is anything but certain. That said, investors still need to piece all the variables together as best as possible in order to make informed decisions.

    More food for thought…

    Steve McKnight | Pty Ltd | CEO

    Success comes from doing things differently

    Profile photo of AAQAAQ
    Join Date: 2005
    Post Count: 47

    The resources boom is supposed to go on for 20 years…… by then we won't be manufacturing anything in this country everything will be imported (we're not far off that now). What happens then or when China & India take over all the rest of the worlds manufacturing requirements. 
    If you visit Mackay or Gladstone you can already see the two speed economy. One for the mining and resources industry the other for those not part of it and struggling to keep up with price increases in everything.
    Large unemployment (or rather lack of competitive opportunity) in all other sectors (apart from resources) along with the aging population would suggest there will have to come a housing price crash.
    It may not come for 5 years or even ten but I worry that it will come and I still have a mortgage…..

    Profile photo of DWolfeDWolfe
    Join Date: 2009
    Post Count: 1,253

    I think this is a really interesting take on this question.

    Many of the comments made on this issue have been excellent. Thanks Steve and everyone for posting.

    I have more questions…

    AAQ has already raised the manufacturing issue, What of infrastructure projects and other initiatives that create jobs and ongoing jobs? Seems like quite a few in high places have shrugged and said hey the mining boom will take care of us for awhile. Then what?

    Retail is getting it in the neck. Eastern states, especially QLD are getting it in the neck, as far as I can tell there hasn't really been a flow of money into anywhere in WA apart from the mining areas.

    I think here in Melbourne we will see a bit of a tough bit, you can't have values rise in some suburbs by $400k in three years then expect it to keep going up.

    Having said that what of the Victorian state governments initiatives on stamp duty. Will this just delay the inevitable or will a new bread of buyers step out of the shadows? Gen Y's who everyone has discounted.

    The baby boomer effect hasn't even started yet, will this cause problems with high housing stock as they sell up or will this cause more employment as they opt out of the workforce to live off investments etc?

    Watch the retail space for the clue to any rate rises. The RBA seems to have clipped peoples wings very suddenly and spooked people. Point to a person you know who has not cut their spending on 'stuff'. I think we are also discounting the amount of equity some people have in their properties. People may not care that the prices drop as they have a buffer. Not everyone will have this.

    What of the return of 95% loans. Indentured slavery or banks confidence in the market?

    I would be interested to hear Steves opinion on the "prestige areas". Steve – Do you think that values will decrease in these areas as people begin  to doubt the "perceived value"?

    Please keep informative discussions such as these coming. Thanks again.


    DWolfe |
    Email Me

    Profile photo of Rosa TongRosa Tong
    Join Date: 2011
    Post Count: 74

    I think that we are heading the same way eventually…

    South american financial crisis….Huge expenditure on infrastructure… however…no one to run or maintain it…
    Asian financial crisis…Japan was a massive saving country..You could inherit mortgage…
    And now the GFC… tell tale signs of insurance going up large accounting companies getting in trouble as well as communications etc.

    The rob peter to pay paul thing…

    Since australia is big on Negative gearing….I feel that this could be a contributing factor…

    Most people forget… actual money is only a representation of a perceived value which are influenced by supply-demand and  how much you act when you hear the financial news….  Usually when the general public are doing one thing… I just do the opposite…

    Profile photo of fWordfWord
    Join Date: 2009
    Post Count: 471

    When we talk about 'perceived value', shouldn't we perhaps ponder over the 'perceived value' of money itself? After all, are sheets of plastic and bits of metal really worth that much?

    It might boil down to supply and demand. If people continue to want to live in certain areas, the prices there will probably rise. For example, I'm unlikely to give up a house by the beach even if the price dropped a great deal. Why? Because I want to live there.

    There is a perception by some that land, being mere pieces of dirt, shouldn't be worth much money. The key issue that is often missed in these instances however, is where this piece of dirt is located. This piece of dirt on which people live on directly impacts the quality of their lifestyle. A comparison between extremes will bring this to light: a pieces of dirt in the middle of a polluted industrial hub versus a piece of dirt of the same size but located fronting the beach. Which would people prefer?

    It's the preferences that drives the prices. These preferences are deeply ingrained into most of us, and it explains why people would gravitate towards certain locations, and it probably also explains why the vast majority of us prefer to sit in an empty row of seas on the bus rather than share it with someone else. Human nature is an interesting thing.

    EDIT: OOPS, the perceived value of money was an issue already mentioned before me. Pardon the repeat. It was purely coincidental, I promise.

    Profile photo of niobeniobe
    Join Date: 2007
    Post Count: 4

    Hi Steve,

    Very timely to be reminding folks of the unavoidable fact that the property market can, of course, crash here too.

    I do however think that this post is very much a reflection of the changing mood in Australia. Collectively we are starting to believe that such a crash is at least possible, whereas 12+ months ago I couldn't fail to hear the phrase "property always goes up" and its analogs at every birthday, bbq and bah-mitzfa. In the last 2-3 months we have even watched the media begin to pick up on this theme. I disagree with Warren Buffet in one respect. There are a select few, who have always kept this possibility – nay, inevitability – in mind and have kept on spruiking even when no-one was listening. The Oracle of Omaha has apparently excluded himself from this bunch – but no-one should believe the "no-one could see it coming" defence when our property market finally falls, even when pleaded by experts such as Buffet.

    Overall this more realistic dialogue is good news (even if it's just holding a mirror to market sentiment). What is not so good though, is that the vast majority don't seem to have any idea how big this long-running bubble is, nor of how little real productive growth is behind it.


    Profile photo of xdrewxdrew
    Join Date: 2010
    Post Count: 479

    I think what everyone realises at the moment is that we just piled a large load of money (March 2009) into 'saving' our economy. It doesnt matter that as a largely unaffected country .. we didnt need it. The flow-on effects for this will be a significant inflationary pressure once it spreads throughout the whole economy. And we are starting to see it already in most household items.

    Bringing this back to house prices, usually house prices go up first with an influx of money washing away from stocks and bonds. People just jump onboard and usually end up borrowing to the hilt for their next property.And then .. inflation takes hold, and the whole price of money rises, flattening especially anyone who is borrowed to a point they cant afford. Its a nice stabiliser, a horrid headache .. but we are just coming due for our inflationary period now. It should straighten things out nicely. Of course .. the end result from the other side is that no-one has any spare cash for a couple of years .. but thats also usual.

    As far as working out if the property market will crash .. you'd need people selling to start that off. People will sell when they really cant afford the payments any longer, otherwise they will grit their teeth .. hold on and bear it as long as they can. The only time I would be getting worried is if the Government FAKES inflationary numbers. In which case .. inflation will go on around you, and what you can buy for that dollar becomes less and less, taking wealth and minimizing it over the longer term.

    We all work on perceived value in any object. The lack of valid sources for excess capital to be invested in has leant itself to movements in collectibles, housing, and of course art. But the areas where it would make a difference and it CANT be invested in are places where it would create genuine wealth. Areas such as manufacturing, farming and the creative arts, which survive and thrive off each other. The risk we face at the moment of rapidly becoming a society that cant tie its own shoelaces without overseas support is not something to take lightly.

    Profile photo of DrastaDrasta
    Join Date: 2009
    Post Count: 1

    In regards to Buffet's comments, that is exactly what was happening in Japan in late 80's until '93 when property bubble burst. It was called the myth of land price: the property prices never go down. Sounds familiar? This myth was established over 40+ years. When a certain condition lasts that long I guess people start to believe it will never change.

    I am Japanese and when I see some property guru talking about capital growth stuff, I often think of bubble burst in Japan. I don't think it is going to happen soon in Australia. I think this country is very young and still at the early stage of growth in its cycle as a country.  But it could happen maybe in 10 years, 20 years, 30 years, who knows, oneday…

    And it happens when no one is thinking that it is coming.

    Profile photo of RomanRRomanR
    Join Date: 2010
    Post Count: 8

    I reminded me of one book that I recently read: “Guide to Investing in Gold and Silver” by Michael Maloney and opened my eyes in terms of what a “real value” of anything is: it is what we are prepared to pay for it at a particular moment, and nothing else.
    There were also some great insights into how the modern financial system works. And it is not something specific to the US, it has been global for quite a while already.

    Profile photo of Mark KelmanMark Kelman
    Join Date: 2003
    Post Count: 18

    As always, Steve gives us good food for thought.

    Our Australian property market, like every capitalist market in the world, is governed by two fundamental forces – supply and demand. The demand of properties depends on many factors, but ultimately the buyers are people – and many are investing for capital gains. If the perception of likely future gains diminishes, then demand may also diminish and prices may fall. On the other hand, a reduced supply and higher demand (with more people wanting to buy – eg as a result of migration not matched by more properties available) will result in increased prices.

    There certainly seems to be a lot of negative media sentiment surrounding property at the moment (both in Australia and overseas) but equally, Australia in particular has a lack of available property and a low completion rate, with an increasing shortage – which may suggest an ongoing lack of supply and future demand.

    While we don’t know what the market will do in the future, current suppression of prices certainly provides a good environment for “bargain buys” for those who are keen. Cashflow positive property with value-add potential certainly looks quite attractive at the moment.

    Profile photo of michaeltwmichaeltw
    Join Date: 2010
    Post Count: 3

    I'm of the same opinion as Steve. Of course the market could go backwards or crash. However the likelyhood of it happening is a difficult thing to determine. My own view is that there should be some consolidation in your portfolio. Unless you have access to sufficeint cash or cash flows, the chances are a correction could impact on you. Being forced into a position will cause panic selling, that is the problem.
    Having said that if you have a position of strength financially and can sustain that for a period of time, at the least you will hold on to your assets, at best there will be buying opportunites. Otherwise you will lose.
    Unforunately the media tends to grab a headline that highlights negative sentiment, when things are a little depressed, so too the experts that fall over themselves predicting doom. Treat the market with respect and understand that unless you are fortunate, going against the herd (trend?) could bankrupt you. If I was to call the market now it would be to hold and/or moving to a defensive position, we personally are very low geared. take it for what it's worth.
    Reading the media lately we in the West were subjected to the head lines "Perth property prices slump etc" the reality was that there was a -2% move during 2010. What is more interesting is that during the last quarter, the rate of change was significant. There is a chance that 2011 could see a 6 to 8% drop. Having said that four of the five properties in our portfolio were above my long term trend of +6%, returning  11.6, 12.5, 12.5, 24.4% . One property returning 3.3%, this property in the Dec qtr was -1.8%, the rest are on target to achieve 2010 gains.
    We bought the hi-gain property in May 2009, the GFC was in full swing ,there were 4 other buyers, our first and only offer was 4% higher than asking price, So there are opportunities in the current market. I would suggest many investors are not in a position to capitalise on opportunities. The few will grow their wealth significantly, for the rest if they consolidate and prepare, the next positive period of growth will be an opportunity. This is not the time to bet on the market. If the purchase of your next property doesn't stack up, then pay off some debt because you are doing the best you can at the time.
    Remember. We can't all be rich, but we can all be poor.
    I'm sure you have all read Steve's book. Pick it up, read it again and stress test your portfolio. There is no absolute prediction that will satisfy all investment portfolios. If you have properties that are likely to fluctaute in value significantly in a negative trend then be prepared to go defensive. Your properties could be middle ground in which case hold and see, if your properties are in the positive growth area, be prepared to act on good buying opportunities.
    External Factors:
    I've been around long enough to experience trends, gold price, oil, jobs, food shortages. Don't mention China, I've travelled that road in my mind countless times. Just think, if the chinese economy goes into a tail spin, ask yourself how many chinese will be in the unemployment queue? You can bet they will be in front of you looking for jobs. The worst case scenario is the longest unemployment queue in history. This phase in world development cannot be halted. A major correction in the wealth of the chinese middle class will impact on us all. It is their gain in wealth that is funding the market. Don't bet on the US supporting the transition of wealth from the west to the east either, something has to give, china will move to democracy or the US will corrupt the market. The game has changed and there are some shocking outcomes. Having said that, I woudln't give quids to be on another planet, it may be a complicated world we see emerging, but hell it is going to be exciting!
    Domestic Factors:
    I like the banks and the goverment, they are so predictable. We seem to forget both institutions depend on cash flow, OURS!
    Currently they are spooking us and we are spooking them. They need us, we are cash flow opportunities for them, stamp duty, bank fees, taxes they need the cash flow more than we do. Just look how they worry about deficits or profits. The banks can't continue with a depressed market, I bet they and the government are working their little fingers to the bone calculating the next move. I'll take a bet sooner than later they will have to release the pressure. New building is in a hold pattern. Investment is slow(other than the resources). Retail is heading for a dive. So expect some change in the budget, it can't be a lame budget, there will be change, superannuation being used for house purchase, a short period where negative gearing will be reduced to perhaps 50% of your tax rate. Remember that the problem is that all the players have been in the market, at the same time, first home buyers, second home buyers, investors. The property markey has been synchronised by policy, taxes etc. you can' t give money to the first home buyers and then expect not to have a surge in investment and prices . The link at least for a period has to be broken. Have you noticed that block prices are on hold or going backwards or being subsidised by giveaways? By impacting on the turnover of blocks (interset rates=less demand) there is in fact a pool of blocks building, the government could quite easily introduce a withholding tax on blocks that have gone through the approval process but are artificially held from the market to inflate prices. 
    I know that there are some contradicting influences and complicated relationships out there in the market, but sometimes it pays to brain storm. How else would you even begin to think you (I?) know it all? 
    Remember. We can't all be rich, but we can all be poor.

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