Sunday, April 17, 2011

Volume 3 Issue 16: Intelligent Investing

House Prices Will Always Go Up?!

I am always curious where most people get their information. I have heard this phrase many times speaking with many friends who have thought about buying houses in Malaysia. Not only do they claim that house prices will always go up and never come down, but they believe it is the single best investment ever. Let us just take a look at Chart 1 below, which compares the growth in house price of the US and the three city states in Malaysia.

Chart 1: House Prices (1999=100)

We can all see that house prices in the US shot up from 1999 all the way to 2007 and suffered about a 10% drop during the 2008-2009 recession. What is more amazing is that the house prices in KL have grown at even higher rate compared with that in the US. House prices in Penang are also almost there. The data for Selangor is a bit biased downwards as it includes rural areas all over Selangor, so my guess is that it should probably be bumped up a couple of notches.

So, Fact 1: NOTHING can go up forever. It will only be a matter of time that house prices will experience a dent, simply because the rate of house price increases does not match the rate of income growth. House prices in KL have grown about 80% since 1999. Just imagine, if the income of a fresh graduate was about RM2,000 in 1999, judging by the same rate of growth, a fresh graduate should be getting RM3,600 today. Clearly, the surge in house prices will make affordability an issue. Of course house prices are not merely a factor of income, especially since people can just borrow money to buy houses. Better still, now, the government is propping up the demand through the "My First Home" initiative, which essentially helps "newbies" to cover their 10% down payment portion. This is artificially propping up the demand without solving the supply side issues at all.

For some of you, you may ask, what is a 10% drop in house prices in the US? Well, my guess is that it has not stopped dropping. But let us look at a more extreme example, Hong Kong - see Chart 2.

Chart 2: House Prices in Hong Kong (1989=100)

Just imagine, if you had bought a house in 1996 in Hong Kong, by 2003, you would have lost about 70% of your wealth. You would have to wait for the price of your house to TRIPLE to get back to where you were (From HKD1 million drops 70% to HKD300,000 and then to get back up to HKD1 million, the house price needs to triple). If you had bought your house in 1989, by 2003, you would be about right where you started. The housing market is not always kind. House prices also have the same kind of up and down movements just like any other investment. The only problem is, its required capital is so much more, resulting in a much lower liquidity. Not only that, for small players like you and me, buying a house is more than just an investment. We have to leverage up (i.e. borrow money) all the way to our necks. So, Fact 2: Houses are NOT the best investment around. You can read here for more on investment vehicles.

What do you think will happen if the price of our house drops by 70%? Scratch that, even if it drops by about 30%, it would take a 43% gain to get back to where you were. Will we keep paying loan instalments to a house that is no longer worth as much as when we bought it? Many people would say no, especially when their income level is low. That is exactly how all banking crises happens. When housing loans become delinquent, banks do not make any money, and become at risk of going under. When people fear their banks may go under, a run on bank happens, and this problem self-propagates, and often leads to a financial crisis.

So, next time you open your mouth and say that investing in real estate is a sure-win, please remember this post.

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