Podcast: Why Would Easier Access to Debt Lead to Higher House Prices? | Ep. 211

Posted by Ed McKnight on 21/04/20
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Show Notes

What's Covered in the Show?

In this episode, we answer a listener's question, which stems from an earlier episode we recorded. In that episode (#208) we discussed three speculative scenarios, where increases to debt availability would lead to higher house prices.

Paul (the listener) asked why increased availability of debt would lead to higher house prices as it wouldn't change the fundamental value of the property.

During the show, we discuss that there isn't really a fundamental value of property, given that home-buying decisions are primarily driven by emotion, rather than rational thought.

We also mentioned the property investment webinar we are holding this coming Tuesday the 14th April, which you are invited to. We're discussing how the rental market will be impacted by the Coronavirus-induced shutdown and the resulting increase in the number of Airbnbs coming onto the market.


Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show we're answering another listener question that's come in, actually after the webinar we just recorded last Tuesday and there are two parts to this question that we'll go through.

It comes from a long time listener, Paul Kay. Thanks for listening to the show, Paul, and for submitting this question and it comes off the back of the last, or one of the previous shows we recorded. So we talked to through three different situations or scenarios that would add heat to the property market.

We talked about what would happen if mortgage terms, uh, were we lengthened, what would happen if the servicing test rate came down and what would happen if the LVR restrictions changed and were relaxed and then Paul said "well, how do, how would this actually impacts the market?"

Walk me through it because if more debt is in the market, if consumers, or sorry, I should say home buyers or prospective property purchasers, are able to take on more debt, that doesn't necessarily change the fundamental value of that asset, the asset being the property. So how does more debt change the price. You know, because it does it because he's right that it doesn't change, I guess, the underlying value of the property.

So we're going to discuss this today and then we've also got some discussions around being a first home buyer as well. Now, Andrew, before I rattle on, cause I could rattle on for probably about 20 or 30 minutes about this, what was your kind of response when initially hearing this question, why would a change in people's ability to borrow and take on more debt change house prices.

Andrew Nicol: So the main reason that finance has such a big part in the property market is because the control of lending based on whether or not you can actually get it and then whether or not you can borrow more money often dictates how much someone's willing to pay.

So for example, when banks are more restrictive, so thinking back to the GFC there was a lot less money available for people to buy houses and there were much, much further restrictions put in place. Similarly we've had, with the LVR restrictions and investors not being able to borrow as much as percentage, same with first home buyers, people's deposit doesn't go as far anymore. So as a result, they can take a bit of heat out of the market because all of a sudden, even if someone was willing to pay 650 for their dream house, they can only pay 600 if that's what the maximum approval is.

And I guess residential property is quite a lot different to commercial property in the sense that it's driven by emotion most of the time. So it's either a first time buyer or, or a, or an owner occupier person upsizing or downsizing. Usually it's driven by people who are making an emotive decision, generally speaking.

And so that will always be determined a little bit in what they purchase and power is. And so quite certainly if there's more money available people tend to pay that more. And with rates coming down, for example, well, it costs them to same to to borrow 700,000 or 600,000 three months ago. So why wouldn't you.

Ed McKnight: I'll just jump in there as well and challenge the initial notion that properties have a fundamental value at all, in terms of what something is actually worth. Because property, because it's about, I believe, 76% made up of owner occupiers in terms of residential property, and only about 24% made up of landlords or property investors. The majority of the market is driven by emotion and just what people are willing to pay.

And so I would first of all state that there's probably no fundamental value of a property, which is different potentially from the likes of a share or commercial property, which is much more yield driven. And you can see, you can boil down a company's assets and if you were to liquidate them, you'd be able to figure out what a company was actually worth. And you could look at its revenues and decide, well, based on how long I would be willing to wait in order to be able to get a return from a dividend or revenues, you know, this is what a share is worth.

We don't necessarily have those same metrics in residential property because it doesn't work the same way. They don't necessarily have a fundamental value because it's driven by emotion. Now, a lot of people would say the share market is driven by emotion as well, and shares don't necessarily have a fundamental value either. And that's why they change so much and vary so much in terms of the price of those shares. I first of all, challenge that part, but I also just want to walk through two different scenarios of what would happen if lending was was more available, the first thing is we would have lower barriers to entry into the market.

So let's talk about the LVR restriction example, which is we're investors who have, not currently under the current rules don't have enough usable equity to be able to leverage their existing properties to go buy another property. If the rules change, they're now able to do that. So the barriers to entry to go and buy more properties comes down. Same with the lowering of their servicing test rate. So if you take that from 7% down to 5%, then more first home buyers are able to get into the market. And simply if you have more people competing for the same number of houses, the price is going to go up because people will start to bid those prices up.

Similarly, if we saw, especially first and second home buyers, if those servicing tests rates decreased, then they would be able to borrow more, and that allows them to go and buy more expensive properties that I can, I'm basically trying to say they'd go and buy nicer properties as well, so they would increase the amount that they're willing to, to bid and increase the amount they're willing to spend.

That brings more competition into that kind of tier of properties. Again, starting to heat up the market so, if any of these financial barriers change and and allow more people to become property buyers, then naturally, they're going to start to bid prices up. And I think we saw this when interest rates came down before 2008, they were up around 8-10% in places. Now that they've come down, structurally, the financial market has changed and that's led to a property boom, and prices have increased severely over the last 10 years.

And that's in part not due to incomes rising, although they have risen, it's actually that people can borrow more and can go out and compete and bid that extra five grand. And then at the next property auction, somebody is able to bid, the extra five grand because they are willing to do it. And all of a sudden people just want to get into the property market.

And so it, ... the difference between what somebody earns and what somebody is willing to pay that's why it has become so different because we've been able to take on more lending, even though, because interest rates have decreased, essentially the payments are the same and, and house prices, uh, are still affordable in terms of what somebody is paying because interest rates have decreased. And I just want to tell a little story. When I was a young, impressionable kid sitting down in south Taranaki, watching the television, we used to watch Mitre 10 dream home. Do you remember that show, Andrew?

Andrew Nicol: Was it in black and white for you? Back in Taranaki...I suppose it was probably...

Ed McKnight: Oh, no, Andrew, you forget that you're about 10 years older than me. No. So we would watch Mitre 10 dream home. Great show that was as well. Oh, it was much before the block. And actually before Mitre 10 dream home, there was was Mitre 10 changing rooms. That was a great show as well.

Look at us reminiscing about the nineties and early two thousands, and what has stuck with me since I was a kid watching Mitre 10 dream home, I would remember those people they'd worked so hard in order to be able to get that, build this property or to to make over this property, I forget exactly how the show worked, and then they would go to the bank and I think during this show they actually went to Kiwibank and they would see how much they could borrow and they would always look at it on a 30 year, and they'd say well, what's the maximum we can get? Because we really want this house. We love this house.

And they would, you know, almost without fail, the TV producers probably planned this, but they would bid the price up to the maximum and then that get really emotional and that wait and yes, they've got the property, they've got it! Now, they weren't thinking about the fundamental value of that property, they weren't sitting there thinking, God, I wonder what this property is actually worth. It's only worth what somebody is willing to pay for it.

And that kind of TV show solidifies in my mind, and it's kind of etched in my mind that people, when they're going to live in a property themselves and they envision their kids, uh, living there and growing up there and having great memories there, it kind of, people don't consider what, what's the fundamental value of a property? And the kind of isn't one in many ways, because what is the value of the house? In some ways, I would just say, well, it's whatever the replacement costs as minus some depreciation. Uh, you know, and in that case...

Andrew Nicol: That's because you just think about the numbers, and you're considered what the books call a psychopath then Ed, but the emotional part of things makes people spend so much more because they can see their kids growing up there, they can say them going to the local schools and, and they're wanting to pay no matter what, whatever amount they can to make that dream a reality.

Ed McKnight: Yes, I wasn't actually just suggesting that we should just go around valuing things on what the replacement cost is, you know, but essentially if you're going to look at a fundamental value, that would be what it is, whatever the replacement cost is, and you might look at the land and, and figure out what somebody is willing to pay for that.

But similarly, then in terms of the actual land as well, that is a, that is based on emotional factors and emotive factors. You know, why is it that Fendalton is a very expensive area, yet Addington, we're talking Christchurch suburbs now, yet Addington, which is just on the other side of Hagley Park, same distance to town, is less than half the price in terms of median suburb values. You know, fundamentally they're the same distance from town, had Fendalton and those sort of nice properties been built on the other side of town, I'm sure Addington would be just as expensive. The land really, fundamentally isn't isn't worth any different. It really should be the same.

But it's the, the neighbourhood, the sort of people that live there, the sort of houses that surround you, the prestige of the area, all of these other factors that people, excuse the pun, buy into, uh, and that bids up the price. So by lowering the barriers to entry, and if everybody had more finance, then that would naturally bid the price of many properties up because more people are able to get into the property market. More people in the market means that they will naturally bid properties, prices up because they're competing for the same number of houses.

Now you might see some more developers properties in order to respond to that demand that that would be expected, but we would expect, uh, quite a significant lift in property prices if, if some of these scenarios played out. And I realise that in order for this, this show to actually kind of make sense, you probably have to listen a couple of episodes back a just to though that other show where we discussed the, the three different scenarios that we anticipated would make the property market go berserk.

Andrew Nicol: And maybe this one three times at half the speed.

Ed McKnight: I wish we could say that we'd hit a few dregs but you know what? I think what it is, Andrew, is that we've just come off, this week has been intensive in terms of the number of webinars that we've actually done. I think I've done four different live sessions or video sessions with different organisations this week and they've all been very, very, data heavy, and people have either said, yes, we're following Ed and not really meant it, or I've just started speaking a lot faster.

Anyway, let's wrap it up there, but please don't forget to rate, review and subscribe to the podcast. It really does help us get the message out to more people. And hey, if you're interested in how coronavirus, and this coronavirus induced shutdown is going to impact the rental market and how an increase in the number of Airbnbs coming onto residential property is going to affect the rental market, then come along to our live webinar that's happening this Tuesday at 7:00 PM.

Now, I'm going to drop the link to that in the show notes. Uh, but so you can just tap or swipe over that cover art and it'll take you right there or just go to our website, Opespartners.co.nz. You can register for that and it's going to be very data heavy, and it's going to be a lot, a lot of fun. So I can't wait to see you there.

Thanks for listening to the Property Academy podcast. I'm your host, Ed McKnight, and I'm Andrew Nicol and we're going to be back again tomorrow with even more daily strategies, tactics, and insights to help you get the most out of your New Zealand property market.

Until next time.