The Pendulum Swings Both Ways

October 1, 2013 3:48 am Published by

the pendulum swings both ways image

 

 A mortgage broker friend of mine and I were recently observing how often folks ask us about “where the market is heading.” In his case, they mean interest rates, in mine, real estate prices. However, the questions are really one and the same. So are the answers- “We don’t know,” “If we were that smart, we would be retired!” While I am extremely bullish on Guelph, and our prospects for continued prosperity, I am also a realist. We do not live in a vacuum, and our market is greatly reliant on forces beyond our control. Low interest rates have fueled a great run in our industry, helped many people become rich, and many more to act like they’re rich. It might serve us well to remember that the interest rate pendulum can swing both ways, and wealth left exposed to interest rate fluctuations can be short lived.

 

About fifteen years ago I was involved in the sale of a small local apartment building. The sale price, was just a little under $1M. Through the wonders of City of Guelph tax increases, higher gas and hydro expenses, the net income of the property is roughly the same some fifteen years later. Yes, the rents have increased, but only to keep pace with the the corresponding rise in expenses. Yet, the market value of the property based on prevailing cap rates has almost doubled. It would be very tempting for the purchaser to extract the equity built up (inflated) in the property, boost the amortization back to 25 years, and STILL have more cash flow. Indeed, it may very well be wise to do so, and a great many folks have. The problem however, is that by doing so, they are exposing themselves to the pendulum swinging back and wiping them out. (I am still young enough to recognize how dreadfully conservative I am sounding.) 

One of the results of the prolonged period of declining interest rates has been a tremendous increase in the value of income producing property. Yet, in real terms, for those few people who are no longer reliant on bank money, they may reasonably conclude that they are not making any more money today than they were a decade ago. Sure, their net worth statements may look impressive, but unless they are extracting equity or selling, an increased net worth is meaningless anyway.To buy, or not to buy, is a very personal question. While I understand those who have grown cautious, I also have a very vivid memory of someone I viewed as a prospective purchaser of investment real estate claiming with full conviction, that he would invest his money in mutual funds until real estate bubble crashed. He would buy for pennies on the dollar – that was in 1998. Who knows, time may prove him correct, but I don’t have that kind of patience. If I were in the position of advising my daughters on their real estate investments (a day approaching more quickly than I could have imagined) I would be encouraging them to buy as much as they possibly could. I may also suggest a long term on the mortgage might mitigate the damage of the returning pendulum. A rise in rates may be inevitable eventually, but the hum emanating from the printing press known as the Federal Reserve lead me to believe that inflation is just as likely. It’s hard to find a better hedge against inflation than real estate, and it’s easier to buy and tougher to misplace than gold bars!

 

Thanks for reading,

 

Jeff Neumann