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The Year Ahead Olly Newland's Column, January 2010 A Happy New Year to you - and hopefully a prosperous one as well. Last year was not a particularly good year. There were times when we thought that the end of civilisation was at hand. Prospects look a lot better now - but I feel that any real recovery could be brittle. Having said that, I'd estimate there is a 50/50 chance that the economy and property prices will remain FLAT during the next 12 months. As suggested in my last column (available here) I think there's a 25% chance of another round of recessionary events and maybe a 25% chance of massive inflation (or hyper inflation) ... especially considering the jaw-dropping amounts of funny money central banks around the world are pumping into economies. So-called 'experts' humbled At the beginning of last year several 'expert' commentators predicted falls in property prices of up to 30%. The media loved it, of course, and published breathless, lurid stories based on these silly predictions. In contrast, I came out and predicted a flat market and that, more or less, is what it has been. Average prices dipped a little - virtually within the margin of error - and have now, according the statistics, recovered almost all their notional losses. Not so lucky were developers and finance companies who took the brunt of the day the bubble burst. Predictions are always tricky, but even so, those so-called experts have been discredited - revealing, in some notable cases, that they possess only a shallow understanding of how the property market actually works. In the same vein, whatever you may think of the pointy head at the Reserve Bank, they have got one thing right in my opinion: low or moderate interest rates are the key to recovery and prosperity. To be sure, there are dangers in too-low interest rates, just as there are dangers in too-high interest rates. These dangers are: Zombie economy Look no further than Japan where interest rates have been at or near zero for years. We too run the risk of a 'zombie' market where prices stay the same and incentives are stifled. I've said it before in other contexts, but the free market capitalist system needs a little creeping inflation to work properly - maybe 2% to 3% per year. Less than that, and we can fall into deflation which is a much bigger nightmare. A little inflation provides the incentive for people to spend money and thus keep production going ... and so creates jobs. Deflation The opposite of inflation is deflation and that would be a nightmare. In a deflating market prices would drop across the board and keep dropping. Short-sighted observers would see lower prices as a good thing - that is, until their own home and investments lose value! That, naturally, would be an entirely different matter indeed. It's always amusing to watch how some socialists carry on about the 'evils' of the capitalist system, but seem remarkably quick to put their snouts in the trough at the first chance they get. Looking at Japan again, as an example, the big worry for their economy at present is the risk of deflation after years of stagnation. Concern about that has seen Japan change its finance minister every few months. By far the worst form of deflation is stagflation - which is a mixture of stagnation with inflation or deflation (stag=stagnant) Inflation Having lived through several bouts of high inflation, I can assure you it can be a wild ride. I remember talking to Robert Muldoon once when he was Minister Finance in the 1970s. We agreed that inflation was definitely the lesser of two evils when compared to a flat or deflationary market. I had a similar discussions with David Lange and Roger Douglas in the 1980s - they too agreed that modest inflation was far more preferable than the alternative. If the Reserve Bank wants the New Zealand economy to get going again, then some inflation is necessary - it's needed to oil the wheels, you might say. Of course we property investors gain during inflationary times, but seriously, isn't that a fair and just reward for the risks and heartaches we must endure as landlords and investors? Without us and our entrepreneurial spirit, tenants would be homeless or rents would be sky high. How one can profit from inflation is an art that can be learnt with huge benefits if correctly used - but you can get badly burnt if you bet the wrong way. Typically I have seen people sell up properties waiting for prices to drop, only to find they have been effectively locked out of the market as prices rise even further. Don't make the same mistake. Decide early if you want to (a) buy and sell on the same market or (b) buy and hold long term ... and gain the benefits that way. Hyper inflation As alluded to above, I believe there is a serious risk of hyper inflation afflicting the world's economies - wreaking havoc as it goes. The risk comes from the trillions of dollars (over $59 trillion and rising) created out of thin air in the last year or so to prop up the US economy - let alone the money printed by the other countries. see: http://www.usatoday.com/printedition/news/20070529/1a_lede29.art.htm History shows that too much money chasing too few goods-and-services can result in hyper inflation. I personally tasted hyper inflation in the late 1980's when interest rates were 22%(!) and upwards - some investors could only pay the interest by constantly revaluing their properties and borrowing yet more. Banks were paying 15% plus for term deposits and it was possible to get 1,000% p.a. (not a typo) for weekend money. Everyone bought what they wanted 'today' because they all knew that 'tomorrow' everything would be even more expensive! But this hyper inflation was nothing as compared to the inflation experienced in recent history in some Latin American countries, China, Yugoslavia, or in Zimbabwe where inflation went into the millions. Of course in the 1920s Germany had hyper inflation. One postage stamp cost 10 billion marks and people said you should to buy two cups of coffee at one time because the second cup would be 100 times the price of the first! link: http://ingrimayne.com/econ/EconomicCatastrophe/HyperInflation.html Lesson: If, looking ahead, you believe that hyper inflation is possible, then a prudent move is to invest some money into into hard assets such as property, gold, silver, art and antiques and the like. Confusion in the ranks? It troubles me when I read the comments of high profile financial commentators bagging property investment as some sort of 'social evil'. I hesitate to single anyone out, but comments by renown multi millionaire and advisor Gareth Morgan seem typical of this ilk - in my view showing their bias when they do so: see: http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10619181 However it seems that Gareth's son, Sam thinks differently about the subject and is obviously not adverse to making a dollar or two out of property speculation. (And all success to him.) see: http://www.stuff.co.nz/business/685667 Maybe the two should have a chat and sort things out. They seem to be seriously out of step in their views. It seems no coincidence to me that many of the critics represent alternative investment to property such as shares, Kiwisaver and bank deposits. As I have said before, I wonder if they asked the poor souls who lost everything in the likes of BridgeCorp, Hanover, First City and others if they could have another chance and invest in property instead. What do you think the answer would be? The banks don't help Other critics of property as an investment, such as NZX boss Mark Weldon or the NZ Herald's loquacious Mary Holms, want us all to invest in businesses instead, either directly or through shares on our lacklustre stock exchange. Unfortunately, banks demonstrate that they are most reluctant to lend to businesses. Over and again my clients tell me that they cannot expand their businesses with the help of a bank loan unless they have collateral in the form of real estate. What does that tell us? It is none other than the banks themselves who are foremost in choking off business growth. Their paranoid reluctance to lend money - without the security of real estate as a back up - has continued to suffocate the overall business climate for decades. You may be the hardest worker, and the most brilliant business operator but without real estate as collateral you will find raising funds very tough indeed. Until this anomaly is fixed by banks being prepared to lend against a borrower's record whether business, personal (or both) without using property as collateral, then the dream of expansion into other avenues of investment will remain subdued for a very long time. Olly Newland January 2010 www.ollynewland.co.nz © 2010 Olly Newland. All rights reserved. Get the benefit of Olly's experience: Visit Olly's website www.ollynewland.co.nz for details of his Personal Mentoring Programme and consulting services. FEEDBACK: Do you agree or disagree with Olly? Send your comments, criticisms, counter-arguments or any feedback to him by clicking here. Read more of Olly's columns here. 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