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The Morning After Olly Newland's Column, November 2008 New Zealanders have a new government and a new cabinet. Some would call it a conservative government, not withstanding National's attempt to be 'inclusive' of selected minor parties. John Key and his coalition partners just had to win the election, judging by the pre-election opinion polls. I would wager that Helen Clark and the Labour members are privately relieved that they don't have to deal with the mess this country and the rest of the world has gotten itself into. The one very good thing about the NZ election result was that the outcome was clear cut. However able and enthusiastic John Key and his colleagues may be, the facts are that events on the international financial scene will overwhelm anything they had been planning to do. The forces at play are beyond the control of this government -- or any government for that matter. It may not be the 'Financial Armageddon' John Key spoke of and which some others predict, but it still has to taken very seriously. It may be a near thing. On the home front, it seems that we are going to endure a mini budget of sorts in December (shades of Muldoon). This will not deliver many Xmas goodies, you can be sure. Hopefully it will be more than merely a re-arrangement of deck chairs. Some small vindication I'm being sought out more and more these days by investors looking for guidance about their options in the dramatically changed market and lending conditions -- as well as those who have been caught short by the very reversal predicted in my book 'The Day the Bubble Bursts'. I take no pleasure whatsoever in my warnings being proved right. As some critics have recently conceded, they're learning the hard way that I did actually know what I was talking about and that my advice was worth following. In the book I set out a roster of warning signs to watch for to indicate that the housing bubble had indeed burst. Many of those indications have indeed come to pass. I also said that the implosion is usually started by an unexpected 'event' which triggers the end of the ride. In previous times it was an oil crisis or the collapse of the wool trade, or a share market crash. This time we have the mother of all credit crunches. This produced the effects predicted in the book -- and will produce a whole new layer of further unexpected problems. Some forecasts for the time ahead - The emergence of new 2nd tier finance companies/funders with money to lend (but at exorbitant rates) - Concerted moves by the banking system to re-negotiate mortgages to prevent a flood of mortgagee sales - Massive government intervention (by regulation, if needs be) into the banking system - The role of the Reserve Bank diminished as the government executive increases control - A re emergence of more aggressive unions as unemployment grows - The collapse of the top end of the art market both here and overseas. (Important discretionary spending stalls) read this - The growing threat of high inflation created to combat the 'greater evil' of depression - A long period of stagflation (been there, done that!) which could last for at least three years - Major retailers closing up shop or severely downsizing - Conversely, the rise of the small retailer (driven by newly-unemployed seeking to create work) - More top-end office space falling vacant, while second-grade space fills - Large developments remaining idle for years (the 'hole in the ground' phenomenon) - Banks downsizing and withdrawing credit facilities -- with little or no notice, and credit card limits being drastically reduced Attitude of the Banks Having seen and experienced first-hand the cold and merciless way the banks dealt with problems in previous downturns, and been a witness to their attitudes to their clients, I can confidently state that it will be no better this time round. Bankers are trained not to display weakness. Some of these heartless bureaucrats will not hesitate to destroy and bankrupt anybody who defaults (notwithstanding a short period of grace). If you think that you will get a better deal from a bank just because times are hard you'd better think again. After my last experiences (read 'Lost Property') I vowed never again to use any of the main banks for mortgage purposes. I'd rather pay a little more interest and have sane mortgagees to deal with. Only recently I was reminded of this when on behalf of some clients under significant financial pressure, I tried to get a ruinously high (for today's market) interest rate reduced on their investment properties. Because of higher-than-budgeted interest rates and lower-than-expected rents, this couple were going backwards at the rate of $500 per week. As a part of the exercise a statement of income and outgoings had to be produced on behalf my clients. This was rejected out of hand by the bank who countered with their ludicrous estimates on what this couple should be able to survive on. We are still negotiating. This is an area where getting a bit of experience on your side helps. People like my clients are at the mercy of the banks . I find myself frequently reminding bank managers of their options if they are unreasonable. Do they really want to own a heap of empty properties as mortgagee in possession and have desperate people hammering on their doors? Time and time again I have seen the banks engage in reckless lending carried away by the same competitive market fever that has gripped so many others. They should have known better. Just look at the staggering loans they made to failed developers as has been revealed lately. Hundred of millions of dollars of other people's money lent out for what were little more than holes in the ground. The trouble is, a bank has big teeth and it is hard to fight back. I'm having to educate them! The interest rate time lag Here's the problem: The official cash rate (OCR) may be reducing but it's not yet feeding through to borrowers and consumers. Locked in interest rates remain locked in, no matter what. Now, I am the first to believe in the free market but in exceptional times like these, this dogma has to be temporarily suspended. (Look at the Wall Street bail-out, and how comprehensively central banks are pouring capital into so-called 'private' banking enterprises.) Maybe Muldoon had a point. When the free market breaks down, regulation may be the only answer -- but just for the duration, that is. For confirmation read here Just to drive the point home: you may have read about the attitude of the banks towards the hapless 'Blue Chip' victims who were [it seems] scammed of their life savings. Desperate and costly legal action and pathetic finger waving from the (now richly deserved) ex-Minister of Commerce Leanne Dalziel merely stalled attempts to evict the innocent up until now. But action -- real action -- from the authorities remains still at an abysmal zero. The state of the residential market Despite the hysterical bleatings of a legend in his own lunchbox property 'analyst' earlier this year, the market has held up reasonably well -- certainly when you compare it to the nightmare scenarios in the USA, Great Britain and other countries. An average drop of 4.2% in the median price (so far) is no big deal. The low turnover figures show that most of the previous year's sales were just people having fun in the market, trying to make a tax-free dollar on the way. Some made it, some got clobbered. Them's the breaks. Right now the market is being driven by those who have to sell, and not by those who would like to sell. Buyers, in turn, rarely have to buy. This mix explains any weakness in the market. As is my practice, I am constantly enquiring from business owners how they are doing. The answers are very revealing. For instance, one contractor I know is an expert bathroom and kitchen installer. He explained that up until the middle of last year, he was flat out putting kitchens and bathrooms into newly built apartments and homes. All this has now changed. Instead he is now flat out renovating existing kitchens and bathrooms. People it seems, have decided to stay put, renovating their present homes up to new standards. This neatly explains the low turnover figures we are witnessing today. But it's not all rosy. I predict that next year will be more difficult than this year has been. Many people are still hanging on by their finger tips -- but they can do so only for so long. Next year will bring some 'capitulation' as unemployment rises, incomes fall, and rents, yields and profit returns stay flat ... or fall further. I deduce this from my work with other investors, some of whom are totally exasperated by the zero-growth-and-falling-rents combination. While prices were screaming upwards it was all such great fun. Topping up the interest shortfall was nothing compared to the '$1000 per week' they were making (on paper) in capital gains. Those days are gone, for now, and the reality is slowly dawning. There is yet some considerable optimism for residential investors. If they can hang on for another year or two longer, things are likely to slowly improve. I foresee a return of many ex-pats who, like the Poles who are returning home from London, are finding that its not all that rosy living through a recession overseas. Australia, USA, Europe and many other countries are shedding jobs at a frantic pace. New Zealand may have its faults, but there is nothing like being able to always get to a beach, have a BBQ, go fishing, grow some veges or run some chooks in the back garden. Interest rates are trending down -- not withstanding the slow trickle-down effect to the borrower. This will help, eventually. Rents could firm as more people choose to rent rather than own. Renting has always been cheaper than owning but now the gap is far too wide. Home ownership should be encouraged. Why shouldn't interest payable on a home mortgages be tax deductible? It is in many other countries. Couple this with a slowdown in emigration and an increase in immigration and the market might be saved from the threatened 'meltdown' we hear so much about. The recent and welcome drop in petrol prices may also breathe some life back into the smaller towns and coastal settlements in the long run -- but rising costs in other living expenses will still outweigh any gains. The falling NZ dollar will put a stop to any chance of fuel prices returning to their previous lows. I would not recommend investing in small towns (whether residential or commercial). The market is simply too thin. One of my recent clients, fired up by the exhortations of a get-rich-quick merchant, invested in a large number of cheap houses in a small provincial town at an average price of $80,000 each. Guess who sold them to him? The very same 'educator' who whipped up his emotions at the hyped-up sales seminar. Half of the houses are now empty and ALL are impossible to sell without a huge loss. Lesson: Always buy quality, in a good location -- and get independent advice every time BEFORE you act -- not after. (I'm doing my best to get him out of the pickle, but it's not easy.) The state of the commercial market The commercial market has had a fairly smooth ride until now -- with of course the big exception being development projects. Shades of 1987 all over again. When some of the failed development projects were revealed it staggered belief that anybody could conceive some of the projects in our market. (Let alone find funding for them! see this). We live in New Zealand for goodness sake! A land of four million people and 80 million sheep. Some of these larger projects dripped with megalomania and unrestrained egos -- even to have considered such big-scale deals was a act of stupendous naivity. We have to invest or build into the market and country we live in. Whether we like it or not, we are a small nation in the South Pacific regarded by the ignorant world as a larger version of Fiji. Unfair it may be, but that's the way it is -- and we have to cut our cloth accordingly. The reported remarks by Auckland Mayor John Banks, "Much of the property values in the [Auckland] CBD have been built on sand and consequently it was only a matter of time before there was a collapse," were unfortunate. However, I'm sure he was only damning the over-blown (and now failed) development projects -- not the whole commercial market. After all, John Banks is an experienced and successful investor in his own right. The commercial market, much like the residential market is made up of a myriad of different parts -- and each goes through different cycles at different times. Some of the parts are: (a) Large developments (as above) are always a very risky venture and should only be tackled by those with very deep pockets (b) Small town commercials are generally less-than-useless. Whether shops, factories or offices, there is little chance of any real capital growth or rent increases and the risk of prolonged vacancies is high. (c) Smaller factories and workshops in the main centres could be winners. As unemployment rises, so will the demand for small spaces by trades folk looking to set up a means of earning. A clutch of small modern factories in among an industrial area could be good buying. (d) While I'd avoid the large retail stores, smaller 'Mom and Pop' retailers will probably be the safest bet for the same reasons as with smaller industrials. In tougher times it is always best to have 5 x $1million properties than 1 x $5million property. (e) Vacant buildings -- especially large ones -- are a no-no unless required for owner occupiers. Tenants are not beating down the doors any more. As interest rates drop, the returns from well-leased small to medium-sized commercial properties will be strengthened. Why would anyone with some spare cash to invest in bank deposits at (say) 6.5% not be attracted to a commercial property showing 7% or better? Throw in the legitimate tax deductions available to investors and the answer is obvious. Closing thoughts -- and an offer of help We are living through volatile times. Only the most naive would say they are not nervous. According to many 'experts' and politicians the world over, we are facing the biggest global meltdown in history and the likelihood of a depression as bad as the Great Depression of 1929-32 is now being taken seriously. BUT... when we listen carefully to all the experts and their depressing prognostications, it should come as no surprise that these experts haven't a clue (let alone any consensus) of what to DO in the current crisis. They're not investors. I cannot believe that the mistakes made almost 70 years ago will be repeated today. We have come a long way since then. The financial tools now available to the authorities are no longer rooted in 19th century dogma and myth. This confusion will only be -- CAN only be -- a passing phenomenon. The confusion will pass. So will the media hysteria. In time the story will become tedious. In time this present turmoil will become just another footnote in the history books. In today's high-tech world, everything moves at lightning speed. We will come out of this crisis and, I suggest, more likely sooner than later. To believe otherwise is impossible to comprehend. What we need is a stiff upper lip and a little steel up the backbone. The days of free and easy money have gone. The looming recession creates an urgent need for investors to re-arrange their investment strategies. Some will have to learn (or re-learn) the basics, others need to find a new approach or make some distasteful decisions -- lessons and knowledge they cannot get from so-called 'educators' who are really spruikers preying on their ignorance. Getting your hands dirty the old-fashioned way is how we'll have to earn our keep -- by adding value or creating it. I can help you deal with the trials and tribulations of these times -- and more importantly, show you how to take advantage of them to climb the property ladder. However, I can only work with a limited number of people at one time -- so contact me by email for more details or call me 0800 66 22 80. Olly Newland November 2008 www.ollynewland.co.nz © 2008 Olly Newland. All rights reserved. Get the benefit of Olly's experience: Visit Olly's website for details of his Personal Mentoring Programme and consulting services. Read more of Olly's columns here. FEEDBACK: Do you agree or disagree with Olly? Send your comments, criticisms, counter-arguments or any feedback to him by clicking here. Order Olly's book: The Rascal's Guide to Real Estate (updated second edition). Browse our website for a wide range of investment-related resources including Olly's best-selling books: Climbing the Property Ladder, The Day the Bubble Bursts and Lost Property -- all essential reading for investors.

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