How and Why Property Market Busts Happen

By Gerald Tay (guest contributor)

There are many investors who invest in properties solely for capital gains. They are not concerned with making a rental profit, and are sometimes even happy to make a rental loss! Understanding why property prices rise and fall is very important if we want to make money.

In Singapore’s highly volatile property market, you should never count your chickens before they hatch. Inexperienced, amateur and speculative investors only know how to count chickens. Successful and smart investors count the eggs and understand why and how they hatch.

It is property prices that drive yield, not the other way round. Property prices are volatile, rents are stable. We call the rise and fall of property prices the boom-bust cycle.

The Chain of Events in a Crash

Something has to cause the crash. Crashes do not happen overnight but they do happen a lot quicker than a boom. Think of a roller-coaster. When you reach the top of a slope, you think the cart will rest at the top but it just tips over the edge and accelerates downwards. At the top of the slope the following will happen at a greater pace than during the climb:

Interest rates rise to curb inflation. Borrowing becomes more expensive and many investments no longer look attractive. The property market slows down.

If speculation is done using private money, then this is not much of a problem. However, recent reports concluded the majority of Singaporean buyers who bought at the current high bought these properties with bank loans. It’s the pulling of the plug by the banks that causes the rapid decline in property investment.

Let me show you a clear chain of events:

When a crisis erupts due to an unforeseen event happening, e.g. Asian financial crisis, Lehman Brothers’ collapse or even a possible financial crisis in Europe, depositors would rush to the banks to withdraw money, thus causing a tremendous outflow of money supply from the banks. The banks would then have to restrict lending as much as possible to prevent a liquidity crisis.

Coupled with increased interest rates which have killed both investment growth and yield, banks would view lending money as a very risky business and thus stop lending. This would then lead to a severe shortfall of money supply in the markets, which will eventually lead to global economic downturns. When banks restrict lending because they are scared, it means fewer people are able to buy. Due to fewer people being able to buy land and property because of the restriction by the banks, land and property prices have to fall.

People who have bought at the peak are now facing negative equity. Their debt is greater than the value of their home. The credit boom cools. Lenders now know that the consumer’s property value has fallen; hence there is no security to lend.

Due to higher than expected interest rate rises, some borrowers start to default. The banks try to access the security by issuing repossession orders but due to property prices falling below the security, the banks start to lose money. Consumption falls as banks are also not providing credit to fuel consumption.

New property launches now look unprofitable due to the lack of buyers, which is the result of banks not lending. Even renting these properties looks unprofitable due to the higher than anticipated interest rates. Projects are aborted. Property developers know that if they carry on they will certainly lose money.

The mass exit from the property market, heavy bank losses and depressed consumer spending causes unemployment. The feel good factor is non-existent! Borrowing and spending both decline. The demand for goods fall as consumption falls. Speculation on the property market looks silly. People think it’s better to save than spend.

As property prices fall, potential buyers will wait till the market bottoms out hoping to get a bargain. Property prices rapidly decline until the professional investor cushions the fall and becomes interested again. (This is where smart investors like me would enter with glee!)

Demand and Supply of Money Is the Real Cause

As you can see, it is not principally the demand and supply of units in the property market that determines property prices to rise or fall, which many self-interest groups and even the government have led people to believe in. Rather, it is the actual demand and supply of money in the markets that will strongly determine if your property or any other investments go up or down in value.

With the European crisis on the brink of global economic catastrophe, coupled with a slowdown in China, I strongly urge investors to avoid buying both local and overseas new property developments being marketed today on hopes of future capital gains.

The above chain of reactions is not a matter of IF but WHEN. Major financial crisis events have existed as early as the 14th century. As my late multi-millionaire grandfather advised, “Inexperienced, amateur and ignorant investors only know how to make money on future capital gains. Smart and successful investors make money on today’s cash flow.”

Today, the still buoyant Singapore property market is potentially headed for a sharp downfall once global credit markets starts to freeze. Don’t forget, Asian credit markets are primarily financed by large European banks, which are already facing huge liquidity challenges caused by the Euro Crisis.

By guest contributor Gerald Tay, CEO and Chief Trainer at CREi Academy Group. Posted courtesy of www.Propwise.sg, a Singapore property blog dedicated to helping you understand the real estate market and make better decisions. Click here to get your free Property Beginner’s and Buyer’s Guide.

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