And therefore will never, ever fall.

House prices at any point in time, like that of any other asset with a built in cycle, depends largely on irrational sentiment and emotion. Fundamentals only tell you what the price OUGHT TO BE, not what the price WILL BE at any given point in time. Fundamentals in the US were largely constant, but the price for certain houses fell as much as 70% during the crash, way below the cost price of the house, and way lower than the fundamentals would indicate. Sentiment is a fickle b*tch, both on the way up, and on the way down.

What we are seeing in Malaysia is a newfound positive public sentiment towards purchasing housing at the highest possible end of affordability, and this is encouraged by prolonged historically low interest rates and a sustained period of consistent outsized gains, which has led to, rightly or wrongly, a perception among many ordinary Malaysians of reduced/zero risk, guaranteed outsized returns and a fear of being priced out in the future. How many Malaysians who hold millions worth of property and mortgage debt are invested in other asset classes? So long as this sentiment lasts, many ordinary Malaysians will continue to bet their next 35 years of earnings on houses which they can barely afford, fundamentals be damned.

Again though, sentiment is fickle, and I think there is a relative lack of sophistication in the average Malaysian investor who tends to decide based on limited anecdotal experience instead of statistics and dispassionate macro analysis. Such investors are just as quickly inclined towards fear on the way down as they are to greed on the way up.

I have a theory that the mentality of those who disregard macro analysis is analagous to the mentality of those going to a casino, or those buying lottery tickets. Let me elaborate.

Statistical data and mathematical analysis necessarily lead to the conclusion that an average person who gambles at a casino is more likely to lose money than gain. Logically therefore, nobody in their right mind should go to a casino. However, there are necessarily people who have had personal experience winning money, and due to the logical fallacy called hasty generalisation, they will tell you that your theory is wrong based on their own limited experience. (i.e. I have won the last 5 times, and my friend has won the last 5 times, and his friend has won the last 5 times, and therefore I believe I will continue to win) There are those who read, understood and agree with your data will tell you that they are exceptionally skilled or lucky (i.e. I am different, I am special, your theory does not apply to me). Ultimately though, regardless of all the theorizing and discussion the casinos are still packed with very wealthy and educated people, and the casino owner laughs all the way to the bank.

Caveat: Macro analysis at the layman level at least will not help you predict the future, and any prediction made by experts with any degree of specificity is usually wrong. Asset markets are inherently unpredictable, and the rules of the game may change at any time with a simple announcement of a new government policy, whether here, China, the US or elsewhere. Nonetheless, my analysis leads me to the conclusion that based on current conditions, people, especially the overleveraged, should start diversifying away (not exiting completely of course) from the property market which is looking increasingly vulnerable.

I do agree with you on that car prices are stupid. Nevertheless, it is a false comparison. Mortgage debt is seldom a cause of bankruptcy during a rising market, as the debtor can simply sell off his house for a price higher than his mortgage debt in lieu of defaulting. On the other hand, in a falling market, your house depreciates in the same way as your car. A rising market obscures the flaws, and a falling market exposes them all. That's precisely why nobody knew about the dangers of the subprime problem in the US - it simply wasn't leading to significant levels of defaults until prices stopped appreciating.

Agreed that we do not have an apparent subprime problem. (Some would argue that there are others kinds of hanky panky which would go on in Bolehland, but that's pure speculation) The only issue is that the ability of property buyers to repay their loans is not tested in a rising market, so the financial resilience of property buyers cannot be determined simply from current mortgage default rates. My angle is that I'm not comfortable making up my mind in this market of ours, and nobody else should be.

It's funny, all of this. The 2007/2008 crisis was paradoxically good for our asset markets, not just because of the investor pullout in developed markets, but also because of their stimulus money which had no where to go. As I recall, the asset bubbles which led to the Asian Financial Crisis was in part due to Japanese monetary easing in the aftermath of their own property bubble back in the 80s. Deja vu anyone? Most people don't understand this relationship, and think that our surviving the 2007/2008 crisis is proof of our resilience. It isn't. It's the magic of fiat money.

We are more prepared for a crisis now than back in 1997/98, but I remember being in Singapore where interest rates were at a stupid ~0% even though inflation was hitting 5%, simply because of the hugely profitable carry trade between the USD and the SGD. My colleagues were actually feeling forced into buying property as mortgage rates at 2% were lower than inflation at 5%. In that period, I note that Singapore, Indonesian and Filipino asset markets actually did even better than us. While the withdrawal of stimulus monies is expected to hurt our asset markets by restricting credit growth, I'm still of the view that the most likely scenario is that any fallout can be controlled and contained because of strong government financials, the fact that the withdrawal of QE is expected to be gradual, and I foresee Japan, GB and Europe to continue easing for a while.

This post has been edited by Anon_1986: Jul 30 2013, 04:00 PM

Let me take a shot at your query. Any asset other than cash is theoretically a hedge against a weakening currency and inflation. However, I'd find blue chips and foreign equities a better hedge than properties, because equities are linked to profits, whereas properties are linked to debt. Here's why I think that way:

Salaries lag inflation, and inflation lags interest rates which are increased to combat inflation. Ergo, property if financed largely by mortgage debt is subject to an anti-goldilocks zone, where interest rates rise before inflation falls, and before salaries rise, leading to a spending squeeze among those who are highly leveraged.

If inflation is high and currency is depreciating:
- Prices of goods = increasing
- Salaries = lagging inflation (salaries are still paid in Ringgit)
Therefore: Company profits = matching inflation (because prices increase faster than salaries, and because currency depreciation makes exports more lucrative in Ringgit terms)
Therefore: Disposable household income = decreasing

Assuming then that central bank then raises interest rates to combat inflation and shore up the currency:
- Interest rates = increasing
- Mortgage payments = increasing
Therefore: Disposable household income = decreasing => increasing defaults on mortgage debt, putting pressure on housing prices

On that basis I'd prefer (export based) blue chips over properties, largely because the level of mortgage debt held by households currently indicates that the market as a whole is very vulnerable to interest rate hikes.

Singapore is an interesting case study for the relationship between property, mortgage debt and inflation because as a small economy that imports everything it consumes, the government is able to inflation using exchange rates instead of interest rates. Hence, over the past 4 years, property has been a very good hedge against inflation in Singapore because interest rates have not risen to combat sky high inflation. When inflation rises, Singapore uses USD to purchase SGD, allowing the SGD to appreciate, thereby making imports cheaper, and this serves to control inflation without having to increase interest rates. On the other hand, interest rates have been floating at ~0% in Singapore because of the profitable carry trade between the USD and the SGD, where US investors borrow money in USD at ~0% to put in Singapore in the expectation (announced by MAS) that the SGD will rise. This has been a substantial contributor to the Singapore property boom in the past 4 years. Hence, property and mortgage debt would be a fantastic hedge against inflation so long as interest rates do not rise in response to inflation.

The key question then becomes, will interest rates in Malaysia rise in response to our impending inflation and currency depreciation? BNM traditionally uses interest rates to control inflation, so more likely yes. However, BNM has the discretion to copy Singapore by using reserves instead of interest rates to control inflation. What BNM will decide to do is a question for political scientists and psychics with their crystal balls.

1) Actually increasing interest will bring in foreign investors for bonds and cash deposits. Foreign investors that come in to invest in industry tend not to borrow in Ringgit anyway, and will not be affected by domestic interest rates. Again though, I foresee any interest rate movements to be gradual instead of sudden.
2) Generally blue chips are less affected by fluctuations in the economy, but I was talking specifically about inflation and currency depreciation. If you throw in a recession in the mix, unemployment will leave condos untenanted and the entire property bubble will collapse as well, and the safest bet is foreign equities then.
3) You are correct that blue chip returns tend not be leveraged, but your risk is much smaller because you are not leveraged, and because entry/exit costs are lower. RM 60k in blue chips, if the market dips 10%, you lose RM 6k, RM 60k initial investment for a 400k property requires like RM 10-20k for closing costs and taxes. A depreciation of 10% (40k) will wipe out your entire RM 60k. God forbid you lose your job, or are forced to sell for some other reason. You will then have to incurr another RM 10-20k to sell it, and will have to wait a gawd awful long time to get your money. I do agree that rental yields can cover part of the costs, but that assumes optimistically that interest rates stay low, and that your property will remain tenanted. There's a precarious balance between interest rates, occupancy rates and rental rates whereby the cost of leverage can greatly outweigh the income from tenanting.

Here's a thought provoking calculation for you (all hypothetical numbers. Feel free to substitute your own)

Property price = RM 400,000
Downpayment = RM 60,000
Loan = RM 340,000 at a conservative average interest rate of 7% over 30 years (ARM interest ranges from 4.2% to ~10%)

Without counting your rental yield, you would have paid RM 60,000 upfront, and RM 2262 a month for 30 years.

Assuming property price appreciation of average 5% per annum for 30 years, your RM 400,000 property will be worth RM 1.7 mil at the end of 30 years.

Now let's look at investing in a sizable basket of blue chips using dollar cost averaging.

Initial investment = RM 60,000
Monthly investment = RM 2262 for 30 years.
Assuming capital gains of 5% per annum for 30 years (unless you have reason to believe equities will underperform property in the long term), and without counting your dividend yield, you will have equities worth RM 1.8 mil at the end of 30 years.

Consequently, there is no real long term advantage for owning property versus buying blue chips. The only reason to buy property over equities is if the rental yield (including periods of vacancy) minus all expenses (taxes, maintenance, vandalism, tenant damage, legal fees, agent fees, reno costs etc over 30 years) is greater than blue chip dividend yield (of a growing stock portfolio) during the same period. Note also that with blue chips you have high liquidity, and low entry-exit costs.

This much is obvious to the educated observer. If properties were really an absolute superior to equities as an investment, why hasn't all of the world's money poured into owning nothing but properties over the past 100 years? Why would anyone ever buy stocks or bonds? I think the equilibrium where buying property is superior to buying stocks is where prices are below historical price to income ratios and price to rental ratios. Both ratios are not making much sense at the moment, and will make even less sense if interest rates rise. In such cases, a portfolio readjustment will be in order.

I actually did take that into account. That's why I referred to the balance between entire net rental yield for the same property over the entire period of 30 yrs vs the dividend yield of a growing equity portfolio that starts at RM 60,000 and ends at RM 1.8 mil. During that period, rental yields may increase, but so may dividend yields.

What most people tend to forget is that a condo and the necessary furniture and finishings may tend to look dated and shitty after 10 yrs or so, and therefore many costs need to be incurred periodically to maintain rental yields. As Robert Shiller said leading up to the US crisis, until the US property boom, few in the US found residential property as a viable investment because residential housing was viewed as a depreciating but durable consumer product that wears out and falls apart as time goes on, just like a car, but substantially slower. (Land on the other hand, does not wear out and is a viable investment. The problem with condos though is that you own too small a share of the land for the price you pay). You then have maintenance costs, legal costs, agents costs, your own time and energy, vacancy risk, troublesome tenants etc to deal with also throughout that entire period. Note also that all these costs will rise in tandem with inflation.

On the other hand, balanced and diversified equity portfolios start small, but require almost zero costs and energy to maintain. If you really want to do the math, it's hard to say which is better than the other because so much can change over 30 years. For instance, property would be a better deal if interest stays at 4.2% for 30 years, but I won't know that today. Property may appreciate faster than equities, or vice versa, but I also couldn't possibly know that today. I prefer to look at long term price/rent and price/income ratios as an indication of when property becomes a better investment than equities.

Do note that I'm not advocating equities over property in general. I'm just saying that many people are overexposed to the property market at the moment, as it's their one and only mode of investment in a time when rental yields are appallingly low relative to long term fundamentals. Slumlords who deal in low cost housing are probably an exception as their rental yields are still high.

Unlikely to hit 7% in next 2-3 years as US rates will still be low. Beyond that I can't say, as I have no crystal ball. But 7% averaged out over 30 years is a conservative estimate, and is based on historical data. You would expect 2 to 3 recessions during that period anyway. Entry cost is low for new launch, but you get a grand total of zero yields while the property is under construction, so it evens out.

Haha, but research is fun! My research has led me to the conclusion that the timing of bubble bursts in asset markets are inherently unpredictable by the layperson, and I look on with bemusement on much of the discussion here about how to predict with a crash with certainty. I felt that Singapore's property bubble ought to have burst in 2008/9, and I organised my finances around that happening, but it didn't. The problem was that I failed to predict the success of the QE experiment in containing the financial crisis, and in flooding safe havens like Singapore with unlimited amounts of cheap liquidity such that mortgage rates were half that of inflation. Similarly today, I still have no idea what impact Abenomics is going to have on us, i.e. whether it can cancel out QE tapering, whether and how other countries like China will respond etc. I also have no idea how much of our RM 433B in reserves BNM will be willing to burn to save homebuyers in the event of an impending crash. At the end, due to my limited intellect, all I can do is try to work around the risk of a crash, and not bet everything on it.

Stock is not necessarily more dangerous than property. The risks are just different, and it's actually easier to hold on to stock than property in a crash because you don't have monthly payment commitments and an illiquid asset that cannot be converted into cash. In 97, the equities market collapsed but not the residential property market. This is easily explained by the fact that the AFC was caused by excessive corporate leverage, leading profitable companies to become unprofitable when debt payment obligations are magnified by a collapsing currency and an increasing interest rate. On the other hand, household debt was low and prices of housing were reasonable relative to fundamentals. Follow the debt, I say, and you'll find where your risks lie.

In any event, even if stagnation is more likely, the risk of an unexpected crash happening is very real and very significant, but too many people like to pretend that this risk does not exist. Due to high leverage and exposure to nothing but property, many out there will not survive a crash. Currently, the biggest risk factor to overleveraged households is the outflow of hot money, leading to a decrease in the value of the Ringgit, and an increase in inflation leading to pressure on the part of BNM to raise interest rates to protect the currency and to manage inflation. If you trace back my earlier posts back in V6 and V7 I hypothesised that the property booms happening simultaneously across emerging markets with little relationship with each other appears to be a symptom of the policy responses in developed countries to the global crisis leading to huge swathes of hot money flooding the region, and is not really caused by domestic factors. This hot money is transient, and won't last forever. If and when QE reverses, so will the hot money and our fortunes. Currently, we are already seeing a drastic weakening in the MYR due to an outflow of hot money. Personally, I found this weakening a bit of an overreaction, as tapering has not even started yet! I'm waiting for a correction before I continue moving my MYR out into USD assets (As I've been doing for more than a year )

Prices will continue to go up because of momentum, but the current cycle seems to be running out of steam. I hear on the grapevine that subsale volume is slowing, and this indicates that rising asking prices are not being accepted by subsale buyers. New launch prices are still increasing thanks to easy financing by panel banks, but it seems that bank policy in general is getting stricter. My preferred bank, of which I am a so-called "premium customer", refused to approve a mortgage for me notwithstanding that the loan is only at 70% margin and is a mere 2x my gross declared income. Reason given was inter alia that the selling price was "too optimistic". I knew that of course, but wasn't really bothered as I could afford it. Ultimately though I was forced to use the developer's panel bank who apparently had no problems with the selling price.

I suspect that the system of "panel banks" cozying up with developers to offer loans is a potential moral hazard risk, as there seems to be pressure to approve ultra-optimistic valuations, and approve buyers more easily in order to get more panel work.

I wouldn't categorise myself as down camp, as I don't think my views on the property market are so simple as to be capable of being categorised into a simple "up" or "down". I like to think of myself a realist who attempts to estimate risk and act based on facts, logical analysis and intuition instead of emotions and oversimplified heuristics. If you read my post history over the past year, you will notice that I never agreed with the DDD camp that the bubble will burst any time soon. Instead, I maintain that our property market is showing the classic signs of a bubble, and appears to be supported by signs of a growing debt bubble across Asia fed by an exodus of hot money from developed economies. Nevertheless, based on my research into property bubbles around the world, I have concluded that the outcome of our bubble is still uncertain at this stage, and in fact there is even a risk that it may grow further.

Currently, I find the property market to be at a medium to high risk stage due to increasingly poor fundamentals, but due to my increasing income, I need to hedge some of my cash in assets other than cash as I cannot allow all my income to enter FD. Although cash is king in the event of a crisis, I do not wish to hold too much cash as I had expected the MYR to weaken. Putting too much cash in the KLCI also has its own risks for other reasons. which I shall not go into here. In my view, the property market is not necessarily doomed to crash as my expectation of interest rates rising in anticipation of inflation may be defeated due to policy changes which are inherently unpredictable. For instance, the Australian property bubble which started collapsing in 2008/2009 was saved by major government intervention, and it then started growing rapidly again. Ideally, I would prefer if BNM and other central banks and governments would always act rationally, but I fully expect they may end up act irrationally for political purposes. Consequently, I would not recommend anybody to exit the property market completely so long as mortgage debt levels remain low relative to income, and so long as residential property makes up only a small proportion of total investment exposure.

I fully understand if you wish to take a different approach towards investing, i.e. by leveraging up on the property market. As I had noted earlier in this forum, it is a depressing fact indeed that many Malaysians have no access to capital, and have little prospect of gaining wealth aside from gambling their futures taking on high levels of debt. That to me is a major risk factor as well, as the residential property market is now overflowing with unsophisticated investors who are leveraged to the hilt, pushing our household debt levels to about 85% of GDP. My personal (and admittedly limited) observations in Malaysia and elsewhere shows me that the level of financial knowledge of the average Malaysian investor is shockingly low relative to those in other countries. An economy is only healthy if wealth gains comes from productivity and value-add, rather than asset inflation and credit expansion. Relying on asset inflation as an investment strategy is inherently unsustainable if this inflation is not backed up by growing yields, but many of our market participants do not have the capacity to appreciate this.

The magic of credit growth is that always creates an "illusion" of a sudden explosion in wealth creation, as households magically fast forward income from the next 40 years to be spent today. Those who fail to appreciate the fundamentals behind credit growth tend to mistake the illusion for the real thing, and their optimism leads to even more credit expansion. However, this trend cannot last forever, and the wealth created is destroyed via the process of deleveraging once credit tightens up.

Not all credit is bad of course. Hedge financing is healthy, whereas speculative and ponzi financing are bad. The problem is we don't know how much is bad, how much is good. I've always taken the view that we cannot tell how healthy mortgage debt is from bankruptcy rates when a market is rising faster than interest rates, as rising prices will increase your asset value faster than your debt even if you don't make a single payment. We'll only be able to tell when interest rates start crawling up. Based on recent news I think it is almost certain that rates will start edging up by the end of the year, and the key question is only: how much?

My two cents: It's all about consumer psychology.

Both luxury houses and luxury cars are designed to be "consumed" by the "consumer" in order to improve his/her welfare. Taking out the "land" aspect, if the consumer desires a luxury car more than a luxury home, then buying a luxury car improves his/her welfare more than a luxury home. Nobody "needs" a brand new luxury home. They just desire it. The desire for brand-new luxury homes over older ones is just as rational (or irrational) as the desire for a brand new BMW. Or as rational as the desire for Apple over Acer, or drinking at bars and clubs over buying drinks at 7-11. A person who prefers a 200k luxury car over a 800k luxury property, could rationally choose to buy the car, and then use the balance of 600k to buy an older, less luxurious house in the same vicinity.

Currently, I see the Malaysian consumer trending towards desiring luxury homes. Price differentials between new luxury properties and older, more run down properties in the same area are huge. Luxury properties have nicer fittings, nicer landscaping, nicer gyms, nicer pool, nicer design, branding etc, and that's what you pay extra for. People are willing to forgo consuming many other desirable goods (like nicer food, cars, electronics, clothes etc) in order to purchase luxury homes because they desire the features and prestige of luxury housing. This desire is exactly the same as our established desire for expensive cars. I'm not yet convinced that our recent consumer love affair with luxury housing at the expense of other goods will last forever, and I'm saying this as myself a lover of luxury fittings, facilities and landscaping. Only time will tell.

One last observation. I note that the prestige of driving a 3 series in Malaysia is more akin to the prestige of driving, say a 7 series or a Rolls in the West. The intangible value of the BMW brand is also a lot stronger in a country like Malaysia where such cars are comparatively rare. Heck, even an "affordable" Japanese or Korean sports car is looked upon like a Ferrari or Porsche in terms of prestige. There is therefore a lot more intangible value in purchasing a luxury car in Malaysia than in the West. Although this does not even come close to justifying the price for new cars, it certainly does so for grey market imports, and that's why these importers are seeing great sales.