Speculation presents greatest threat to housing market

Laura Slattery discovers that dependence on loan finance is one of the reasons why a speculative housing bubble could be much more dangerous than a stock market bubble. Property markets, particularly here and in the UK, have been doing very, very well, while we've seen a collapse in equity markets.

Equity bubbles, as any technology investor will tell you, burst. Property has a reputation for being a safer, sounder investment. But caution is advised: property bubbles are even more dangerous than equity bubbles, says Mr Jim Power, chief economist at Friends First, and the market at the moment is "pretty hot".

"A property bubble can also be susceptible to bursting, as they did in British and Japanese markets in the late 1980s and early 1990s," he says.

"There is a danger that there's a speculative bubble in Britain and there's a danger there's a speculative bubble here."

This is the message Mr Power will deliver to an audience of auctioneers at a property seminar hosted by the Irish Auctioneers and Valuers Institute (IAVI) next Thursday.

At the seminar, Mr Power will discuss the pros and cons of bricks and mortar versus stocks and shares, comparing their performance on a national and EU basis over the past 10 years.

The performance of equities and properties tends to mirror each other but, over the past few years, the high correlation between the two has broken down, Mr Power notes.

"Property markets, particularly here and in the UK, have been doing very, very well, while we've seen a collapse in equity markets."

Equities have traditionally delivered higher returns than property but not recently and not necessarily over the course of the next five years, he says. The market will level out but the legacy of the bubble that burst means that returns are likely to be less spectacular than they were in the late 1990s.

"Investors will be doing well to get 5 per cent per annum on average. I think the return on property will be similar," Mr Power says.

Property, the world's biggest asset class, has begun to look like a "safer, sounder investment". Low interest rates also encourage investors to opt for property. In OECD countries, $43 trillion (€43.6 trillion) is invested in property, compared with $23 trillion in equities.

But there is a risk of over-investment in property, particularly if it is used to shore up poorly performing pension funds, according to Mr Power.

"For most people, their house is their single biggest investment. If their pension is invested in property as well, they don't have a diversified portfolio."

Typically, only around 5 or 6 per cent of managed pension funds are invested in property, according to investment analyst Mr Frank O'Brien, who last week addressed the trustee forum of the Irish Association of Pension Funds (IAPF) on risk and reward in managed pension funds.

But in some pension funds, the weight on equities has been cut recently and increased investment in property is one option available to fund managers trying to make up the difference.

"Property has a number of attributes that are attractive to pensions. It's a long-term asset, it's tied to growth in the economy and it yields a good income, which equities haven't done recently," says Mr O'Brien, a specialist in pension fund investment. But it's also an illiquid, lumpy asset: "You need millions of pounds rather than hundreds of thousands."

Fund managers can also move more easily from high-risk equities to lower-risk bonds than they can trade in property, where either a hunt is on for a suitable location or a buyer. "Fund managers like a bit of flexibility. If €1 million is put into a big fund, they like to invest it quickly. Property is a slow process," Mr O'Brien adds. Transaction costs such as stamp duties are also much higher on property than they are on equities.

Returns on equities depend on entering and exiting the market at the right time: the same is true for property, Mr Power says. "Certainly buying into the UK at the moment could be a risky proposition, because you could be buying in close to the peak," he says.

The British property market has been growing at a rate of 20 per cent per annum and, if you do wish to take a chance on it, there are numerous ways in which Irish investors can join the party. For example, ACCBank last week introduced a SolidWorld property bond. Based on the performance of the UK Halifax House Price Index, it allows investors to track movements in this British residential house price index for a minimum investment of just €2,000.

On the commercial side, BCP Asset Management last month launched the London Commercial Property Fund 1 to investors with minimum capital of €30,000 to spare. The fund uses a mixture of investor funds and loan finance to purchase office buildings with "blue-chip" tenants in London.

Dependence on loan finance is why a housing bubble is "much more dangerous" than a stock market bubble, Mr Power says. Equities and bonds do not have the same association with debt. "People borrow to invest in property, they rarely do to buy shares."

Sensible investors should remember to diversify their risk. "It's all about perspective and balance," Mr Power concludes.