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Residential property: A ponzi scheme or an investment bubble?

With residential property prices racing higher, could the market be a ponzi, a bubble or simply imbalanced?

By John Berry

Last week Bernie Madoff, 12 years into his 150-year jail term, died in prison. Convicted in 2009, Madoff pulled off history’s biggest ponzi scheme, fleecing tens of billions from wealthy investors.

They willingly invested, wanting Madoff’s impressive and consistent annual returns. The problem was his returns were paid out of money collected from new investors and his investment records were fake.

New Zealand had a similar ponzi experience with David Ross cheating over $100 million from investors. In 2013 he was sent to prison for over 10 years, although he has since been released on parole.

An investment opportunity’s returns that keep rising, looking almost too good, may raise the red flag of a ponzi scheme. This is especially true in areas with limited regulatory oversight.

If consistent high returns delivered year after year are the test of a ponzi scheme, then that sounds a lot like residential property investment.

But no, residential property does not tick the ponzi boxes. Unlike Madoff and Ross’s investments, the residential property being bought and sold actually does exist. There is transparency around ownership and there are safeguards so the same property cannot be sold twice.

The money of the people entering the residential property market is used to pay the people leaving (again, sounds like Madoff’s operation). However, this matching of buyers and sellers is how markets function, it’s not a ponzi.

Residential property has more in common with an investment bubble than a ponzi.

In a bubble, buyers over-inflate asset values. They keep buying beyond the point that the value can be rationally justified.

Think of dotcom stocks in the late 90s and financial products based on US sub-prime mortgages in the 2000s. Maybe even Gamestop shares this year.

In a bubble, assets spike up because of the “greater fool theory”. This means a buyer knows the asset probably isn’t worth what they are paying but they believe they can soon sell it to someone who will pay even more.

Residential property in New Zealand jumped 12 per cent in 2019, 19 per cent in 2020 and surged over 6 per cent in the first three months of 2021. Like the S&P500 index of US shares and the cryptocurrency Bitcoin, residential property is at all-time highs. Does this price spike make it a bubble?

That depends on whether price is driven up by people with a genuine reason to buy (like they want a house to live in or they believe investment property really does make good financial sense). Or are they buying simply because they think someone else will pay them more in the future?

In an investment bubble the talk about “expected future capital gain” can be just hope someone will pay more.

Maybe residential property is neither a ponzi scheme nor a bubble, but is simply an inefficient and imbalanced market. Demand exceeds available supply and the only escape valve is for prices to rise.

But ultimately the question of whether property is a ponzi or bubble is flawed.

Flawed because this reinforces the idea that housing is simply an economic asset to exploit. Instead, we need to return to thinking of housing as an essential social and family asset.

Essential for building cohesive communities, which in turn are critical for productive and prosperous modern economies. When it comes to housing, investment thinking shouldn’t completely dominate the market.

John Berry is the Chief Executive at ethical fund manager and KiwiSaver provider Pathfinder Asset Management. This piece was originally published by Stuff April 19, 2021. Pathfinder recently supported funding of community housing in New Zealand.

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