Spruikers Gonna Spruik and Fair Value Part II

About seven months ago, I did something exceedingly arrogant. On my Facebook profile, I added “Australian English” to languages. In retrospect, I couldn’t have been more wrong about my claim. At that point, I had never:

• Eaten a bikky for brekky
• Attended a footy and baracked for my favorite team
• Lodged an enquiry
• Realized that driving a Holden whilst listening to Iron Maiden would make me a bogan
• Had snags and a few coldies with my mates in the arvo
• Invited the relos over for a barbie
• Earnestly replied “fair dinkum” during a business conversation
• Had a lamington

Julie and I were lucky to have my parents over for a visit between Christmas and New Year’s. After staying in Melbourne for two weeks, my folks headed up to Sydney for a few days before returning to the States. I was insanely jealous as we have yet to go to Sydney. I saw my Dad post something on Facebook about trying to read the Sydney Morning Herald (local newspaper) but couldn’t understand any of the articles. As much as I like to pick on the old man, I actually sympathize. It is a different language. It seems like at least once a week, I learn a new word and expand my vocabulary. After getting interested in the bizarre state of the Australian real estate market, I picked up the word “spruiker”. As far as I know, this word has absolutely no meaning in American English. In Australian English, it means “One who promotes his own cause; one who toots their own horn.” (http://en.wiktionary.org/wiki/spruiker)

A few months after arriving in Oz, I got to see a world class spruiker in action. Every aspect of buying and selling property here differs from the States. To this Yankee, it seems like every step of the process is designed to appeal to the emotion of the buyer rather than reason or logic. If one were to buy a house or condo in the States; one would start by identifying their price range, desired neighborhood, rough size they were looking for, etc. The perspective buyer could either go online or contact a realtor and start with a list of properties that meet the bare requirements. From there, they could go and take a look at the properties and make an offer or not. In Australia, on the other hand, about half of the properties are listed WITHOUT prices. What’s more about 30-40% of properties are sold at auctions. I have never seen anything quite as bizarre as an Australian real estate auction.

The condo next to our old place on Stokes Street was sold at auction. I walked out of my living room to see a gathering of 30-40 people standing on the street for the auction. It seemed more like a Baptist revival than a business transaction as the auctioneer began spruiking.

“Ladies and gentlemen, we are here today to auction off this magnificent property here at 38 Stokes Street. This is truly a once in a lifetime opportunity. Imagine being steps from the beach, steps from shopping on Bay Street, and just a few minutes from the CBD (Central Business Distrect or downtown Melbourne) by public transport. This will not last long as we are going to auction off this property to the highest bidder right here (pause for dramatic effect) today. You will not want to walk by this property in ten years and think to yourself, ‘I could have bought it when it was affordable.’”

The spruiker paced about as he babbled in a full stream of consciousness. The underlying message was that the situation was urgent, action needed to be taken right here right now - TODAY, and that one would be a fool not to bid on this property. The foreplay portion of the auction consisting of the spruiker talking up the wonderful opportunity to the mostly disinterested crowd lasted for a full fifteen minutes. It was time to get serious.

“Let’s start the bidding, ladies and gentlemen. The bidding will begin at $900,000. Who will make the first bid on this amazing piece of property? This property will not last long. You do not want to miss this!”

Complete silence.

“Ladies and gentlemen, how can you afford to pass on this opportunity? If you do not buy this property, you are going to regret it for years to come. At 900 - going once.”

Silence.

“At 900, going twice.”

Awkward silence.

“At 900. Going three times with no bidders. Ladies and gentlemen, I am absolutely shocked that you would fail to see this opportunity. My associate and I are going to go inside and await further instructions from the vendor (seller of the property).”

The spruiker disappeared inside the unit. The crowd on the street murmured a bit and waited.

The spruiker came back and admonished the crowd like a preacher who felt their congregation was falling prey to sin. He then started the bidding, which I though had ended when no bids were received, at 900. A man sitting on the sidelines then put in a bid for $900k. It was the only bid and the unit was sold. At the selling price, the monthly mortgage cost was DOUBLE what we were paying in rent for the unit directly next door to it.

In my half year here, in addition to picking up a new language, I have realized that my tastes are starting to change. When I first got here, I failed to appreciate the Victorian architecture that many of the houses maintain. Homes that were made of bricks and featured wrought iron failed to excite me. Instead, I preferred a newer area of Port Melbourne that featured condos made from brightly colored stucco. The locals mockingly referred to it as “Lego Land” as all the houses looked nearly identical brightly colored Lego blocks all snapped into a neat little grid.

Now we are living in a Victorian style house and I am trying to figure out how long the real estate Ponzi scheme can continue. Our new rental is four bedrooms and has 270 degree views featuring a park, the port, and the city. We have a patio big enough to comfortably accommodate a table for eight outdoors where we entertain and look at the water. We are one block from the beach and roughly a kilometer (a little over half a mile) from Lego Land. We love our rental enough that Julie and I would probably consider buying at the end of our two year lease so long as the price is reasonable. In trying to assess “reasonableness” I decided to attend an auction of a four bedroom house in Lego Land.

The auctioneer was the same spruiker I saw at my first auction. The crowd was bigger this time and I walked through the home prior to the auction. To be fair, the house did have four bedrooms (a bit of a rarity) and a decent layout. I felt like it was a model home in a Newport Beach, California neighborhood instead of a charming Victorian unit. It was missing the intricate crown moulding, wrought iron fixtures, and fine craftsmanship I have come to appreciate. The kitchen/entertainment room offered a 180 degree of a parking lot. Location-wise, the unit was located next to a good park for the kids, close to Port Melbourne Primary School, and about four blocks to the beach. Anyone who lived there could get on the tram and be downtown in about twenty-five minutes.

The spruiker began by talking about the location and the “once in a lifetime opportunity”. Again, his spruiking was all about emotional appeals and although he was full of passion, anyone listening logically would realize that he contradicted himself several times. He started the bidding at $1.6M. I found it particularly interesting that he said, “We sold a similar unit to this for $2 million. (pause) Of course that was in 2010.” To the logical observer, one would realize that the bidding was starting at 20% lower than what similar units sold for just two years ago, that real estate prices were in fact DECREASING at an alarming rate, and maybe waiting would be the better strategy.

The other interesting contradiction was when the spruiker declared, “Even if you’re not ready to live in this amazing property, it would make an incredible ‘investment’. We have managed this property for the last several years and have demonstrated that it can maintain a rental income of between $1,000 and $1,050 per week.”

I was flabbergasted that the spruiker could call this an investment property with a straight face. At $1.6M the monthly mortgage repayment would be $10.5k per month. With a rental income of $4k per month (which did not include a significant “property management fee”) that would leave a shortfall of over $6k per month. Even if the magic of negative gearing made that shortfall $4k per month, that’s still a lot of money to fork over for an “investment” on an asset that is depreciating rapidly with no end in sight.

Would anyone logically buy into an investment that is difficult to sell, had large transaction costs associated with it, would cost $50k per year to keep, and is depreciating rapidly? I didn’t think so and apparently, neither did the crowd.

The auctioneer seemed a bit more defeated and put a little less effort into soliciting a bid than I saw at the first auction. The auction closed without any bids and the property is now listed as a private sale POA (price on application - wouldn’t want buyers to be too informed before making a decision like this).

My point in attending the auction was more than just gawking at the spectacle. I was trying to establish “fair value” for the neighborhood and a four bedroom home. I have written before about Apple stock and how, by traditional measures, if anything it is undervalued. On any market driven purchase, the concept of fair value can be very difficult to accurately assign. Homes or shares of stock will trade at exactly the price a seller is willing to accept from a buyer. However, I am going to take a stab at what I perceive to be fair value taking into account the property’s location, size, style, and potential rental income.

Given that the property is reasonably close to the beach and the CBD and is in a desirable neighborhood, lacks beach/port views, and has the potential to bring in $4,000 - $4,200 in rental income per month; I believe it would be fairly valued at roughly half the asking $1.6 million. At $800k with a mortgage payment of around $5,250 per month it would still be cash flow negative. However, a few years of steady rent increases could bring it to a self sustaining level. From there, so long as real estate continues to rise with inflation, it should bring a decent return by the time the mortgage is paid off.

Just as deciding fair value for Apple stock is difficult, so is concluding fair value for this piece of property. However, I am willing to state that Apple stock MIGHT be undervalued. I am stilling waiting for ANY evidence that Australian property will appreciate at any time in the near future in real terms. Any argument relying on the argument from authority (trust the RBA and the government), past performance (Greater Fool Theory and Extrapolation Errors), and Australia somehow being magically different will be summarily rejected.

Give Me Fuel, Give Me Fire, Give Me That Which I Desire

Once upon a time, a utility company based in Portland bought a utility company in Salt Lake City. Maybe it was the other way around. Either way, two utility companies merged and there was a lot of work to do to integrate their systems and prepare for the dreaded Y2K problem. There were technical resources in Portland and technical resources in Salt Lake City. Management worried about upsetting either group so they decided to do the system integration work on a rotating basis - one week in Portland and one week in Salt Lake City in order to ensure that neither group would be happy.

Although the employees of the newly merged utility company were not happy, I was happy. At the time, I was twenty-five years old. I had taken all of my meager material possessions and placed them in a storage locker. I stayed in hotels during the week and crashed at my girlfriend’s place in California on the weekend. I lived off of my per diums and banked my entire salary. Being homeless was not so bad.

The first week I arrived in Portland, I stayed at the Fifth Avenue Suites in downtown Portland. I didn’t know the area and was told a lot of people on the project stayed there. It was nice, but every day involved a forty-five minute commute via the Max (Portland’s light rail system) to the Lloyd Center. The Lloyd Center is a mall in suburban Portland and my coworkers and I never tired of telling people that we worked in a mall. However, the project consisted of 150 employees and consultants and we all needed some place to go daily. The powers that be rented space in the mall and we ate our lunches in the food court, watched people go ice skating, and proudly asked for our mall employee’s discounts.

In my consulting days, I always found the first week to be the hardest. I would come into a new city and not know my way around as this was in the dark ages before everyone had a GPS built into their phones. As I was getting the lay of the land, I noticed that there was a Doubletree Hotel across the street from the Lloyd Center. The Doubletree was also on the list of approved hotels, yet no one seemed to stay there. I immediately switched my reservations and started staying at the Doubletree and enjoyed getting an extra hour and a half back in my day by not commuting.

Within a few months, more junior consultants were added to the project and I was reunited with the gang I had established during a month long training course. There was a lot of work. There was a lot of drinking. Every morning in Portland, I was the last one to get out of bed and the first one in the office no matter what had happened the night before. Being directly across the street had its advantages. Being a rational person, I could never understand why my friends stayed at the Fifth Avenue Suites and added an hour and a half’s worth of commuting to their every day.

I was hung over and tired when Johnny came by my desk and suggested going to Starbucks. Being hungover was pretty much par for the course when your best friend goes by the name “Johnny” and you are over the age of ten. By the time Johnny suggested Starbucks, I probably would have been willing to drink the coffee at the nearby 7-11 that had been in the same pot without being cleaned since President Reagan was in office. Now, I know better and recognize that Starbucks is shit coffee, but I was desperate.

Johnny and I were walking back when I asked, “Why do you guys all stay at the Fifth Avenue Suites?”

Johnny beamed as if he were about to tell my the answer to life, the universe, and everything. “It’s the miles, fool!”

I nearly spit my coffee out - not because it was bad, it was Starbucks and by definition, it was bad. The sheer insanity of Johnny’s argument caught me off guard. “The miles?”

Johnny was still smiling, “Five hundred extra miles a week!”

“You do realize that miles have a cash value, right? I think I read that they are worth between a cent and a cent and a half. So you’re saying that you’re agreeing to a forty-five minute commute EACH way, every day so that you can get something worth between $5 and $7.50?”

Johnny was no longer smiling.

“We are here five days a week and I’ll throw the commute out for Monday morning and Friday afternoon because I’m going to the airport with you guys. However, that means you’re commuting six hours a week that I’m not. That commute is like working a side job for $1/ hour.”

It’s been fourteen years and I can still remember this argument. I am no longer in my twenties. Back then the extra sleep was good for sleeping off whatever was done the night before. Now, in my thirties, I wish I could throw a dollar at the alarm clock and let me recover the lost hour in the night before from when my daughter had a bad dream or my son was sleep walking around the house. I would gladly pay my alarm clock one stinking dollar for an extra forty-five minutes of sleep.

However, back in the nineties, I was on quite the roll. “It’s not like you have a shortage of miles either. You get miles for your flights. You get miles for the money you spend here through your Amex card. You’re probably racking up about four thousand miles a week altogether, you’ll have more miles than you’ll know what to do with and you actually give a shit about five hundred stinking miles?”

Johnny was annoyed. “You know what your problem is? You’re too logical!”

Guilty as charged. I am incapable of chasing things irrationally.

On a related note, in 2008, with the entire economy of the First World about to collapse, Australia increased its First time Home Owner’s Grant (FHOG) from $7,000 to $14,000 for first time buyers of existing housing. The government, in its wisdom, was trying to “stimulate demand” and prevent a hard landing in property prices as experienced in the United States, UK, Spain, Ireland, and elsewhere that had seen rapid property appreciation suddenly go bust.

It worked too, if you consider working to inflate air into an already inflated bubble. As buyers and “investors” flooded into the market with increased money to use for a leveraged purchase, they competed against each other bidding up house prices by roughly $50,000. That’s right, in an effort to cash in on $14,000 of “free money” buyers were paying $50,000 more than they would have without the FHOG. Even worse, property prices in Australia were already high by any traditional measure. Instead of letting property prices fall in a swift, much-needed way; the government decided to artificially inflate prices for several more years. After a single year of decline in 2008, property prices grew spectacularly until 2011.

The FHOG irrationally attracted Greater Fools to the housing party. The increase in property prices convinced even more Greater Fools that houses would always be expensive, that property prices would always increase, and that they would have to act now or “miss out”. The reality is, that purchasers overspent in an effort to get “free money”. Property prices in Australia were so far removed from the underlying fundamentals that it is going to take a long and painful correction similar to what has occurred in other countries to create real stability and sustainable growth.

Many Australians feel that they were not affected by the Global Financial Crisis. That is not true, through government manipulation, the affects of the crisis were merely delayed by a few years. Those who put their faith in the RBA and the government to avoid the crisis will find that the housing market has behaved irrationally and that continuing to prop it up will only prolong the pain.

Whether it is relatively low value airline miles or a government subsidy to buy inflated properties, “free stuff” can cloud otherwise smart people’s better judgement. Now that over a billion dollars has been spent on the FHOG and interest rates are at historical lows (for Australia), the only rational response to the current property market is to simply wait until prices are in line with their fundamentals.

The Maestro

It is hard to believe, but during Arizona Republican Senator John McCain’s failed presidential bid in 2000, the Senator stated that he would retain then Federal Reserve Chairman Alan Greenspan if elected. Senator McCain went one step further stating that should something happen to Mr. Greenspan, he would prop him up like in the movie “Weekend at Bernie’s”. He was only half joking. The economy of the United States was firing on all cylinders and a lot of the credit, at the time, went to the Chairman. He was beloved by both political parties and was known simply as “the maestro” for his seemingly fantastical manipulation of the economy through an unstoppable expansion.

Fast forward a dozen or so years and Time magazine lists the former Chairman as the number three person (out of twenty-five) to blame for the financial crisis. Political and financial journalist Matt Taibbi called Greenspan a "classic con man" who, through political savvy, "flattered and bullshitted his way up the Matterhorn of American power and ... jacked himself off to the attention of Wall Street for 20 consecutive years." Ouch!

How did this same man go from hero to goat so quickly? Appointed by President Ronald Reagan as the successor to Paul Volcker in 1987, Mr. Greenspan pumped liquidity into the market immediately following the 1987 stock market crash. Although blamed by President George H. W. Bush for not winning a second term, Mr. Greenspan was retained by President Clinton.

Throughout the go-go nineties, Mr. Greenspan presided over the Federal Reserve as the United States equities markets exploded. Speaking out of both sides of his mouth, he famously stated that investors were “irrationally exuberant” about stocks in 1996, but proceeded to slash interest rates in 1998 during the Asian Financial Crisis. During this period of temporary market insanity, it was not uncommon for “dot-coms” to have an Initial Public Offering without having earnings or even a timeframe for when the company would be profitable. The few tech stocks that did have earnings were trading at absurd multiples, and the Fed quite literally through gasoline on the fire. The party came to an end in May of 2000, but the Fed did not start raising rates until after the tech bubble had burst.

The tragic and senseless 9/11 attacks prompted the Fed to reverse course and lower interest rates to stimulate the economy. By 2002, the Fed rate was down to 1%. The extraordinary and unprecedented low interest rate directly contributed to the housing bubble and devastating recession that followed it.

It is said that hindsight is 20/20, but in a speech delivered in February of 2004, Mr. Greenspan advocated the use of Adjustable Rate Mortgages. Ironically, the Fed then began to raise rates from 1% to 5.25%. Any homeowner that had listened to “the maestro” would have seen their monthly mortgage payments steeply increase. These rate increases led to the subprime mortgage crisis, the collapse of Lehman Brothers, and nearly ended Wall Street. Four years after the bailouts, the United States is still in a state of an economic hangover having partied too hard through the dot-com years and the following housing bubble.

Now that several years have passed, it is possible to take a more critical look at the role of Mr. Greenspan had throughout the economic expansion. It is entirely possible that there were multiple factors that led to the expansion; breakthroughs in technology, baby boomers spending throughout their peak earning years, a peace dividend brought by the end of the Cold War, and more. None of these factors had anything to do with the Federal Reserve or their policies. If anything, the Federal Reserve directly contributed to not one, but two bubbles in the space of ten years. When times were good, no one questioned the Fed. When times went bad, it was too late.

I share this story about the US Federal Reserve and the former chairman because I believe that there are lessons to be learned that are directly applicable to the current housing market in Australia. I have no doubt that the members of the RBA (Reserve Bank of Australia) are well educated, hard working, love their country, and have good intentions. Australia has benefited from a mining boom and exports to China which has improved the lives of millions of Australians. However, there is a certain faith in the RBA, a belief that they know how to avoid the financial meltdown. The RBA, it is believed, will prevent the economic collapses that affected my homeland and the bulk of Europe.

If anything, the RBA has benefited from factors outside of their control all the while directly contributing to the housing bubble that has seen the average house appreciate 127% between 1996-2010 while the average income has increased only 47%. While every meaningful metric for property valuation from price-to-rent, the median multiple (median home price divided by median income), and mortgage debt to GDP ratios point to housing bubble. The housing bubble might have ended much earlier if it were not for the decision to keep the party going in the form of a First Time Home Owners Grants (FHOG) in 2008 (I plan to write a bit on this later).

Instead of faithfully trusting the RBA, it would be a better service to Australia to look to the economists who successfully called the housing bubble in the United States. The best and brightest at the Federal Reserve either could not or did not see it as the bubble formed right in front of them. Even if I am wrong, the indicators merit further and serious investigation.

Fair Value

There have been many articles in the tech industry lately pointing out that the market capitalization of Apple now exceeds that of Microsoft and Google - combined! To think that about a decade ago, Apple was at death’s door hemorrhaging cash and seemed destined to go down in the history books as a cautionary tale. A year ago, it was big news that Apple might exceed the value of their longtime nemesis, Microsoft. Today, they are the most valuable company in the world.

Can Apple really be this valuable? Well, they are a publicly traded US company, so plenty of information is readily available. As of today, their trailing twelve month price to earnings ratio is 14. Historically, stocks are considered to be “fairly valued” with a P/E ratio of about 15. Is it possible that not only is Apple worth every penny it is currently valued at, but it might also be undervalued?

The stock market, to borrow from Janet Jackson, is a very “What Have You Done For Me Lately” game. The P/E ratio is an important metric, but it is a backwards looking metric and only tells the analyst what has happened. Any rational trader is far more interested in what will happen. As in any market driven exchange, a bull and a bear case can be made for Apple.

From the bull’s perspective, Apple is the only computer OEM (Original Equipment Manufacturer) that is showing signs of growth. MacBooks and iMacs experienced positive 26% year over year growth while rivals such as Dell, Lenovo, and HP are seeing negative growth. However, even though the Mac operating system is growing, 70% of Apple’s revenue is coming from its iOS devices. This is a category that did not even exist six years ago. Before the iOS devices, the iPod had conquered roughly 75% of the MP3 market and iTunes was the dominant legal download service. Apple boldly introduced new products that have taken the world by storm and created a new product category with the iPad. Apple’s last quarter was an absolute blowout beating even the most optimistic of any analyst’s expectations.

Apple has been successfully creating new products, revitalized its core computer line, created a new sales strategy with branded retail stores, and is a top recognized brand in the world. During all this success, they have created favorable terms for their components and manufacturing and hoarded a staggering $100 BILLION USD in cash reserves. The market for smartphones and tablets is still in its infancy, as there are plenty of new consumers to target with future iPhones and iPads. The company has executed flawlessly under the guidance of the late Steve Jobs and the transition to Tim Cook seems to be a smooth one. With a P/E below historical norms and a PEG ratio of .6, the bulls can make a strong case that Apple is incredibly undervalued.

To be fair, there is a bear case to consider as well. Yes, Apple has produced impressive results, but this is the tech industry where the only constant is change. Will Tim Cook’s leadership be as effective as the Steve Jobs’? Will the labor conditions at the FoxConn manufacturing plants lead to consumer boycotts? Will increasing competition from Microsoft and Android end the very high margins that Apple currently enjoys on its iOS devices? Will the market for shiny gadgets saturate sooner rather than later? Will Apple make a strategic misstep?

These are all valid questions and there are no real answers. Before the iPhone, the Blackberry was considered absolutely essential to corporate users. It was known, affectionately, as the “Crackberry” because they were considered addictive by their users. Now, Research in Motion - the company that makes Blackberry products; is losing revenue, shedding jobs, launching ill conceived products, and constantly in talks of being a buy out acquisition. Just five years ago, they were king of the world and now they are in last place in the smartphone wars, defeated in every way by competitors who were not even in their market at the time.

Some bears believe that Apple cannot continue to innovate at their current pace. The competitors will continue to make products that are similar and undercut Apple on price. Backlash against their heavy handed developer contracts and lack of control of their devices might be their undoing. All of the scenarios are very real possibilities.

Every weekday (except holidays), investors from around the world vote with their dollars on the future value of Apple. For every single share that is bought, there must be a seller. The seller is implicitly stating that they believe the best days for Apple are behind them (or they need the money). The buyer is stating that they believe in the future of Apple as a company and that they will continue to see further appreciation in the stock. Millions of shares are changing hands every single day bought and sold by anyone from an individual investor in their living room to large mutual funds. There are ups and downs and no one can claim to know the future of the company. In the long run, the bulls may be right, but it could just as easily be the bears.

Although Apple is the most valuable company in the world, one never hears anyone refer to an “Apple bubble”. This is a real company, making real products, bought by real consumers. The financial metrics to value this company, if anything, point to a company that may be undervalued. This undervaluation may or may not be rational due to the significant risks Apple faces in the market. Buyers of Apple stock are not Greater Fools or participating in some type of Apple Ponzi Scheme - even if its growth decelerates, the stock is not priced to perfection.

In short, Apple is the exact opposite of the Australian housing market. Every key metric - price to rent, price to income, debt to GDP, etc. is not just overvalued. It is EXTREMELY overvalued. There is no rational explanation for the incredible run up in home prices over the last decade. Since residential property is no longer tied in any conceivable ways to its fundamentals, there is no explanation other than it is a bubble, driven by emotions, and bound to pop. Very recent history has shown the old mantra “you can’t go wrong with real estate” is patently false. Home values in the United States, the UK, Spain, and Ireland have fallen 40-60% from their bubble peaks. The swift increase in home prices in Australia has already eclipsed the run ups in the previously mentioned countries who have seen their bubbles burst. There is no other possible outcome.

Disclaimer: Between Julie and myself; we own one MacBook Pro, two MacBook Airs (one was provided by Julie’s work), two first generation iPads, and two Apple TVs. We have each owned the original iPhone, the iPhone 3GS, and two iPhone 4’s (we sold our US phones before leaving and got new iPhones in Oz). I have been accused of being an Apple fanboy. Although I believe this takes things too far, I do tend to buy their products and have a certain degree of loyalty to them. That being said, I do not own a single share of Apple stock. I do not advocate buying or selling Apple - it is really hard to say if it is fairly valued or not, but if ever there were a company that I would call fairly valued, this would be it. Please do not take my very rudimentary analysis as financial advice to either buy or sell Apple stock. However, if you own residential property in Australia, immediately build a time machine and sell it in 2010.

What's Wrong With Retail?

Home prices are not the only thing trending downward in Australia, retail sales are being affected as well. There are many underlying causes for the year-over-year decline in retail sales. The “wealth effect” from increasing home prices is starting to erode for starters. However, I think that real competition, from online stores, is finally starting to catch up with the stone age policies of the typical Australian retailer.

I am a borderline evangelist for Bluetooth headphones. I have given them away as gifts and literally forced people to try them out. For the last several years, I have used the Motorola S9HD and S10 models. Once I made the switch to wireless, there was no going back. I was blown away by the sound quality of my first pair of S9HDs and was shocked when they stopped working. I have now come to accept that I sweat a lot and that my headphones are only going to last my six months to a year.

When I shorted out my last pair, I went to an Australian big box retailer to replace them. I spent a decent amount of time trying to find a salesperson to help. When I finally got someone’s attention, I was told, “If we carry them, they would be on this aisle.” Not very reassuring, but I finally found a single pair of Bluetooth headphones for the bargain price of $150. They were not the brand that I had grown comfortable using and I didn’t want to spend that much money on something that unknown.

I did what any sensible shopper would do and pulled out my smartphone and searched. The reviews were mostly positive and I definitely would have considered purchasing the headphones. However, the EXACT same headphones that were selling for $150 at the retailer that advertises “always low prices” could be had online for $40.

I realize that Australian retailers are faced with high labor costs, increased shipping costs, higher rents, and a few other factors. However, no savvy consumer would be willing to spend 375% more for an identical item. I wound up buying the familiar Motorola S10s from Amazon. Even with a $40 expedited shipping fee, I wound up paying roughly half of what I would have spent at retail.

As if the stratospheric prices were not enough of a deterrent, I have found the customer service to be sorely lacking. I have had difficulty making returns for items which have been unopened and with a receipt. This is not an isolated experience, every time I have gone to make a return, it has been a painful ordeal. In the end, the item is usually taken back but the experience is miserable.

I have conditioned myself to ask the question, “What is your return policy?” before purchasing ANYTHING. I have been in situations where I asked and was told, “We don’t like to take returns.”

“But what is your policy?”

“We don’t like to do it.”

“I didn’t ask if you liked to do returns, I asked if you will take them.”

Eye roll. “If it is done within seven days and you have a receipt we will take the return.”

“So your policy is to take returns, but do it grudgingly?”

Real conversation. For the most part, I refuse to make any purchase outside of food from a retailer. It is far, far cheaper to comparison shop online from a reputable e-tailer. What’s more, if there are issues with the merchandise, it can be returned hassle free which is more than I can say from my experiences here.

Australian retailers need to wake up from their slumber and realize that consumers now have dynamic pricing information right in their pocket. The competition is no longer the guy down the street, but the e-tailer in a different country. Consumers will always spend money, but to get them to spend their hard earned dollar, the experience should be enjoyable. The consumer can easily be convinced to purchase out of impulse without price checking if they are living in the moment. With the decline of the wealth effect and difficult consumer spending ahead; unless the retail experience, service, and prices become competitive - retailers will continue to lose customers.

Movie Soap, Groupon, and the Shear Insanity of Negative Gearing

2001 was not a good year for me. For the first time in my life, I was unemployed after several years of continually rising paychecks. I had grown accustomed to my lifestyle and can remember vividly being at a gas station on a cold November night filling up my convertible Corvette with premium gasoline. I was approached by someone asking me for money. I shrugged my shoulders and said I could barely pay for the gas I was putting in my car. The irony of the fact that I was driving a semi-expensive sports car while claiming to be broke occurred to me much later.

Seeing as times were tight, this self-proclaimed movie buff had to give up some luxury items. Unfortunately, going out to movies was one of the first things that we gave up. That is until one night I was walking around the grocery store in a haze trying to stick to the absolute necessities and trying to do it cheaply. My shopping list had soap on it and I was trying to get the cheapest soap possible. That is until I noticed a promotion run by Lever 2000 claiming free movie tickets. Again, when something seems to good to be true, I usually assume it is not as it seems.

I stopped in my tracks and start looking for fine print. Surely, there were restrictions on the dates the tickets could be used. Nope. There must be restrictions on certain movies not qualifying. None that I could see. OK, only certain theaters would be eligible. Again, it looked like every theater I frequented was eligible. What’s more, the soap didn’t cost any more than any of the other soaps I was considering buying. There had to be something wrong here, but I couldn’t figure it out. I was looking at purchasing a non-perishable necessity, it would cost no more than any of the other choices, and it would give me a bonus luxury item that I really wanted. I decided to risk it and bought about a two year supply of soap.

It wasn’t until Julie and I went to see “Blackhawk Down” on a Friday night that I believed the promotion was legitimate. For the next few months, every time we saw a movie we used our “movie soap tickets”. There was absolutely no downside. Sure, the soap lasted a lot longer than the tickets, but we eventually used it all. Additionally, the soap was really a necessity and the movie tickets were just a bonus. I bought something that I needed and got something that I wanted too. A real win-win and one of the only times where too good to be true worked out.

On the opposite end of the spectrum is the phenomenon seen through companies like Groupon. I really have nothing against Groupon, if someone is going to buy a good or service at a discounted rate that they wouldn’t ordinarily purchase, fine. However, there is a certain mindset that believes they are SAVING money when using a Groupon versus spending money.

For example, say a massage is ordinarily $100. I really don’t care for massages and would never spend $100 for a massage. If a Groupon came out offering a 20% discount, I would never say, “I’m saving $20!” I would think that I was still spending $80. That’s just me as obviously this model is extremely successful and the company is experiencing rapid growth. The problem is that plenty of folks believe that they are saving money by purchasing goods or services that they ordinarily would not even consider because they are saving. It is only saving if you would have bought the good or service anyway, like “movie soap”.

Back to the housing bubble. I walked around a $1.8M condo with a mortgage, property tax, and insurance payments that cost over $12,000 per month being rented out for $6,000 per month. My brain could not simply process the information. I kept checking my math and wondering how could this be.

I then expressed it out loud to a native Australian and received a response back of, “Silly American, the property is negatively geared.”

I moved on with our property search and made a mental note to figure out what negative gearing really means. In Australia, home owners cannot deduct mortgage interest from their income the way they believe Americans can (Americans can but, they lose the standard deduction, so it really only affects those in the higher end of properties). Under negative gearing, Australians who purchase an “investment” property can deduct the difference between mortgage payments and rent payments. In the above scenario, the property was negatived geared to the tune of about $6k per month. Assuming the “investor” was in the highest tax bracket, he or she would then get the equivalent of $2k back in the form of a tax shelter.

Although receiving two grand a month back is nice and all, it amounts to little more than a bit of Vaseline for the $4k they would be losing PER MONTH. No one likes paying taxes, but losing four thousand a month just to avoid paying a little bit in taxes is not a winning strategy. Of course, if using negative gearing, the “investor” were losing $48k per year, but the property appreciated 8% over the course of the year, the “investor” would have made $100k in profit. Entering a business venture with the expectations of making a six figure profit over the course of a year is entirely rational. However, using an expected rate of return of 8% on property, which should provide a rate of return near the rate of inflation, is not rational. The fact that some of the losses can be used as a tax deduction will be of little concern once property values start falling. Negative gearing makes about as much sense as buying a massage for $80 because it used to cost $100 and thinking that you are saving money. Negative gearing certainly isn’t the “movie soap” that “investors” portray it to be.

Boogie Nights

I couldn’t help but think of the 1997 movie “Boogie Nights” recently. When I went to IMDB to look it up, I was surprised to find out that it originally opened on just two screens in the United States. After strong reviews and positive word of mouth, it was available on nearly 1,000 screens in a few weeks.

Featuring an ensemble cast made up of up and comers and has beens but not a single actor who was a star at the time, I had little interest in seeing it. I thought of Burt Reynolds as the guy from “Smokey and the Bandit”. Mark Wahlberg was associated with Mark E. Mark and the Funky Bunch and really bad music to me. I had never heard of William H. Macy, Don Cheadle, or Julianne Moore. Yet as the weeks went by, I kept hearing more and more about the movie to the point where I broke down and finally saw it.

The movie was truly divided into two parts - the rise of Mark Wahlberg’s character, Dirk Diggler, and his eventual fall. Although the subject matter was about the adult entertainment industry, the first part of the movie was light hearted and fun. Dirk found success, fame, and a surrogate family who truly cared about him. I remember genuinely enjoying this first half of the movie and laughing out loud at parts even if some of the material was a bit over the top. The second half took a decidedly different tone.

As Dirk descended into a nightmare of his own making fueled by cocaine and meth, his actions became increasingly desperate. He found himself in bad situations of his own making, finally forced to go back to his mentor and beg for his old job back. While the ride up to his pinnacle of fame and success was entertaining and fun, the descent into madness was borderline painful to watch. Coming out of the theater, I felt a bit overwhelmed. I thought about it for a few days and decided that I liked the movie. A lot. I understood the well earned buzz the movie received.

Months later, I rented the movie for a rare second viewing. However, the experience was different watching the movie the second time around. It was harder to enjoy the light hearted humor at the beginning of the movie knowing how the movie would end.

Here I am, fifteen years later, in the midst of a housing bubble far worse than the one that devastated the United States and I can’t help but think to myself, “I know how this movie ends.” House values are starting to decline, and Australia’s central bank, the Royal Bank of Australia (RBA), is continuing to drop interest rates. Rates have already dropped from 4.75% when I arrived in May to 4.25%. Rates in the States are near 0% and it doesn’t matter as housing prices there are still sinking.

The signs are all around. The average income of my suburb, Port Melbourne, is $85k per year. The average home sells for $950k. My first week in Oz, I looked at a condominium to rent that sold for $1.8 million. The rent on the unit was $6,000 per month. The cost of paying mortgage, home owner fees, and property taxes would be well over double that amount. The “investor” (using the term very loosely) would be losing over $70,000 per year. It made absolutely no sense to me. I was assured by various people that, “this is how it is here” or, my favorite, “Australia is different.” It’s not. It just took me a little while to figure it out.

I messed around with a rent versus own calculator before we moved to the new house. There are the standard questions in the form: how much do you spend on rent, what is the purchase price of the theoretical house, how much will rent increase, and how much will the property appreciate?

The default value for property appreciation was EIGHT PER CENT ANNUALLY! Keep in mind that the inflation rate has been fairly stable at below four per cent, so the calculator assumed that property will continue to appreciate forever at double the rate of inflation (see my previous post about Ponzi Schemes, the Greater Fool Theory, and the Extrapolation Error). For an “investor” who purchased a home at $1.8 million, lost $70k in the difference between income collected for rent and paid out in mortgage, and experience a gain in property value of 8%; they will have wound up making about $80k over the course of the year. It is a rational choice, so long as property prices keep increasing.

Unfortunately, like a game of musical chairs, the moment the music stops, the person who does not find a chair is in deep trouble. We heard it all in the States before our property bubble burst. Renting is “throwing money away”. Homes always appreciate. You can’t go wrong in real estate. All of it was true, so long as a greater fool came along and paid more for the property. The moment the music stopped, it got ugly. Home values are now about 40% lower than their bubble heights.

For the “investor” who sank $1.8 million into a new condo depending on capital appreciation to make it a good investment, they can easily see a 40% or greater drop in property value and lose everything. $800k can go up in smoke on a property that cannot pay for itself through rental income. This is not an isolated example, it is the standard.

Australia was fortunate enough to not experience the pain of the Recession (they refer to it as the GFC or Global Financial Crisis). There is a feeling that Australia is special and unique. I agree, this country is spectacular. However, the laws of economics, just like the laws of physics, still apply.

I enjoy being here. I love the sunshine, the scenery, the people, and the experience. Being in a country that has an unemployment rate about half of the United States is a great opportunity. However, just like the second time I watched “Boogie Nights”, I keep thinking to myself that I know how this movie ends...