When a love affair goes sour

The love affair that Australians have enjoyed with property investing is turning into a horror story in other parts of the world.

This month the Standard and Poor's Case-Shiller house price index showed that house prices across major metropolitan areas of the US have now fallen 15.3% for the year to the end of April. Gloomy commentators are predicting US house prices might fall as much as 25% before the market cycle bottoms out.

What is chilling is that when you look at the data sources for the Case-Shiller index it does not include any of the infamous sub-prime mortgages so if anything it is understating the impact of the drop in housing value at least in some parts of the US.
Worst hit metropolitan areas according to the Case-Shiller index are Miami and Los Vegas losing more than 26% respectively over the last 12 months. Even New York prices fell 8.4% over the same time period.

While not as dramatic similar reports of slumping house prices in the UK and Ireland are also making news along with steep falls in consumer confidence as the impact of rising interest rates and fuel prices bite hard.

The question it raises is whether the same could happen with Australian residential house prices. Now we have all heard the hackneyed catchcry - usually from spruikers trying to sell the latest property development - that you can never lose money on property. That is simply not true of course.

Property is a cyclical market like any other. Given the right market conditions - lax lending conditions, rising interest rates and unemployment anything can happen. We should be thankful that our lending and banking system did not gorge itself on sub-prime type financing so our market's adjustment should be a lot less painful. But we should not be too smug. Mortgagee auctions are reportedly on the rise and clearly in certain areas across the country like western Sydney the evidence is mounting that there is real financial stress on households. The concept of "negative equity" which is where you owe more on the house than it is worth can quickly become reality where most of the purchase price has been borrowed.

While it is simply wrong to think you cannot lose money on property what is true is that property is a foundation asset for most people's finances.

It is the house that underpins a lot of borrowing and investment - something that has created a true "wealth effect". It is also a critical factor in consumer confidence - high levels of equity in a home go a long way to shoring up our feelings of financial security.

Our tax system also plays a key role here. As another tax year draws to an end the ability to negatively gear investment property undoubtedly has helped drive house prices higher and should also help keep a floor under property values.

Learning lessons from other people's mistakes is the cheapest form of education you can get. The US and UK property markets are reminding us that what goes up can go down and it underscores the need for a financial plan that takes a long-term view and looks at your financial position through the broadest possible lens.

Diversifying your portfolio across the different asset classes - property, shares, fixed interest - according to your risk appetite is the sensible way to guard against a major shock in one specific market - be it credit crunch or property crash. It is the unforeseen risk that has the potential to derail investors in the most costly fashion.