Something I’ve been thinking about a lot lately is where financial advisers should stand with respect to residential property.
Traditionally, advisers have oriented towards advising on financial assets – cash, fixed interest products like term deposits and bonds, managed investment schemes, direct shares, superannuation and Kiwisaver products.
Certainly, there is a tendency towards equating “financial advice” with financial assets. Property isn’t a “financial asset”. It will never be regulated that way.
But let’s back up a bit. If you define a financial adviser as someone who helps clients achieve their financial goals and manage the risks to which they are exposed, then they should have an opinion about real estate, shouldn’t they?
After all, for many people, the biggest source of wealth is the equity locked up in their home.
I also wonder whether financial advisers can add more value to clients by focusing on real estate rather than financial assets.
Why? Because financial markets resemble efficient markets. The value of a publicly listed stock is the collective valuation of thousands of educated buyers and sellers. The value of the stock might not be “correct” (in the sense it might not reflect the prevent value of all future cash flows), but it’s the best guess of many people.
The residential property market, on the other hand, is at the other end of the spectrum. It’s not efficient and does not resemble an efficient market. (I quote nobel laureate Robert Shiller on this elsewhere. In short: it’s hard to understand how supply responds to demand, and you can’t short sell the property market. In such a market, looking at comparable recent sales is not a good gauge of whether a price is fair.)
I’m not saying that financial advisers should definitively say that a property investment is a good one or a bad one. The only honest answer a person could give is that they don’t know. But they should point out the characteristics of property that make it riskier than many people think.
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Take, for instance, that a property is illiquid, has high transaction costs, is undiversified, and is geared. If a financial adviser recommended that a client invest a significant proportion of their wealth in a single financial product with those characteristics, they’d probably be found negligent.
Furthermore, there are not a lot of people out there who have an unconflicted interest in providing advice about property. Think about it: you have real estate agents, who want to sell properties. You have lenders and mortgage brokers whose incentives are aligned with people buying properties and spending large amount for these properties.
So. People need independent, unconflicted advice. Decisions to buy and sell property can have an enormous impact on a person’s financial situation.
If a financial adviser isn’t going to advise on property, who will?