Here’s why Australian house prices have not corrected yet.- Pete Wargent

We’ve seen the charts which show house prices and a raft of other data stretching all the way back to the 1800s which proved to us that a property correction was both inevitable and coming Australia’s way, so why didn’t property prices retraced in 2013?

Why hasn’t it happened?

A material correction could still be imminent, of course, but at least a  meaningful part of the reason is that the market conditions are not the same as they were only a quarter of a century ago.

It’s common but incorrect to blame the big run-up in Australian house prices on investors.

In reality a far more significant reason for the change was completely unintentional and absolutely led by homeowners.

As households decided to ‘get ahead’ in the housing status stakes by taking advantage of using two incomes instead of one, the early adopters got ahead.

For a while.

But when a husband and wife working became the new norm, any relative advantage was eroded, and the rather unhappy end result was higher house prices all round.

And there was a bigger reason than this still:

Specifically, Australia’s return to low inflation, which continued after the introduction of inflation target in 1993 and ultimately saw mortgage rates effectively halved.

Of course, this represented a once-only downward adjustment, yet the impact has been colossal.

chart-pack_Страница_08

The increase in household debt was not completely irrational in one sense.

When mortgage repayments plummeted, home owning couples essentially had three pivotal choices.

(1) Continue to pay the same mortgage repayment figure and be debt-free more quickly;

(2) Pay the now lower mortgage requirement and spend or invest the extra cash on other stuff; or

(3) Trade up to a more expensive house.

No prizes for guessing which choice the housing-obsessed Aussies went for (it was ‘3’ by the way).

Australia, a country largely built upon poor immigrants from the United Kingdom, the Mediterranean and Eastern Europe, has seemingly forever attached status to the ownership of resplendent housing.

[sam id=35 codes=’true’]

Aussies who had previously been unable to afford it were granted a ticket to play in the guise of the structural adjustment to low interest rates, so they traded up.

Unfortunately, the extraordinary drop in interest rates didn’t prove to be quite so extraordinary for first home buyers as existing owners stampeded the market in their drive to get ahead.

In plain English, home ownership rates did not increase as a result of the lower mortgage repayments.

Of course, for all the talk of ‘higher net worth’ and housing wealth, as a country we’re no better off.

As a general rule, we just have more debt.

Buying and selling existing properties from and to each other adds nothing to a country’s wealth, only to our own perception of it.

And indeed, there is little gain in making a profit on the sale of property if your next move on the ladder is to a more expensive property – which itself has likely increased in price.

The obvious beneficiaries from housing booms are speculators who own multiple properties (and potentially those approaching retirement who plan to downsize) but there weren’t so many of them in Australia in decades gone by.

What about the role of investors?

I alluded to the role of investors above, and investment property did have its part to play in the last great housing boom through to the end of 2003.

The concept of investment in property was a relatively new phenomenon for everyday Aussies since banks had been previously been reluctant to lend for speculative purposes.

These days, of course, the banks can’t get enough of interest-only products to boost their bottom lines and returns-on-equity.

One consequence of the last great boom was that by the end of 2003 average yields became pitiful on residential housing at around 3.5% – and nearer to 2.5% after costs – as the number of willing landlords began to exceed the demand from renters.

The Reserve Bank began to jawbone the market highlighting exactly this point – professional investors demanded yields at least twice as high as this, they lamented, so what on earth were Mum-and-Dad investors doing?

Interestingly, however, it wasn’t high interest rates which killed off the last great Aussie housing boom, and nor is it likely to be so in this cyclical upturn.

Recall that the cash rate was hiked only to 5.25% in December 2003 and did not move again until March 2005 (to 5.50%), and then not again until May 2006 (to 5.75%).

The last boom just ran out of puff.

The present upswing in Australian house prices is also unlikely to be throttled by interest rate hikes as the cash rate sits at just 2.50%, and even now the yield curve remains inverted.

In my opinion, it’s more likely to the ‘QANTAS effect’ which eventually turns us off housing this time around: we hear about others losing their jobs and start to worry about losing ours.

That, and residential property yields falling to miserable levels again, which is already beginning to happen in Sydney in certain cases where properties are bid up miles over the reserve.

It remains to be seen how long this upturn lasts for and it depends on your viewpoint – housing bears say 6 months, and bulls suggest that the market will peak in 2016 with a downturn in 2017.

In truth, I don’t have a clue and nor does anyone else… 

When you begin to consider the number of variables involved, it’s silly to suggest otherwise.

From the perspective of the powers that be, it’s likely better that a property cycle ends with a tapering in demand, rather than a stampeded for the exits caused by a nosebleed cost of borrowing (cf. the early 1990s when the cash rate was well above 15% leading to a horror show).

High interest rates can lead to recessions.

Closer to the city

I have to laugh when I read property books that can’t wait to tear into people like me (the sneering term “self-proclaimed ‘experts’…” inevitably features – oh, the sarcasm) who have the temerity to suggest that the great long-term trend in property markets is that people want to live in the lifestyle suburbs, near the center of the major cities and their beaches.

We’re “stuck in the past” apparently, “spouting the same old lines” from years ago.

Heaven forbid, suggesting that investors stick to where people want to live and work!

Well, we’ve been hearing for at least two decades now that everyone will be working from home and moving out to regional towns.

LOL, don’t let the facts get in the way of a good story!

Check out what the latest demographic statistics show, which is that Australia’s population increased by a massive 407,000 persons in the year to June 2013, with 70% of people heading to the main five capital cities.

Matusik delves into the time series spreadsheets and carves it up nicely here, where he highlights that 80% of the population growth is occurring in only the capital cities plus the Gold Coast/Sunshine Coast, Townsville, Newcastle and Cairns.

So much for everyone moving out to the regions.

Now what is the case is that a good portion of the capital city population growth is happening in new and outer suburbs.

Apparently, so the yield-chasing theory went, superior capital growth returns will also be found in the outer suburbs and the regions.

However, this is patently not so.

It doesn’t especially bother me what people choose to believe after starting with their conclusion and grappling for any evidence, no matter how feeble, to support it later – a textbook case of confirmation bias if ever there was one.

But if you’re interested here is what yet another independent review by AHURI found, which is that capital growth has been consistently better in suburbs closer to the CBD over more than three decades. Note that I said “closer to the CBD”, not “within the CBD”…one of the great old favourite misquotes.

And, notably, the trend has very obviously continued beyond the financial crisis as well.

Meanwhile those suburbs located out on the outer in “growth zones” are sold for a loss a “staggering” percentage of the time. For more on this, refer to RP Data’s ‘pain and gain’ report and note what percentage properties have been sold a loss in Adelaide and particularly regional South Australia in the past half decade.

For a full dissection of the actual facts, read this article here at The Conversation.

The conclusions are somewhat disturbing, showing that we are in the process of busily building ‘cones of wealth’ around the cities while simultaneously trapping buyers in remote suburbs and areas out of these markets perhaps forever, while condemning them to low capital growth.

For example, here is what has happened in Melbourne’s south-eastern corridor, which is quite depressingly conclusive:

 

 Melbourne's south-eastern corridor

I’m not cherry-picking, incidentally. Here’s the southern corridor (same story):

southern corridor

And the eastern corridor (same again):

eastern corridor

And the northern corridor (repeat dose):

northern corridor

And the western corridor (ditto):

 western corridor

What about the theory that regional centres will outperform capital cities like Sydney and Melbourne?

Wrong again, as the RBA’s December chart pack clearly shows, regional prices in aggregate have flattened out as household debt levels have levelled off, while cities like Sydney are rocketing in response to the ultra-low interest rate environment.

The latest RBA chart pack only runs to November, future releases will show the Sydney property market scaling new heights.

 

chart-pack_Страница_09

 

I also note that house price growth has fairly well stalled as we expected in Adelaide over the last six years since that city was supposedly going to be the ringer, so it looks as though we ‘self-proclaimed experts’ lucked in on that one as well.

I was down in Adelaide last week and the dynamic is so far removed from our major capital cities.

I suppose that sharp capital growth could happen again one day, but it would only result from draconian supply-side planning restrictions rather than booming demand (refer to the latest employment data to see why – jobs are being added in all the major states, but are being lost in South Australia, where the existing unemployment rate is also higher).

Many of Sydney’s inner- and middle-ring suburbs have boomed by more than 30% since 2009.

My own nominated favourite sector of the market (Sydney’s inner west) is on track for an absolute corker of a year, with prices rising by 20% in 2013 and still going strong.

Note that this represents actual capital growth in established dwellings, not merely a distortion of median prices caused by new stock.

Meanwhile in another lucky win for the self-proclaimed experts, well-located London properties are performing incredibly well, which is great news for ‘growth investors’ (heck, don’t mention the regions though – prices in the UK regions have crashed by 30-40% in plenty of areas since 2007 and have quite simply never recovered).

premium london

Source: AllenWargent Buyers Eye 2013

All of this isn’t particularly surprising by the way.

The vast increase in Australian household debt flattened out around 2006.Hate to break it you, but it ain’t going much higher either – not with debt levels at 150% of household disposable incomes – and therefore most property types in Australia can only increase on average in line with income growth over time.

And that’s in the best case scenario.

More likely, we’ll get a housing market day of reckoning some time over the coming decade, and when the tide goes out, we’ll surely see who’s really swimming naked while speculating in remote markets.

chart-pack_Страница_10

The current property market upturn to date is largely an investor-led story (and perhaps a foreign money story, depending upon who you believe – note that our dollar is sliding too…) which is largely why Sydney has been leading the way.

First home buyer malaise?

Appreciating house prices seem remarkably unfair to potential first home buyers since rising prices clearly benefit existing owners who tend to be older and earn more.

One piece of good news is that the Baby Boomers who have benefited from the housing boom should be able to pass on some of their spoils to help their kids onto the housing ladder.

Perhaps we will also see a rise in second-generation wills.

This isn’t a whole lot of use to those of us from broken families, those of us with lots of siblings, or for that matter, those of us with deceased grandparents (admittedly, by luck as much as anything, I’ve been one of the fortunate beneficiaries of the housing boom sine the mid 1990s). So, it’s clear that this passing on of family wealth this may benefit the younger generations iniquitously.

But if you’ve been a long-time follower of housing markets, it’s probable that you don’t worry quite as much about housing affordability and the intergenerational wealth divide.

Why?

Because markets are ultimately self-correcting.

If people cannot afford property, then prices must and will fall eventually.

The timings are forever uncertain, but the end result for unaffordable housing markets, where they truly exist, is inevitable.

Quite simply, if prices cannot be afforded, then they won’t be.

As the older generations move on and pop their clogs, by definition the only buyers left will be the younger crowd, and they will only pay what they can afford to pay.

[post_ender]



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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


'Here’s why Australian house prices have not corrected yet.- Pete Wargent' have 10 comments

  1. January 31, 2014 @ 8:03 am Dave

    Hi Pete,

    Graet article. I think you are right on the money.
    I allways see margaret Lomas banging on about the regionals but as an investor, I am not willing to
    take a chance on outpost, to try and catch its once in a lifetime sugar rush on prices.
    I believe those experts push those areas as its easier to sell to the mum and dad investors on the
    affordablity to hold the investment. If they try to push an inner city property, the negative cash flow wil be to great to sustain. Often the data in these regionals is skewed by a new development
    of new houses, which make the area seem likr the medium has increased but in reality its just new developer stock.

    Reply

  2. Pete Wargent

    January 31, 2014 @ 6:36 pm Pete Wargent

    Thank Dave.

    Yes, I agree.

    The NSW south coast is a prime example of a region where just that can happen.

    Pete

    Reply

  3. February 1, 2014 @ 2:08 pm Joe Gardiner

    Hi Pete,
    Great article, really interesting points about affordability and a potential flattening of growth so as to come into line with affordability. As an investor it is prudent to invest with these larger trends. From a social perspective, those demographics of movement to capital cities really raises the spectres of city sustainability, state infrastructure strain, and ‘what is to become’ of the regions. Lastly, on affordability, the federal government has in January 2014 referred an inquiry into ‘Affordable Housing in Australia’ to the Senate Economics References Committee for inquiry and report. The findings from this enquiry may be wider than expected given the now widely acknowledged disadvantages that First Home Buyers face…I wonder what the impacts could be on FHB and Investors alike!

    Reply

  4. February 1, 2014 @ 3:31 pm Jason

    I’ve been saying it for ages and can’t believe that was the first time I’ve actually read it somewhere. It amazes me how no one else seemed to understand the whole move from single income to double income households has caused much of the rise in prices over the past few decades. Great article!

    Reply

  5. Pete Wargent

    February 1, 2014 @ 4:43 pm Pete Wargent

    Joe, yes it’s not a great social trend but at the rate Australia is populating it’s likely that the desirable suburbs will continue to see high prices, especially as gradually increasing wealth is reflected in inner city land values.

    Not sure if you caught it but Mark Armstrong recently gave a good explanation of land value and how investors should think about what types of apartments they look at (i.e. boutique and not the high rise blocks) :

    http://realestatetalk.com.au/whats-ahead-for-property-in-2014-house-or-apartment-whats-a-better-investment-update-on-super-funds-whats-ahead-for-the-economy/

    Jason, thanks, yes it’s not as widely acknowledged as it might be, I suspect because it seems particularly unfair to those in 1 income households. Nevertheless it has been the case that dual incomes and ultra-low interest rates have made life pretty easy going for existing owners on variable rates in recent years.

    As for the run up in household debt, it’s largely the inverse of what’s happened to the cash rate:

    http://australianpolitics.com/topics/rba/interest-rates-since-1990

    Ask anyone who as been an owner or investor through a couple of cycles and they’ll tell you that the 1990s recession and beyond was excruciating. It’s rarely mentioned in housing affordability debates , I guess because the majority of people decrying higher dwelling prices have never felt the intense pain of high interest rate mortgages. Hopefully Australia won’t go down that path again…!

    Reply

  6. February 1, 2014 @ 5:15 pm Billy

    Very imformative and realistic article. While it is possible for house prices to fall, I believe it would require a massive upset to our economy such as skyrocketing unemployment/interest rates. I just got back from the USA after spending a month there, and even though they might have 320 million citizens, there is simply so many towns and so much supply that except for cities like new york or san francisco,

    Reply

  7. February 1, 2014 @ 5:21 pm Billy

    Very imformative and realistic article. While it is possible for house prices to fall, I believe it would require a massive upset to our economy such as skyrocketing unemployment/interest rates to do it. I just spent 1 month in the USA, and even though they might have 320 million citizens, there is simply so many towns and so much supply that if a town got too expensive you would just move on to another one (except for perhaps San Francisco or NYC). Australia on the other hand has maybe 10 large cities/towns to move to so supply in popular areas over time becomes even more constrained and prices must move upwards. That’s my two cents anyway!

    Reply

  8. Pete Wargent

    February 1, 2014 @ 5:26 pm Pete Wargent

    Billy,

    Yes, it’s true that Australia is very much focussed on a handful of city locations.

    Mark Armstrong actually referenced the same topic in another of his articles recently too:

    http://www.propertyobserver.com.au/demographics/why-australia-s-population-dispersal-creates-stability-in-the-property-market/2014012867400

    Reply

    • February 1, 2014 @ 5:59 pm Billy

      Nice link Pete, pretty much what I have suspected since I got back from there (but Mark has done the homework to prove it in detail- the pictures are also quite compelling). For now on I will have a much higher level of skepticism towards property doomsayers – on a highway in the USA, every 15-30 minutes you will see a different small town, and they all seem to have the same kind of layout with the same stores/services etc, giving purchasers an abundance of choice. On the other hand, some people in Sydney drive 1 or 2 hours just to get to work everyday from where they live!

      PS sorry about the broken english in first comment, I am typing on a mobile haha.

      Reply

      • Pete Wargent

        February 1, 2014 @ 6:13 pm Pete Wargent

        Didn’t even notice the broken English, Billy, so no worries.

        Yes, you’re absolutely right, and this is why experienced investors who have been around the traps for more than a couple of property cycles advise those who are buying property for investment purposes to stick to certain types of suburbs in capital cities – those where the supply is essentially fixed but demand for that supply is growing.

        Being a Brit I’ve seen first hand what can happen when people try to get too clever by chasing yields out in the regional towns – in Britain’s case it was absolutely horrific. Even now – in 2014 – prices are down from their peak by some 30-40% on 2007 levels in plenty of areas. Of course, this is not in the case in London or in cities within easy striking or commutable distance of London.

        I note that one of the trends which is likely to unfold this year in Australia is the disorderly unravelling of a number of mining town property markets. The construction phase of mining projects tends to be highly labour intensive, the production phase is not. I remember when I worked in mining one of our projects had hundreds of staff working on the mine construction, but once production is up and running many of the mining contractors are moved on. Hence, keep a close eye on vacancy rates in a number of these resources-focussed markets through 2014/15.

        Cheers

        Reply


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