Annual growth rates for house and unit values buzz around these days like blue-arsed flies.
Many of them include a decimal point; some, even two!
Yet, few seem to know what they are actually measuring or what the growth rate really means.
Let’s start with measurement.
Ask yourself whether the price growth being promoted is a flat rate; or whether it is compounding.
Also ask whether the growth rate is in real or nominal terms.
Real rates are nominal rates, minus inflation.
And to make it crystal clear, nominal values are not adjusted for inflation.
Rising inflation means your purchasing power is falling.
Australia’s inflation has reduced your purchasing power by 25% over the last ten years.
I often ask these questions of those supplying price growth figures.
Too often, they don’t even know.
To illustrate – if, say, values were to increase from $500,000 in 2006 to $1m, ten years later – a doubling in value – then, based on a flat rate of growth, values would have to rise by 10% each year.
This answer would be in nominal terms.
In real terms, and using the Australia inflation rate over that period, the answer would be about 12.5%.
But if the same value lift occurs, the annual rate of nominal compound growth is 7.2%.
In real terms – and again, using the Australian inflation rate over that ten year period – it would be closer to 8.5%.
Obviously, nominal terms – if you don’t realise what you are reading – are higher than real terms. Most in the real estate industry publish change in flat and nominal terms.
What does it mean?
A simple way to assess an asset’s growth performance is to review how much it has grown over the past ten years.
To help you work this out, apply the rule of 72.
The rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return.
The rule states that you divide the rate, expressed as a percentage, into 72.
This then gives you the years required to double investment = 72 divided by the compound nominal annual growth rate.
Many believe, for example, that property values double every ten years.
It is a property marketer’s staple line.
A real estate mantra: “Don’t stress, time heals a buying mistake. Property values double every ten years or so.”
Remember, values must be growing – at a compound nominal rate – at 7.2% per annum for property prices to double in ten years.
In real terms, they must be going up by 8.5% per annum (based on the last ten years).
On a flat rate, up 10% each year or 12.5% per annum (again, based on the last ten years) in real terms.
So, when applying the rule of 72 over the past decade (2006 to 2016), which residential markets are running true to the ‘double in value every ten years’ motto?
These results are based on nominal rates.
For detached houses:
- Sydney 10.4 years
- Melbourne 10.4 years
- Brisbane 19.7 years
Adelaide 16.3 years
Perth 171.4 years (yes, that is right)
Hobart 21.4 years
Darwin 17.9 years
Canberra 17.6 years
Australia 15.8 years
For attached property:
- Sydney 11.1 years
- Melbourne 13.4 years
- Brisbane 20.6 years
Adelaide 17.9 years
Perth 44.2 years
Hobart 29.7 years
Darwin 16.4 years
Canberra 26.8 years
Australia 14.9 years
Another thing the real estate industry likes to publish is past performance.
Most in marketing will correctly say that “past performance sells”.
But what if the future is very unlikely to be a repeat of the past?
The results listed above reflect the past.
We have questioned the logic behind assuming that past trends continue.
But regardless of what lies ahead, the rule of 72 is a good one to remember.
Importantly, it only applies to nominal compound rates of growth.
And its recent application shows that one of the staple real estate mantras may no longer apply.
Changes are coming, which include much lower rates of property growth, either measured by flat or compound rates.
Whilst real growth rates are becoming more aligned with nominal results – that happens in a deflationary world – very few properties are likely to double in value in the next ten years.