Could Sydney’s median house price really achieve $1 million? | Pete Wargent

Could Sydney’s median house price really reach $1 million ? 

There been a number of rebuttable presumptions concerning this property cycle, particularly through the course of 2014, including:

  • Investor demand having been pulled forward, prospective buyers would fairly quickly “run out of money” and the real estate market would switch into reverse; and
  • Yields would slide low enough that prices would inevitably soon follow suit and decline.

We have periodically highlighted a couple of possible counter-arguments here at various points through this calendar year.
Sydney's median house priceFirstly, rising dwelling prices create equity for existing property owners, and as such although investor demand may have been pulled forward, investors can remain active, at least while banks continue to lend to them (we might also just briefly note here the potential role of foreign investment capital).

And secondly, the yield argument scores a miss, because, to our knowledge at least, nobody buys capital city property primarily for its yield – it wouldn’t make any sense to buy a heavily leveraged asset for the relative strength of its income component, particularly one for which the net yield is at best going to be close to nil.

Further the generic yields quoted by capital city do not always reflect the reality of the expected yield from an investment property. Let’s take in a stylised example.

What does an investment property cashflow profile look like?

An investor redraws existing equity and produces a 20 percent deposit to buy a $500,000 unit in Sydney, which she then rents for $420 a week.

[sam id=40 codes=’true’]

Even without shopping around or undertaking a renovation, or indeed doing any research at all, a unit with such a yield of 4.3 percent is not hard to find.

Clearly the gross yield is ordinary compared to the ~5 percent that we would have seen when buying back in 2008.

Yet gross yields have not been eroded to the extent that might have been expected, since median weekly apartment rents have risen strongly in Sydney by up to 25 percent over that time.

What commentators sometimes overlook is that the lending environment has also changed dramatically since early 2008, with the the cash rate a thumping 475bps or 4.75 percent lower than it was at that time.

This makes a material difference to a property investment decision, despite superficially weaker gross yields.

In the example above, an investor can fix an 80 percent LVR mortgage for fully 5 years at an interest rate of around 5 percent, meaning that the annual rent of $21,840 more than covers the interest repayment of $20,000, with the inherent expectation being that rents will rise in the future.

Even where there are a range of other annual holdings costs (e.g. repairs, insurance, strata fees etc.) of, say, 1 percent or $5000, after all allowable deductions including “on paper” depreciation allowances are added back and the paper loss is offset against other income, the effective net loss after tax is likely to be as close to $nil as almost makes no difference to most investors.

In other words, lower yields have not deterred investors and nor will they do so now unless the cost of debt rises significantly.

Price growth expectations are what matter

As implied above, to my mind there is only one logical reason for which folk might invest in capital city residential property, that being that, as a traditionally effective long term inflation hedge, the asset is likely to be priced at a materially higher nominal dollar amount in a dozen years time than it is today.AKA: capital growth or pure price speculation.

Do punters believe that capital city prices will be more expensive in the future? Probably so. The experts certainly do, and by a huge margin at that, so it’s a fair bet that the answer is “yes”.

Residex, by way of an example, forecasts long run price growth for Sydney of 5-6 percent per annum.

We don’t necessarily agree with all of the Residex forecasts – in fact they appear to be remarkably bullish in some cases – but if sustained such a rate of growth implies that median prices would in fact be double what they are today in only a dozen years time, and certainly within well under 15 years.

Meanwhile, it would also be expected that gross rents from a well-located investment property would rise over such a time horizon too.

 Price growth expectations are what matter
Moving on to yesterday’s mortgage index release from Australian Finance Group (AFG) let’s see what we can learn in three short parts.

Part 1 – AFG mortgages boom to 21 year high

Can Sydney’s median house price really soar to above $1 million in this cycle? The data certainly suggests that this may eventuate.

AFG released its latest mortgage index for October which revealed a startling result and one which suggested that an affirmative may not be out of the question – the notion of an unprecedented Sydney boom is certainly gathering a little more support of the back of data sets like this one.

In the month of October, Australia’s largest mortgage aggregator wrote well over 10,000 mortgages (totalling 10,463), a figure which the group has never previously come close to during its 21 year history.

Even allowing for likely shifts in market share, these are hugely strong numbers.

The trend data is not seasonally adjusted but, volumes written are up by 36 percent over the past two years.

AFG mortgages boom
In terms of the value of mortgages sold, the result was even more astonishing at more than $4.7 billion in mortgages written.
That’s an increase of 9 percent on September, which was itself an all-time record high for AFG, a whopping 17 percent rise over the past year, and a thunderous 53 percent increase on the October 2012 reading.
AFG mortgages sold

Colossal figures which suggest that the housing market has more life left yet in this cycle.

Part 2 – State versus state – New South Wales roars higher

It is in the drilling down to the state level which reveals the most eye-popping figures. AFG wrote 2996 loans for New South Wales in October, a 19 percent increase on the prior year equivalent figure.

AFG mortgages sold by state

Meanwhile, the chart below is the most dramatic of the entire data series, with the value of New South Wales loans written soaring some 34 percent higher over the past year.

Thanks to record low borrowing rates, the value of loans written in Victoria have increased by 19 percent year-on-year and in Queensland mortgages sold have increased by 12 percent in value terms.

South Australia was flat, recording no increase over the past year.

AFG mortgages sold by state $

The average mortgage size in NSW exploded higher in October to be up by more than 13 percent over the past year, although to date only 8 percent when calculated on a 3 month moving average basis.

Avg mortgage size by state

There appear to be only three possible conclusions might be drawn from this data set:

(i) AFG has massively increased its market share at an astonishing rate; or

(ii) we have just witnessed an anomalous month of lending in October by AFG; or

(iii) Sydney’s median house price is heading to $1 million, and on the strength only of this evidence, with short shrift.
Time will tell which of these three conclusions is correct, or the answer could feasibly be a combination of the above.

Part 3 – Investor share of loans eases

And finally, an interesting point from this release was that following on from the warnings of macro-prudential interventionary measures relating to mortgage lending, the share of investor loans reported by AFG magically fell across every reported state in the month of October.

While the percentage of investors remains elevated in New South Wales at 49 percent, the share of loans for investment housing declined across all states with South Australia recording the sharpest drop down to 30 percent.

Investor share of loans eases

Again there are seemingly only three possible conclusions which one might draw from this:

(i) The Reserve Bank’s “jawboning” campaign has worked, and investors have pulled back from the market (certainly possible, although seems somehow unlikely); or
(ii) Homebuyers are picking up the baton and a surge in lending for home buying has taken over from where investors are leaving off to drive the market forward; or
(iii) the October data is anomalous, or misreported.

The Wrap

AFG’s mortgage data is the most timely that we have available, and it implies that a monster month of mortgage lending could well be reported when the Australian Bureau of Statistics (ABS) releases its full October figures, yet with investors seemingly taking up a lesser share of the pie.
The WrapOf course, this is only a market snapshot and the data can easily head fake us as observers, yet previous releases have often proven themselves to be fairly useful indicators of market trends.
With the value of loans written in New South Wales racing up by more than a third over the past year (2013 itself being a strong year) it seems that commentators may have under-estimated the sheer scale of this Sydney property boom.
With Sydney vacancy rates remaining low on a city-wide basis at just 1.7 percent, in stark contrast to the preceding boom a decade ago, borrowing rates at previously unthinkably low levels, and apparently no interest rate hikes on the horizon, an unprecedanted market blow-off could be a possibility.
In short, the once distant $1 million median house price could become a reality for the harbour city considerably sooner than had been expected.



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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

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