Key takeaways
Property prices have grown faster than incomes and borrowing capacity combined, indicating that other factors contribute to property growth and affordability for some buyers.
Higher household incomes do not necessarily guarantee better capital growth rates in property. While income may have an impact, it is difficult to isolate its effects from other influencing factors.
Property prices can be influenced by factors such as land value appreciation, improvements on the land, investment returns, migration, inheritances, business exits, and career progression.
The borrowing capacity is unlikely to increase at the same rate as in the past, and average incomes are unlikely to rise significantly. This suggests that relying solely on borrowing capacity may not drive property prices in the future.
Investing in locations where the wealthiest 15% want to live is important because they are more likely to have additional financial resources, such as inheritances, which can impact property prices.
Commentators often refer to the price of property relative to household incomes.
For example, it is estimated that property in Melbourne and Sydney now costs more than 10 times the median household income.
But is this really a meaningful measure if it is, property cannot continue to grow at a faster rate than incomes (a point often made).
How will property be affordable if prices continue to rise faster than income?
At the beginning of this year, I wrote about the factors that have driven property prices higher over the past four decades.
I concluded that borrowing capacity and higher incomes have increased 3.5x since 1980, whereas property prices have increased 4.5x.
Prices have grown faster than incomes and borrowing capacity growth combined.
Clearly, something else has contributed to property growth for it to be affordable for some buyers.
It is worth stating at this point that borrowing capacity is likely to be flat in the future.
That is, borrowing capacity will not increase anywhere near it has over the past four decades.
That will probably have an adverse effect on property price growth in many locations.
Do locations with higher incomes perform better?
Data analyst, Jeremy Sheppard has done some work on this question and found there’s a weak statistical relationship between income and capital growth rates.
The thesis is that people who earn more can afford to pay more for property.
Therefore, we should invest in locations that have above-average household incomes.
A big problem with Jeremy’s analysis is that the data may not be accurate and/or out of date (which Jeremy acknowledges), so this thesis is impossible to test.
I think the reality is that incomes do have an impact, but so do many other factors, so it is impossible to isolate the impact of income alone.
Also, do you really need census data to identify the locations that wealthy people want to live in?
I think those locations are pretty obvious.
What other factors may be pushing property prices higher?
Approximately, one-third of Australians own their home without a mortgage, one-third own their home with a mortgage and one-third rent.
That means that approximately two-thirds of Australians’ (owner-occupier) property decisions are driven by lifestyle goals.
Of course, people will draw on financial resources other than income to achieve their lifestyle goals.
Property prices can be driven higher by two factors.
Firstly, an appreciation of the underlying land value (which is a function of supply and demand).
Secondly, improvements on the land e.g., renovations, rebuild, etc.
It is important to remember this when studying how median prices have changed over time.
Houses are more expensive because, to some extent, the dwellings have been improved.
I discuss the financial resources that some people use to upgrade their homes and/or invest in property.
1. Investment returns
Share markets have returned circa 10% p.a. over the past 40 years.
Super funds have delivered similar returns (circa 9% p.a.).
Some of this ‘wealth effect’ will eventually make its way into the property market as investors use some of this wealth to upgrade, improve their homes, and/or invest.
2. Migration
According to the Migration Policy Institute think tank, it is anticipated that 125,000 millionaires will immigrate to Australia in 2023.
I haven’t verified how reliable this projection is, but clearly, Australia is considered very “liveable” and as such will continue to attract wealthy individuals.
3. Inheritances
The Productivity Commission forecasts $3.5 trillion of wealth will be inherited between 2020 and 2030!
In fact, the amount of inherences received by Australians is expected to increase to $224 billion per year by 2050.
Of course, some of this will find its way into the property market, which will push prices higher.
4. Business exits
If an entrepreneur is fortunate enough to sell part or all of their business, often one of the first things they do is upgrade their home, buy a holiday home, and/or invest in property.
Capital gains from businesses also stimulate property prices/demand.
5. Short-term incentives, bonuses, career progression
According to the ABS, average weekly earnings have increased by 5.8% over the past 53 years.
However, of course, a lot of people’s incomes increase by a lot more than the average.
This can occur due to career progression (e.g., promotion to senior management), bonus incomes, and short-term incentives such as restricted stock units (RSUs) and so forth.
Variable (at-risk) remuneration, which is becoming more common (particularly RSUs) helps a lot of buyers increase their purchasing power.
In our experience, a lot of people who buy property in blue-chip locations enjoy a much higher rate of income growth than the average Australian.
Other financial resources contribute substantially to property price growth
A couple of years ago, my wife and I sold a commercial property to assist with upgrading our family home.
After all, that is the reason we invest – to achieve lifestyle goals.
Therefore, I know first-hand from personal and professional experience that the above factors (financial resources) absolutely contribute to property price growth.
Therefore, focusing on income alone (as a measure of affordability) does not provide the full picture, especially in highly sought-after, blue-chip locations.
Borrowing capacity will not drive prices in the future like it has in the past
I have previously highlighted that borrowing capacity has increased by 2x to 3x over the last few decades and this has contributed significantly towards property price growth.
However, borrowing capacity will not increase at this rate in the future.
In fact, I think the safest assumption is that borrowing capacity will probably not change very much at all.
Also, average incomes are unlikely to rise at a rate greater than 4-6% p.a.
That’s why it’s important to invest where the wealthiest 15% want to live
It was interesting to read recently that Knight Frank estimates that almost 3.8 million Australians have a net worth that exceeds $1.5 million ($1 million in USD) – that’s almost 15% of the population.
And if your net worth exceeds $8.3 million ($5.5m in USD), you are in the wealthiest 1% of Australians.
I believe that it is important to invest in locations where the wealthiest 15% want to live because it’s more likely that these people will have access to the additional financial resources discussed above, particularly inherences in the future.
This is why I wrote last month that property investors must be more selective in the properties they buy (invest in).
Maintain perspective about the “lack of affordability” noise
The media write endless articles about how property is unaffordable.
Most people would agree with this notion because prices have risen so much. But the fact is, people continue to buy and sell property and push prices higher.
So, clearly, property is still affordable for some Australians (if it wasn’t, prices would not continue to rise).
Therefore, the perspective we must maintain is that property is less affordable for most Australians but not all.
That is, not for the wealthy cohort.
So, if you invest in property they want, you’ll likely benefit from rising prices in the years to come.
