In his article today in the Australian Financial Review Christopher Joye, economist and director of Yellow Brick Road funds management and Rismark discusses how the various sectors of the real estate market have performed as property investments. He says…
In bull markets you often see boutique developers gravitating towards luxury products.
There is a cachet attached to producing pricier citadels. In a similar fashion, wealthier individuals tend to collect ensembles of more expensive homes.
My question is whether this is a smart strategy.
We recently let go of a holiday house in Sydney’s Palm Beach. During the eight-month sales process I was struck by how many bidders already owned two, three, or four multimillion-dollar properties in the immediate vicinity.
These were sophisticated folk who had built up considerable wealth during their careers. They had a rich universe of alternative investments available to them.
Yet there seemed to be a visceral attraction to the assumed safety of bricks and mortar.
As I’ve shown in previous columns, an individual dwelling cannot be described as a low-risk asset. Our quantitative research implies that a single home’s annual return volatility is around 15 per cent – akin to equities – and that’s before you start loading in leverage.
Of course, residential property doesn’t just appeal to the wealthy. Australian families pour more than $60 billion each year into the acquisition of investment properties for rental purposes.
In a world where the average super fund has furnished a miserly 3.7 per cent annual return over the past seven years (less than bank deposits), and Australian shares remain 35 per cent below their 2007 peak, many savers are defaulting to simpler approaches they believe they can trust. Cash and property feature prominently.
I want to resolve two essential questions relevant to readers of this newspaper: first, how important is the luxury sector to Australia’s overall housing market? And, perhaps more interestingly, how have luxury assets performed vis-à-vis the rest?
In July 2012 the median dwelling price across Australia was only $412,500. If we strip out regional markets and simply look at capital cities, the median price is $460,000. Even in Australia’s most costly metropolis, Sydney, the median dwelling price is just $535,000.
The fact is that you get an exceedingly distorted picture of the wider housing market if you extrapolate out from Sydney’s eastern and northern suburbs. Unfortunately, this “anchoring bias” contaminates the judgments of many commentators.
One way of evaluating the significance of the luxury sector is by examining the distribution of all home sales ranked by price.
I’ve done exactly this for the population of sales over the last year.
I found that 79 per cent of dwellings purchased in Australia were worth less than $600,000. And I can capture 90 per cent of all buyers if I include properties up to $800,000.
In contrast, homes worth more than $1 million account for only 5 per cent of buyers. Fewer than one in 100 buyers purchase properties priced more than $2 million.
The bottom line is that the $1 million-plus market is irrelevant to 95 per cent of Australian owners. If you want to successfully scale a real estate business, you should therefore concentrate on price points in or around $500,000.
How have luxury homes performed?
My second question is how luxury homes rate as investments. This is not easy to address. You need access to years of individual purchase and sale records. You then have to match trades and precisely measure the returns realised by owners over time.
With the help of RP Data and Rismark, I’ve been able to do that.
We took 2.75 million transactions between 2000 and today, and sorted all purchases and sales of the same properties into four equally-sized portfolios ranked by price from low to high. The results are stunning.
The more expensive the property, the worse it performs. The cheapest 25 per cent of dwellings in the bottom portfolio generated by far the best returns, with a median compound annual growth rate of 9.8 per cent. This is two-thirds higher than the 5.9 per cent annual capital return yielded by the most expensive dwellings in the top portfolio.
The analysis highlights the clearly inverse relationship between a property’s price and its future performance. As you scan across the chart from cheaper to more expensive homes, the returns experienced over the last decade decline.
The bad news for the affluent does not stop there. It would seem that luxury markets are also characterised by higher risk.
I divided RP Data-Rismark’s Australian capital cities index into three subsidiary benchmarks covering cheap suburbs, the middle market, and the most expensive suburbs. Looking at rolling annual returns on a monthly basis since the end of 2005, I found that while the cheapest regions displayed the lowest return volatility, the most expensive markets were subject to demonstrably greater risk.
And this applies during both good and bad times. Properties located in luxury suburbs earned double-digit returns in 2007 and 2009. Yet they suffered the steepest losses in 2008 and 2011.
If you want to make money in property, focus on the mass market.
Christopher Joye is an economist and director of Yellow Brick Road funds management and Rismark. He previously worked with Goldman Sachs and the Reserve Bank of Australia. This article appeared in the Australian Financial Review
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