25 July 2017

Property market mid-year sanity check

| Arek Drozda
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Opinions about the Australian property market, served every day so generously in the media, are rather difficult to reconcile with the reality. Even the experts cannot make any sense of property prices continuing to rise stubbornly to new heights “despite all odds”. Everyone wonders when it will end and how badly…

In this three-part series I would like to share a few of my favourite statistical indications that help explain, surprisingly accurately, what is happening in the Australian property market. There will be references specifically to the ACT as well, but first, let’s deal with some facts to put what follows into proper context.

One of the main causes of confusion about the property market is that the media loves chasing extreme views and celebrity commentators (who mostly either have a hidden agenda to push or are charmingly opinionated but blissfully uninformed on the subject).

In depth analysis of issues is a tedious task. It takes a lot of effort to conduct these thoroughly so it is much easier to reach for the “ready-made opinions”. Therefore, what propagates are essentially self-perpetuating myths.

As a result, you hear every year in May that “we have reached the peak” and that the end is nigh. Or that Australia has a “housing affordability crisis” (a situation that is strangely persisting for a second decade in a row now – but don’t let this fact spoil a good headline).

Or that “prices are not sustainable since there is ‘no growth’ in wages” – but let’s conveniently disregard the fact that even 2% annual growth in average wages allows borrowing an extra $20-25,000 each year with very little or no negative impact on family finances. After a few years the capacity to borrow can grow to quite a number!

Then there are claims that prices “will fall soon and by at least 40%”. It is only explained in the fine print that this ‘may happen’ sometime in the next decade or so.

Not to mention continuous blaming of foreigners and property investors for “paying over the odds for properties” and in the process “mindlessly blowing the property bubble”. However, there is a total disregard for the elephant in the room – that is, the effects low interest rates and cash loaded upgraders have on the market.

In this environment it is very rare that a balanced opinion filters through to a wider audience. Not for lack of trying though – no major media outlet, independent or commercial, is prepared to touch “this stuff”. It is simply considered too controversial for their audiences. The truth is that it is better for media business to serve what the public likes to hear, and not what properly explains the reality.

I, for example, went on record in early 2014 sharing the results of my analysis on property prices in Australia and market outlook for the following decade but it did not generate any interest from the mainstream media. Not even as a counter argument to otherwise one-sided ‘debates’ on the property related issues. What happened to journalistic creed of presenting objectively all sides of the story?

Yet, three and a half years later, my mid-range growth scenario is proving quite accurate while the then media-favoured property market doom scenario failed to materialise – mind you, doom sold so well at the time…

There was a real, tangible value in that analysis so, from time to time, I revisit bits and pieces of the original information for the public good. This is another such occasion.

When you review the updated charts and commentary, I only ask that you consider it all in the context of real events that took place in Australia in the last 30+ years, and not “how improbable” it all sounds at present and comparing it to current popular opinions.

Let’s begin with a quick recap of the main concepts underpinning the analysis:

  • The key to understanding what is happening in the property market in Australia is to recognise that the price of a property is only a secondary consideration in the purchase decision. Yes, you read it correctly! The most relevant consideration for the purchase decision is the annual cost associated with buying a property (comprising of mortgage payments, council and water rates, maintenance costs, etc.), and how this cost compares to the cost of renting, as an alternative accommodation option. This is simply because hardly anybody buys for cash these days and the overwhelming majority of buyers rely on credit to make a purchase.
  • Therefore, growth in property prices over time reflects relative change in personal incomes, buying costs and renting cost, and all three tend to increase in the same proportions over time. Periodic imbalances between the three indicators point to the likely short term direction of the property prices.
  • Indicators like house prices to income ratio, or house prices to rental costs ratio, are totally useless measures for assessing housing affordability and predicting short term movement in property prices. This is simply because these ratios have been rising continuously for the last 70 years, reflecting structural changes in the market and not a ‘deviation from the norm’, as many mistakenly interpret them. Anybody who quotes these ratios in support of affordability or price bubble arguments has zero understanding of the underlying issues, no matter how many titles they write before and after their name. An alternative affordability indicator, reflecting the cost of buying, is the appropriate measure to use for meaningful conclusions.
  • Since the majority of property transactions involve borrowing money, monitoring flows and level of credit gives timely insight into the market conditions and likely medium to long term price movement.

The following charts provide an updated perspective on where things are at in June 2017 (please note, the results for the second quarter of 2017 are only estimates and can change).

Long term view - property prices Australia

Long term view – property prices Australia.


Long term view - property prices Canberra

Long term view – property prices Canberra.

In a nutshell, market dynamics have not changed dramatically in three and a half years since my original analysis, so the anticipated outcome under the most probable mid-range growth scenario is still valid.

In particular, property prices in Australia increased just over 30% in that time (so, at a slightly faster pace than a mid-range growth scenario anticipating 60% increase in property prices over a decade). Since growth in incomes is over and above the rises in the cost of buying and the cost of renting, there is still plenty of room for further property price increases.

Please note, 1986 is as far back as the official house price statistics go but also happens to be a period almost unanimously accepted as the time when “things were cheap and balanced”. Hence, it can be appropriately used as a reference point.

All in all, working Australians can afford current property prices. In fact, we can afford to pay on average 28.5% more and still be under the historical affordability threshold.

Price growth potential Australia

Price growth potential Australia.

As it turns out, affordability is what really drives property prices in Australia, not exuberant property investors or cashed up foreigners. But you will never have inferred that following only populist opinions.

The potential for price growth in Canberra is even more substantial since local price rises have been subdued in comparison to the national averages.

Price growth potential Canberra

Price growth potential Canberra.

Concluding, the charts above demonstrate the capacity for property prices to increase much, much further – if it happens, it would be to the total astonishment of the masses and a loud outcry of commentators professing the property price bubble in Australia.

Next week we will examine if there is still a fertile environment for prices to continue growing and if there are any visible clouds on the horizon that may suppress that growth.

Does this information change your perception on what is happening in the Australian property market or are you still sceptical as to its merit? Would your decision whether to buy or rent property in the last three to four years be different if you had this information on hand in the past?

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devils_advocate4:25 pm 08 Aug 17

dungfungus said :

chewy14 said :

dungfungus said :

Here is the latest about the state of the real estate market in Australia from Bloomberg:

tps://www.bloomberg.com/news/articles/2017-08-03/australia-slams-brake-on-property-investors-and-price-boom-cools

Encouraging news for some, disastrous for others. I am thankful that at last a financial journalist has pin pointed where the “investor” problem is, in this case a 29 year old Australian resident who has 6 investment properties. Note that he is not an evil, property hoarding baby-boomer.

Yes, it’s clearly those rich, young investors snapping up multiple properties and not the vast majority of investment properties that are owned by baby boomers and the huge tax incentives that go with them that are the problem…..

Most baby-boomers are now retired so if they did have negatively geared property it won’t be anymore.
Being a bay-boomer myself very few of my baby-boomer peers have large holdings of rental properties that I am aware of. Quite a few have property they have inherited however and there are no tax advantages that go with that.
Conversely, most of the young people I know are into negative gearing. Personally, I would like to see negative gearing, for all types of investments, totally abolished with no grandfathering.

Your proposal would actually help existing property investors and speculators. “Abolishing negative gearing” essentially means imposing quarantining of income – so no deduction of rental losses against wage income. OK. BUT, you can still deduct losses against profits in that same income stream.

For example, having bought before the boom in 2000, I have some properties that are “positively geared” and a few that are, at least on paper, “negatively geared” taking into account depreciation losses. But given the amount of profit generated on the portfolio as a whole, I would still be free to take on loss-making (in the short term) property investments because I would be able to deduct the losses against the profits from the older properties.

So this would entrench my current advantage over potential new investors, as well as any potential so-called ‘rent-vestors’ looking to get a start in the market by buying where they can afford, as opposed to where they want to live.

devils_advocate4:19 pm 08 Aug 17

gazket said :

do you really really think that new properties are not sold to foreign buyers ? What is stopping an Australian Chineese buying a new property then selling it on the market in China . They keep it in their name here as part of the contract.

I’m sure there are many other ways to do it as well.

New properties ARE sold to foreign buyers. That is the whole point of the policy. Rather than encouraging speculation in existing houses (which does not increase supply) they are restricted to new homes, driving the construction market, local employment and providing the critical mass for large-scale development. As for conspiracy theories about Australian residents holding properties in their own name, the FATA does have general anti-avoidance provisions as well as specific provision which trace through to beneficial ownership, so if people want to take on the risk of getting found out and subject to penalties and potential fines/criminal sanctions – as happened in the circa 2015-16 crackdown- well good luck to them.

chewy14 said :

dungfungus said :

Here is the latest about the state of the real estate market in Australia from Bloomberg:

tps://www.bloomberg.com/news/articles/2017-08-03/australia-slams-brake-on-property-investors-and-price-boom-cools

Encouraging news for some, disastrous for others. I am thankful that at last a financial journalist has pin pointed where the “investor” problem is, in this case a 29 year old Australian resident who has 6 investment properties. Note that he is not an evil, property hoarding baby-boomer.

Yes, it’s clearly those rich, young investors snapping up multiple properties and not the vast majority of investment properties that are owned by baby boomers and the huge tax incentives that go with them that are the problem…..

Most baby-boomers are now retired so if they did have negatively geared property it won’t be anymore.
Being a bay-boomer myself very few of my baby-boomer peers have large holdings of rental properties that I am aware of. Quite a few have property they have inherited however and there are no tax advantages that go with that.
Conversely, most of the young people I know are into negative gearing. Personally, I would like to see negative gearing, for all types of investments, totally abolished with no grandfathering.

gazket said :

do you really really think that new properties are not sold to foreign buyers ? What is stopping an Australian Chineese buying a new property then selling it on the market in China . They keep it in their name here as part of the contract.

I’m sure there are many other ways to do it as well.

There is no doubt this is happening in Melbourne but I am not aware of it being widespread in Canberra.
The big problem in Canberra is the way people, mostly from a certain employment sector, speculate by buying units off the plan with their risk capped at 5% of the purchase price which is usually the deposit. Some have already walked away from completing contracts as unit prices have fallen more than 5% in the last 12 months so they have no equity to realise on through a re-sale. Agents are quietly re-selling these properties with qualifications like “original purchaser unable to complete the purchase due to transfer….etc.”

As they say, it’s always a good time to buy real estate but it’s turning into a buyers’ market in Canberra.

do you really really think that new properties are not sold to foreign buyers ? What is stopping an Australian Chineese buying a new property then selling it on the market in China . They keep it in their name here as part of the contract.

I’m sure there are many other ways to do it as well.

dungfungus said :

Here is the latest about the state of the real estate market in Australia from Bloomberg:

tps://www.bloomberg.com/news/articles/2017-08-03/australia-slams-brake-on-property-investors-and-price-boom-cools

Encouraging news for some, disastrous for others. I am thankful that at last a financial journalist has pin pointed where the “investor” problem is, in this case a 29 year old Australian resident who has 6 investment properties. Note that he is not an evil, property hoarding baby-boomer.

Yes, it’s clearly those rich, young investors snapping up multiple properties and not the vast majority of investment properties that are owned by baby boomers and the huge tax incentives that go with them that are the problem…..

Here is the latest about the state of the real estate market in Australia from Bloomberg:

tps://www.bloomberg.com/news/articles/2017-08-03/australia-slams-brake-on-property-investors-and-price-boom-cools

Encouraging news for some, disastrous for others. I am thankful that at last a financial journalist has pin pointed where the “investor” problem is, in this case a 29 year old Australian resident who has 6 investment properties. Note that he is not an evil, property hoarding baby-boomer.

devils_advocate10:58 am 07 Aug 17

gazket said :

continually let foreigners buy houses the market always has new buyers and prices will continually rise. In the long run we will all suffer for it .

No, foreign investors are only allowed to purchase new houses. Many ‘off-the-plan’ apartments sales are only financial viable for the developer with substantial pre-sales to foreign investors, so in a real way they are adding to the supply of homes. In recent years the government has been more diligent in securing compliance with the prohibition on foreign investors purchasing established homes. So foreign investors are helping the affordability issue by supporting the supply of new homes.

continually let foreigners buy houses the market always has new buyers and prices will continually rise. In the long run we will all suffer for it .

I see the French Macaron is increasing tax on foreign property owners in Paris because a lot of places are sitting empty. Our pollies will follow Europe like lambs to slaughter .

I am glad to hear Maya123 that you have found it of interest.

True, 18 -18.5% interest rates lasted no more than 10 months, however interest rates of 15% plus started in May-86 and lasted to Sep-87 (18 months) and then again from Dec-88 to Dec-90 (25 months). So more than 3.5 years. According to RBA data, standard mortgage interest rates stayed above 10% between Jul-80 to Apr-93 (13 years in total). So my point is still valid – it is relatively easier now to manage the debt than it used to be but feel free to argue the opposite.

(By the way, I have just noticed I incorrectly referred to 10 years in my previous reply, it should be ”after 5 years”; over 10 years paid off principal would be 26.3% and 8.6% respectively.)

Arek Drozda said :

That is correct in general, however when interest rates are low, most of the monthly mortgage payment goes towards repaying the principal. At 15-18% p.a. as they used to be, the principal repayment is much smaller in the initial years.

To illustrate, if P&I loan is at 5% p.a. over 25 years, you would repay 12% of the principal after 10 years but only 3% if interest rate was 15% p.a. The devil is always in the details.

Interest rates of around 18% only lasted a short time in the 1980’s so your example is not valid.

That is correct in general, however when interest rates are low, most of the monthly mortgage payment goes towards repaying the principal. At 15-18% p.a. as they used to be, the principal repayment is much smaller in the initial years.

To illustrate, if P&I loan is at 5% p.a. over 25 years, you would repay 12% of the principal after 10 years but only 3% if interest rate was 15% p.a. The devil is always in the details.

Arek Drozda said :

Thanks for your comment. True, “20% deposit” was a smaller proportion of income in the past BUT it doesn’t mean it was easier to save that amount and/or to do it over a shorter period of time. Long story short, saving for a deposit does not happen in a vacuum:
– renting takes smaller proportion of income now, so you are able to save proportionally more of your income as well;
– in the past the capacity to save was smaller simply because rent was bigger proportionally to incomes;

In the past, once you bought the house, a significant proportion of your income went on servicing the mortgage, not leaving much for the repayment of the principal. There was no interest only loans, no offset or all-in-one accounts and interest was calculated only once a month, not daily. Nowadays, if you can maintain a comparative financial burden as in the past, you would be better off by a substantial margin and pay off your mortgage quicker as well.

I will be writing more on housing affordability soon, meantime I hope this old story will give you more context to what I write about: http://www.propertyobserver.com.au/forward-planning/investment-strategy/65-first-home-buyers/29615-crisis-of-confidence-or-crisis-of-affordability.html

” a significant proportion of your income went on servicing the mortgage, not leaving much for the repayment of the principal. “

I think you have got that wrong as the mortgage loan included principal and interest divided into equal monthly repayments so the principal was being paid down commensurately with the interest over the full term of the mortgage.

Thanks for adding extra context. I don’t see things so dramatically. Property ownership has been more beneficial over the long term than renting (I will return to this topic in future articles, meantime just a reference to an old piece http://www.propertyobserver.com.au/finding/residential-investment/28721-should-residential-property-be-treated-as-an-investment.html). Historically, it beats any other form of investment so, plenty of reasons why many people are prepared to wear higher costs (mind you, also interest rates recently increased and nobody seems to object to banks rising out of cycle, how interesting). Another reality of life is that hardly anybody starts on top salary in their first job. So, people tend to earn more over time as they progress through their careers. Therefore, what looks like a mountain of debt turns into a molehill in 10-15 years time… hence easy to conquer in the end.

Arek Drozda said :

Thanks for your comment. True, “20% deposit” was a smaller proportion of income in the past BUT it doesn’t mean it was easier to save that amount and/or to do it over a shorter period of time. Long story short, saving for a deposit does not happen in a vacuum:
– renting takes smaller proportion of income now, so you are able to save proportionally more of your income as well;
– in the past the capacity to save was smaller simply because rent was bigger proportionally to incomes;

In the past, once you bought the house, a significant proportion of your income went on servicing the mortgage, not leaving much for the repayment of the principal. There was no interest only loans, no offset or all-in-one accounts and interest was calculated only once a month, not daily. Nowadays, if you can maintain a comparative financial burden as in the past, you would be better off by a substantial margin and pay off your mortgage quicker as well.

I will be writing more on housing affordability soon, meantime I hope this old story will give you more context to what I write about: http://www.propertyobserver.com.au/forward-planning/investment-strategy/65-first-home-buyers/29615-crisis-of-confidence-or-crisis-of-affordability.html

Forty years ago the maximum term for a home loan (P&I) was 20 years – sometimes 25 if the deposit was higher than the regulated minimum.
These days 30 years is the usual which is necessary to “shoehorn” the purchasers into a repayment schedule they can service.

Most in this category would be better off if they rented for the rest of their lives.

Thanks for your comment. True, “20% deposit” was a smaller proportion of income in the past BUT it doesn’t mean it was easier to save that amount and/or to do it over a shorter period of time. Long story short, saving for a deposit does not happen in a vacuum:
– renting takes smaller proportion of income now, so you are able to save proportionally more of your income as well;
– in the past the capacity to save was smaller simply because rent was bigger proportionally to incomes;

In the past, once you bought the house, a significant proportion of your income went on servicing the mortgage, not leaving much for the repayment of the principal. There was no interest only loans, no offset or all-in-one accounts and interest was calculated only once a month, not daily. Nowadays, if you can maintain a comparative financial burden as in the past, you would be better off by a substantial margin and pay off your mortgage quicker as well.

I will be writing more on housing affordability soon, meantime I hope this old story will give you more context to what I write about: http://www.propertyobserver.com.au/forward-planning/investment-strategy/65-first-home-buyers/29615-crisis-of-confidence-or-crisis-of-affordability.html

Those graphs and this way of looking at the data, i.e. repayment affordability, certainly does make a lot of sense.
I disagree on the conclusion that there isn’t an affordability problem though. Add a couple more data series to the graphs like “number of lifetimes required to pay off mortgage” and “number of lifetimes to save a deposit” and the affordability problem will be clear!

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