Housing boom: where the shortage myth is relevant
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The residential property boom, which resembles more of a Ponzi scheme each week, reached new heights last year as panicked buyers swamped the market. Most of the fear was generated by real estate insiders who benefit from property transactions, with buyers stimulated by government stimulus and cliché (“property always goes up”). With real yields (after council rates, maintenance, body-corporate costs and most importantly, depreciation) in many capital cities about 2%, something has to give. That is, either (1) prices need to fall; or (2) rentals need to rise for yields to return to “normal” levels. Property returns (be it for investors or owner occupiers, who are theoretically able to invest their money elsewhere) like any asset, should return a premium to the “risk-free” rate. Those returns are a function of rental yield and capital growth. Yield is easy to calculate, being the rental return less all costs (cash costs and depreciation). Capital growth is largely dependant on inflation or economic growth. In most instances, the rate of capital growth should resemble inflation, but in some cases, it may be higher (for instance, if an area becomes more popular due to better amenities). With current “real” yields in capital cities sitting at 2-3%, and inflation of approximately 1%, capital city property is in many cases, providing a net return of less than 5%. At the moment, variable mortgage rates exceed 6% so investing in property doesn’t even meet its cost of the capital. This is where the shortage myth is relevant. While many property buyers are unsophisticated and do not use much of their own money to purchase a house (property purchasers are among the highest leveraged investments most people would ever make) they are not completely stupid. No one would purchase an investment that returns less than it currently costs unless they believed that the income received (from rentals or capital gains) would increase in the future. Property investors appear to believe (largely spurred by the real estate industry and the largely unsophisticated media) that rental costs will increase substantially (possibly caused by the mythical housing shortage). It is understood that the shortage will lead to higher rental yields and stronger returns and later, capital growth. The problem with that theory is that demand and supply factors are working to counteract the shortage. On the supply side, when prices increase, that provides motivation (in the form of higher profits) for developers to construct more dwellings. As Robert Shiller noted: “One fact is often forgotten: the construction industry is capable of building vast numbers of homes, including high-rise units, at far below the cost of homes in many urban areas today.” A looming shortage also compels the government to release more land and possibly ease zoning restrictions. The Financial Review reported last week that “the total number of dwelling approvals rose by 5.9% in November [2010] to 13,724 units, pushing total building approvals up by 33% over the year.” The long-term average for dwelling approvals is slightly more than 13,000 per month (approvals dropped below 10,000 earlier this year as prices slumped). The solution to high prices is funnily enough, high prices. An increase in supply will reduce rental yields and dampen capital growth. Demand factors are also working against rental yields. The Age reported that “temporary skilled workers migrating to Australia have halved since this time a year ago, after more stringent workplace laws came into force”. Reduced skilled migration softens demand for rentals, further decreasing yields. When combined with historically low unemployment, the belief that rental yields will increase substantially appears to be based on scant evidence. Last year, with immigration at record high levels and building slumping, the market was not far off equilibrium. As the employment and immigration ease and supply returns to historical levels the alleged housing shortage should disappear. As Shiller noted: “We used to think homes were in the same category as cars: depreciating assets that grew obsolete, were costly to maintain, went out of style, eventually to be replaced. Now we think of them as claims on increasingly scarce resources with prices potentially sky-rocketing soon.” The original theory — of property as a depreciating asset is correct. Houses don’t last forever. Similarly, no asset (even land) increases in price indefinitely. Eventually, market forces (like increased developer profits and reduced migration) will dampen yields, often forcing an overreaction on the downside as the price of the asset returns to its intrinsic value. The days of endless capital growth in housing must come to an end. If rental yields don’t increase substantially, the current level of housing is unsustainable. |
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12 Comments
So I guess the questions are, what level is yields are acceptable? What does this mean for average rent over what amount of time?
Is the residential housing market sensitive to shocks that might cause a price fall and what are they, and how likely are they?
Looking at the circle of interest around property prices who are all interested in prices going up - the government for tax, banks for interest, general home owning public for higher value assets I can’t see how this can change.
You forgot about negative gearing when determining the yield. You can depreciate the purchase price over 40 years giving you a tax deduction of around $10,000 a year. You also forget that for investment housing, the interest portion of the mortgage repayment is also tax deductable. This brings the yields of investment property a lot higher than the 5% quoted.
As for property prices increasing indefinitely, the market will decide this. You rail against the public for their stupidity in taking on debt to buy property, but I don’t believe that most people (or the banks) are stupid. While there might be a few nutters out there, the vast majority of people only buy what they can afford. That is why default rates are so small in Australia.
@Scott - Not to mention that there is no such thing as a non recourse loan in Australia - the banks will keep people in their homes for as long as they can, and people will pay their mortgages come hell or high water or they will be hounded into bankruptcy.
These property is evil columns are really starting to get old. I have been reading the same story from Adam Schwab for over a year now and we’re still waiting. The Australian property market is expensive, yes, but it has never been easy to buy a house. We have seen so many people earning ridiculous - I mean, getting-paid-$60K-to-push-a-broom-at-the-mines-ridiculous - incomes they have invested into property, not only that, but there is a pressure cooker boiling away: The baby boomers are just about to start retiring.
Not only that, but I think there have been a whole bunch of boomers who put off retirement due to the GFC and their super sinking like a lead balloon who have seen the market come back over the last year. They will start considering that their fund is back to a reasonable level, maybe not as good as it was, but not bad - as well as the fact they have worked for another 2 or 3 years more than they wanted to, and WHOOSH. I think we will see an exodus on the workforce over the next 18 months.
This will bring wage push inflation back. Vacancies will rise, people will get promoted and earn more. They leave positions that need to be filled, and so on. Salaries start to rise due to the skills shortage which will again cripple the economy, and, in turn, this is going to see people ready to take on a mortgage with their new $$$.
(For those who can’t see it - the magical HOUSE PRICE TO HOUSEHOLD INCOME RATIO will fall).
Which again will see house prices rise.
Just my opinion but hey, take it for what it’s worth.
Keep at it Adam…the stark negative reality of property investment in Oz will one day be realised.
If the Internet was around in Feb 1637, ABARKER would have been posting comments informing the likes of Mr Schwabb that that Tulip market was only going to keep going up and that Schwabb simply did not understand the realities of the Tulip marketplace.
The brilliance of Scott’s post is basing his argument on the belief that people are not stupid.
As Einstein once said: “Two things are infinite. The universe and human stupidity, and I’m not sure about the universe”.
I hope both of you are heavily investing in the property industry and that you are leveraged to the tip of your nose on this sure fire bet to stupendous wealth
(((That is why default rates are so small in Australia.))))
Define a default rate…the true default rate is really only one rang up the ladder from severe mortgage stress, and we have only just begun the cycle of interest rate rises. By June this year there will be a few smiles wiped off a few faces as they tippy-toe through the Tulips
As mentioned, the banks are parading their new found practise of being more tolerant with struggling mortgagees and propping them up for as long as possible. ….this is a feel good PR facade and it won’t last.
@Orin - No, see Tulips are nice to look at but not a basic need, like housing. Everyone needs a roof over their head and we simply don’t have enough of them.
I do not believe property is a better investment over say shares, or managed funds, nor do I believe that it is a worse investment. All have their positives and negatives. What annoys me is the continual harping of people who scream blue murder that the sky is falling. They flood forums and boards on this site and others screaming that everything is terrible and everything is going to hell in a handbasket, when most of these people are
a) jaded because they missed the boat, and are therefore cheerleading for a collapse so they can get that dream home at a bargain price, or
b) too bloody lazy or stupid to work hard, educate themselves and get a higher paying job, save, sacrifice and go without to get into the market.
There are websites dedicated to this - http://globalhousepricecrash.com.au/
If these people got off their behinds and spent the time they use sitting on the net snickering over how all those greedy landlords will lose the shirts off their backs, to go out and work harder and earn a bit more, they’d have a house by now.
I don’t believe we will see a major boom in house prices for some time, but nor do I believe we are going to see them collapse. There are too many votes at stake, there is too much wealth at stake, and therefore it will not happen - the banks and government won’t let it.
This continual bleating of the housing market is overpriced, it will fall down in a big way has been done to death, and time and time again it has been proven wrong. I believe my comment around the baby boomers is pretty close to accurate. We will see wage increases in the coming years as the workforce declines. We will see people use this additional earnings power to get into the market.
We are not America or the UK. We are totally different with different laws and markets and that’s how we have survived the GFC. As for the banks turfing homeowners out on their ear, that won’t happen either because it will cause a huge scandal and political problem.
As for your comment about hoping I am heavily invested up to my ears (obviously so I will meet my inevitable doom), well, that just shows the jaded point of view from those who are bears. And for the record, yes, I own a home and an investment property with my wife, and both have a mortgage. Shall we have this conversation again in say 10 years?
@ABARKER
*******(a) jaded because they missed the boat, and are therefore cheerleading for a collapse so they can get that dream home at a bargain price.*******
If this were true, and I don’t believe it is…would it be any worse than those who buy property purely for the purpose of speculation and hoping to make a killing at the expense of future generations?
******b) too bloody lazy or stupid to work hard, educate themselves and get a higher paying job, save, sacrifice and go without to get into the market.*******
Oh puleeeaaase!!!….now you are just being plain silly.
I don’t think anyone in their right mind wants to see the property market collapse, but there a lot of “intelligent” people who believe the Australian Property Market has been artificially sustained and primed by Govt intervention, reckless banking policy, corrupt realestate industry practises and anything but natural market forces of supply and demand.
The Watchmen on the wall say it can’t last….and I say they be right.
@ Gary Johnson - ‘natural forces of supply and demand’. Oh, please. ‘Natural’ forces. There is nothing ‘natural’ in economics, that’s like believing in the tooth fairy. Economic distortion is everywhere you look. Start with the fact that there is no CGT on owner occupied homes. Will there ever be such a tax? Not whilever there is democratic government in Australia, I reckon. So if you accept that as an example of the property market being ‘artificially sustained and primed’ etc (and I say it’s the biggest example) then expecting such ‘artificial’ influences to stop acting in a major way on the property market is like, well, believing in the tooth fairy.
@GaryJ - I don’t see what’s so silly about wanting better things in your life. There are so many people out there who want to whinge and complain about their lot in life, without really wanting to do anything about it (ie work towards fixing it).
There is nothing silly about the statement I made - if you want something, you need to work out how you get it. For those who want to be able to afford a home, it’s either earn more, or spend less. There’s nothing magical about it. Either apply for a better job, that may take some study, or, look for a promotion. Cut back on things you dont need, and save the excess. Either you choose to do these things, or you don’t.
If there’s something I have said that sounds ‘silly’, please point it out, because I’m not seeing it.
And as a closing note, land owners have always controlled the wealth, but these days, anyone can be a land owner. There is no ‘expense’ of future generations, because in today’s world it has never been more egalitarian to create wealth. Anyone can access information, education and capital. Anyone. It has never been easier to get educated, or access knowledge than it is at this point in history.
Go back to feudal times where there were dukes and serfs, and look how different it is today. Sure the numbers are a lot bigger, but it is a lot easier to get a slice of the pie. You keep talking on these boards like home ownership is a universal right, well I’m sorry, but it’s not - it’s one people work hard for. For those who are least likely to be able to get access to a loan to buy a home, well, truth be told, they probably shouldn’t be given it - Sub Prime anyone?
@AB
Knowledge is good AB..if it becomes wisdom. Education is good too, if there are opportunities to be exploited that were created by that education. Hard-work is also good, but working smart is better.
In my year 10 class at High-School, a very low class in learning standards…the next class down was the intellectually challenged so you it was very low on the ladder. Six of the worst learners in my class went on to run very successful businesses and in material terms are very wealthy people.
So it certainly was n’t education that got them there. Hard- working?..maybe, but I would say they were smart workers.
A lot of those in the higher classes and much better achievers academically went on to become alchoholics, drug addicts and employed in menial positions they loathe.
So from my experience in life, …it is “silly” to place so much emphasis on education for “edjakaishens” sake.
If I had my way, Australia would become a nation of shop-keepers…entrepeneurs who are self sustaining and independent..ie..self employed instead of relying on big business and govt to save them….commerce and business should be mandatory from a very young age and you would be amazed what could come of this.
And yes, I do believe it is a universal right that people are entitled to a roof over their head without the debt-slavery of a mortgage…but it does n’t have to be a sub-prime thing. As I mention to you ages ago, too much money is tied up in mortgaes in the first place that should be invested in job and real wealth creation…not the false economy of the Australian Housing Market.
It’s good to hear about the guys who worked hard and went on to do well. And yes, some high acheivers do realise after school that the real world isn’t so accommodating. But they are the exception, not the rule. Besides, access to finance, the banking system, contract and legal frameworks and yes, dare I say it, even maybe the equity in their home helped them get there - nobody is a self made millionaire - everything people do now has evolved from hundreds of years of legal and financial evolution.
In most cases however, education will lead to a higher standard of living and a higher degree of satisfaction and happiness. I’m not saying people need to go to Uni to be rich - when I say education, I mean pick up a book - read a website - get more people’s point of view, or find out what they did. It’s not so secular like it used to be. The rich people’s stories are in books now. They are generally approachable. Not like back in the day when the banker rolled around in his chauffeur driven ghost back into his gated community while the paupers lived outside in slums.
As for your view of little Australia, that’s ridiculous. Not everyone wants to be an entrepreneur. Some people like the fact they can have a 9 to 5 job with an employer and feel secure that way. Not everyone has sales skills, merchandising or the necessary book keeping or financial savvy to run a business. Some people don’t want it. To suggest we bin big business and return to the agrarian subsistence style of living, that’s what’s silly. Besides, who says one of these little guys won’t buy the guy down the road, and the one next door, and suddenly up springs a big business? Should we put rules in place on that? It’s called Communism.
And yes, having a roof over your head is a right - owning the roof however is not. That is a privilege and, before that, a choice. Debt slavery? Debt is a tool. Like fire. Used responsibly it can be a very powerful thing. Yes there is plenty of money tied up in mortgages but that means banks are bigger, real estate agencies can hire more people, more work for property services such as conveyancing, property management, maintenance people etc. Would you recommend we wind all that back and put them all out of work?
If nothing else it provides stability. I know I can’t go riot in the streets about the injustice in our world, because I have to get up to go to work to pay my mortgage.