In somewhat a quixotic state of affairs, the Weekend Financial Review reported that one of the reasons for the continued strength in property prices is due to the “Bernie Madoff syndrome”. The so-called syndrome involves risk-averse investors avoiding the vagaries of equity markets in favour of bricks-and-mortar investments, such as property. Well, that is according to one of Australia’s leading real estate agents, who, of course, has no vested interest in the matter whatsoever.

BRW rich list member (the White family is believed to be worth $470 million) Brian White told the Weekend AFR that “for so many investors, it’s [a case of] I can go and touch the walls. I can kick the letterbox. This is mine. I haven’t really invested in someone who I don’t know … I reckon Bernie Madoff had an impact on real estate all around the world”.

The only problem is the Madoff effect appears somewhat fallacious — even less believable than the oft-quoted “shortfall” excuse (which is contradicted by actual statistics, not that anyone has actually bothered to check). For one, the Madoff effect refers to investors when it has largely been owner-occupiers (spurred by the first home owner’s grant and its flow-on effects) who were largely responsible for Australia’s 11% median price growth in 2009.

Then, there is the fact that the Madoff effect would presumably be most pronounced in the US, where the vast majority of Madoff’s “victims” resided. However, the US has experienced continued property price weakness in 2009, with the Case-Shiller index indicating prices fell by 5.3% last year (and continued their fall in October and November), this compared with a 16% increase in the Dow Jones benchmark.

The Australian property market has remained resilient — although this is not because of any fictitious Madoff effect or even the apparent shortage (which has barely resulted in rental growth) — but due to Australia’s continued love affair with debt.

If anything, property appears to show more resemblance to a Ponzi scheme than the share market (it isn’t a real Ponzi scheme, of course — property does have underlying earnings, they are just not especially high). Based on median rental data calculated by APM and a median price of $460,000 according to RP Data, that gives a ‘gross’ yield of 4.5 percent.

However, there is the often forgotten fact that bricks and mortar has a down side — that is, the very nature of something you can feel also means that it depreciates (a financial term for fall apart or break down). Anyone who owns a home or residential property will be all too aware of the constant maintenance (and possibly body corporate) costs that eventuate — from structural repairs to electrical to unusual events or built-in appliances, the costs of owning property are not insignificant. These costs are conveniently ignored when real estate agents talk of “gross yields” — an utterly irrelevant and largely misleading concept.

Like any investment — its real value is determined by the present value of cash flows from that asset — in the case of property, those flows are reduced by maintenance, council rates, insurance and for rental property, management fees. Factoring those costs in, the average “real” yield for residential property in Australia (based on medians) would be closer to 3%.

Factoring in an annual increase based on the income growth (or inflation, whichever is greater) and property prices should appreciate (on average) by about 6% annually. The ABS, however, has found that since 2002 prices have risen by 90%. This coincides with household debt doubling from 9% to 19% and increasing as a proportion of housing assets rose from 11% to 29% since 1992.

While agents put price rises down to shortages and New York Ponzi schemes, the more likely reason is that Australians pay too much for property using too much debt.

Peter Fray

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