The founder of Platinum Asset Management, billionaire investor Kerr Neilson, has released an interesting report warning about Australia’s frothy house price valuations and the risks of a correction once “conditions change, [and] a lot of the assumptions are found wanting”.
The report highlights four “facts” about Australian housing:
1. Returns from housing investment are often exaggerated and flattered by inflation.
2. Holding costs of rates, local taxes and repairs are estimated to absorb about half of current rental yields.
3. Long-term values are determined by affordability (wages + interest rates).
4. To be optimistic about residential property prices rising in general much faster than inflation is a supreme act of faith.
It then goes on to examine each of these facts.
On returns, the report notes that “the rise in the price of an average home in Australia…[has] been about 7% a year since 1986. In dollar terms, the average existing house has risen in value by 6.3 times over the last 27 years. No wonder most people love the housing market!”
But rental returns have gotten progressively poor:
…we earn a starting yield of say 4% on a rented-out home or if you live in it, the equivalent to what you do not have to pay in rent. But again, looking at the Bureau of Statistics numbers, they calculate that your annual outgoings on a property are around 2%. This takes the shape of repairs and maintenance, rates and taxes, and other fees. This therefore reduces your rental return to 2%, and what if it is vacant from time to time?
And the prospect for future solid capital growth is low due to poor affordability:
…the last 20 or so years has been exceptional. Australian wages have grown pretty consistently at just under 3% a year since 1994 – that is an increase of about 1% a year in real terms.
Affordability is what sets house prices and this has two components: what you earn and the cost of the monthly mortgage payment (interest rates).
…even though interest rates have progressively dropped, interest payments today absorb 9% of the average income, having earlier been only 6% of disposable income.
Today, houses cost over four times the average household’s yearly disposable income. At the beginning of the 1990s, this ratio was only about three times household incomes. As the chart over shows, this looks like the peak.
Finally, the report argues that for Australian home prices to significantly outpace inflation over the next ten years, as they have in the past, “would require a remarkable set of circumstances”, namely a combination of:
1. Continuing low or lower interest rates.
2. Willingness to live with more debt.
3. Household income being bolstered by greater participation in the income earning workforce.
4. Average wages growing faster than the CPI.The last point is improbable seeing that wages and the CPI have a very stable relationship, while the other points are not very likely.
Reproduced with kind permission from Macrobusiness.
A really excellent summary. Strange how everyone knows another iceberg is ahead of us but no one is willing to change course. Perhaps it’s because we can’t.
Pretty obvious stuff. We all think war is a terrible thing for about 30 years and then repeat the same idiocy. Same with the property cycle. If you don’t remember the past you are condemned to repeat it. By the way it is a measure of our stupidity that we can’t see the inevitable coming. Proves we are not really superior to other animals.
Perhaps the problem is the “remembering” part. Thirty years is roughly a generation, so there’s no memory there for the next generation, only stories and history books from the previous one, which usually invoke an eye-rolling “yeah sure old fella, we’re smarter than you guys were” reaction. It’s the emotional memory not the factual one that steers us away from danger. Until you’ve been burned, the “danger hot” warning means little. I think that’s [partly] why we repeat and repeat and repeat.
This is exactly i used to think and other analyst would suggests so, but many times I have seen things just does not seem to work logically, who would have seen the recent price rise in Sydney and Melbourne two year ago, I bet no one, it took us by surprise.
You’re right, it was hard to predict prices rising this much, just ask Steven Keen. And it was also hard to predict the volume of foreign cash pouring into Oz real estate.
But what was and still is predictable is how the market will react to interest rate movements. Watch inflation and the resultant effect on rates.
This country is heading for a reality check, More employment is being lost than is created, mining is no longer the be all it was! It is becoming harder to compete in the open market due to labor costs, we are heading down the track to a third world country in the not to distant future!
If Australia does not focus more on economic growth and improving international competitiveness, we are likely to head down the same path as Greece.
Same as Greece……or Argentina
It’s hard to argue with this article. Regarding affordability Mr. Nielson says “Affordability is what sets house prices and this has two components: what you earn and the cost of the monthly mortgage payment (interest rates).”
However I would add another two factors into the mix.
1. Government Subsidies. The market reacted strongly when both Federal and State governments introduced first home buyer and new home building grants.
2. Greater Loan to Valuation Ratios. In the past we have had LVR’s of 85%, and at their peak LVR’s reached 95% and sometimes more. Presently they are around 95%. Imagine if LVR’s went back to 85% and first home buyers in particular were required to come up with an additional 10% deposit, $50k on a $500k purchase, before banks will lend them the remainder.
Four factors that have fueled rising Australian house prices in the last 10 years: