The future of Australian property prices

[UBIQUITOUS]

I have done the calculations over the years....on a 300k loan using 7% interest expense, and capital growth for the houses of 10%...
it works out the home owner walks away with closer to 300k cash after 10 years, after deducting the interest cost....the renter has nothing to show for their rent costs of 158,000 assuming they paid the 3% as rent on the same costs.....

Kincella, I really believe that your 'logic' epitomizes why housing is unaffordable for the majority of people and so many property speculators have got themselves into trouble. You simply got lucky and rode the wave, but are now putting it down to insight with your 'calculations'.

You have managed to borrow money with a view that housing with provide capital growth of 10% pa. Now, if I went into the same bank, looking to borrow money for a business, and showed obviously incorrect figures which fly in the face of the truth, I am sure that I would be asked to come back with realistic expectations.

 

[MACCA350]

Here's a real long term example:
Property bought 90 years ago 3.6km from Melbourne CBD for 12k pounds(1963 Australia changed to Dollars at an exchange rate of 1pound=2dollars) so for simple sake we'll make the buy price $24k. Property sold in 2008 for $795k

That's a long term compound capital growth of about 3.97% pa
From Here(graph 4, source ABS) we see the 100 year(1900-2000) actual average inflation rate is 4.5% pa

So...........does that mean that the property is actually worth less than it was 90 years ago

One extra note, to keep up with inflation it should have sold for $1.26M compared to the $795k it actually sold for..........that's a minimum(not including costs) inflation adjusted $465k loss after 90 years!!

Not what I'd call a good investment

cheers

 

[bellenuit]

A short article in today's "Sunday Times" (Perth) stated that Australian property prices were overvalued by 50% according to The Economist, based on long term price to rent ratios.

I have found The Economist report here:

http://www.economist.com/businessfinance/displaystory.cfm?story_id=15179388

I can't find an online version of the Sunday Times story, but it went on to say that based on this finding a $620K house should just be $310K.

I would have thought that 50% overvalued would mean a $620K house should be fairly valued at $413.33K. Overvalued, means how much the price is over its value so the base used in the calculation is the real value. If that were $310K, then $620K is 100% overvalue.

That aside, how do others view The Economist assumptions that the long term price/rent ratio is fairly constant. I can't quantify it, but several stories over the past few years have mentioned that young people are staying at home much longer than before. I would guess that such people would most likely have been renters rather than buyers, so that trend would take pressure off rental prices, but not off property prices, accounting for some of the upward divergence in the ratio.

 

[Go Nuke]

ps dont tell me how unaffordable it will be for the kids, property at least keeps pace with inflation , well actually about 2% above....
and I don't notice everyone complaining about the price of food, petrol, electricity, health care and everything else considered a necessity in life, I guess they are happy with those weekly costs.....

What makes you think wages keeps up with inflation?

Hands up who got a payrise that reflected the CPI in the last couple of years?
Not me.

And if thats the case why are more kids living at home with parents longer and longer...I think it might have to do with the high price of rent/morgage repayments.
Because lets face it, your not earning a great deal as a student or apprentice. Even if you share accomodation I doubt there would be much money left over to spend.

 

[UBIQUITOUS]

In my opinion, the inevitable appreciation of the Yuan will pull the rug out from this 'miracle economy'. The house of cards will then collapse. Its only a matter of when. My call is 2011..

 

[Mofra]

One extra note, to keep up with inflation it should have sold for $1.26M compared to the $795k it actually sold for..........that's a minimum(not including costs) inflation adjusted $465k loss after 90 years!!

So property in Australia is chronically underpriced and prices should rise immediately?

 

[MACCA350]

So property in Australia is chronically underpriced and prices should rise immediately?

Either that or:
1, it was overpriced when it was bought 90 years ago
3, being new 90 years ago the price was about right, being old and only worth the land value now(even though it has been renovated and extended over the years) it's not really undervalued.
2, the 4.5% average inflation figure cannot be directly applied to house prices

If you've read any of my previous posts you'll note I don't believe house prices are undervalued. But looking at the example I presented it does make you wonder whether inflation has any real relation house values, and if it doesn't then how can it reflect the real increase in living costs.

It's interesting that none of the property spruikers in the thread have commented on it...........especially since it blows their 10% pa capital growth expectation, at least for the long term, out of the water:

cheers

 

[Mofra]

But looking at the example I presented it does make you wonder whether inflation has any real relation house values, and if it doesn't then how can it reflect the real increase in living costs.

Which measure of inflation? Property Prices in recent memory can lag behind AWOTE stats even during some "boom" times. Inflation's effect on RBA rates probably represent the bulk of impact inflation has anyway.

It's interesting that none of the property spruikers in the thread have commented on it...........especially since it blows their 10% pa capital growth expectation, at least for the long term, out of the water:

I think only 1 person has noted 10% - in any case, pacing with inflation would be a solid result for many property investors, taking into account the effect of inflation on the debt used to acquire the property itself. The after-tax returns on the contribution to the purchase (rather than the PP) would be a better measure, however such results are highly individualistic.

 

[kincella]

my theory has proven correct for me over 20 or more years....
so your concept did not change my mind..

apprentices and uni students are usually not fhb's....but more likely to live with their family ...rather then rent...except for the country students who need to go to the city for uni studies

the regular property bloggers have either left or are on holidays....
so this forum has been very quiet.....
not even robots posting of late

another way for you to look at the price rise scenario....is your dollar is devalued each year....so you need more dollars to buy the same thing
think I read somewhere, your 1930 dollar power now buys only 5%...it has devalued by 95%

 

[MACCA350]

Which measure of inflation? Property Prices in recent memory can lag behind AWOTE stats even during some "boom" times. Inflation's effect on RBA rates probably represent the bulk of impact inflation has anyway.

I thought inflation was the measure of the increase of the cost of living over time. In which case it would stand to reason that to compare something from 90 years ago to today's monitory value you would need to adjust for the increase in the cost of living(ie inflation) to achieve a true representation of the equivalent value.

I think only 1 person has noted 10%

You may be right, but it seems to be the number used by the media and almost every property investor and real estate agent from here to Timbuktu

in any case, pacing with inflation would be a solid result for many property investors, taking into account the effect of inflation on the debt used to acquire the property itself.

If inflation is a true representation of the increase in the cost of living then surely just keeping pace means there is no capital gains in real terms

The after-tax returns on the contribution to the purchase (rather than the PP) would be a better measure, however such results are highly individualistic.

Which would reflect the individuals investment return, once inflation adjusted. But my example was only with regard to the properties value itself.

I guess what this shows is that there is no capital gain on property over the long term in, and the only way an long term investor would make money on the deal is in the rental return.


If I take that approach using current rental returns for similar properties in the area lets see if that makes a difference.

Similar properties in the area range from $235-550pw rental so let's say $350pw(which is probably a tad high for the condition).
$350pw accumulated over 90 years taking into account inflation works out to a total of $415k..........which if you take off the $465k adjusted capital loss still works out to an adjusted $50k loss for an investor over 90 years...........and that doesn't include costs(ie rates, utilities, maintenance, estate agent fees, etc).

So what's the deal, I can't see a reason for property as a long term investment other than for a public service or to store some cash, unless you were able to purchase and rent it out with the proceeds and tax benefits being enough to cover the majority of the costs.

It would seem that if you had the cash to purchase an investment property in full you'd be much better off putting it in the stock marked than housing. If we take the DJIA as the comparison from 1920-2010 it went from 105-10600pt which is a compound interest increase of 5.26% pa which means that same $24k(12k pounds) would be worth $2.42M giving you an inflation adjusted profit of $1.16M with negligible costs over the 90 years.

cheers

 

[MACCA350]

my theory has proven correct for me over 20 or more years....
so your concept did not change my mind..

Are you referring to my example?
If so, it's not a concept, it's an actual property purchase and sale.

another way for you to look at the price rise scenario....is your dollar is devalued each year....so you need more dollars to buy the same thing
think I read somewhere, your 1930 dollar power now buys only 5%...it has devalued by 95%

Which is why I used the long term(100yr) inflation figure of 4.5%(you'll see from the link I gave is sourced from the RBA). Since this is an asset not cash, it does not devalue as cash does, surely we use inflation to ascertain it's current equivalent value.

cheers

 

[Mofra]

If inflation is a true representation of the increase in the cost of living then surely just keeping pace means there is no capital gains in real terms

Disagree - if the property is tracking inflation, the debt used to purchase the property is reducing in real terms due to the effect of inflation on the debt.

I guess what this shows is that there is no capital gain on property over the long term in, and the only way an long term investor would make money on the deal is in the rental return.

That would depend - if a $400k property is still worth $400k in real terms in 20 years' time, the debt would be $400k (assuming I/O payments) minus the effect of deflation on the debt over that time.

It would seem that if you had the cash to purchase an investment property in full you'd be much better off putting it in the stock marked than housing. If we take the DJIA as the comparison from 1920-2010 it went from 105-10600pt which is a compound interest increase of 5.26% pa which means that same $24k(12k pounds) would be worth $2.42M giving you an inflation adjusted profit of $1.16M with negligible costs over the 90 years.

I'd agree on a like for like basis, even before you take into account (using Australian examples) holding costs, imputation credits, peridoic vacancies, etc.

Housing really has a massive cheap credit advantage over other forms of investment which is why so many people still use it as a wealth creation platform.

 

[MACCA350]

Disagree - if the property is tracking inflation, the debt used to purchase the property is reducing in real terms due to the effect of inflation on the debt.

Yes, but the cost of the debt(ie interest rate, fees, mortgage insurance) over the repayment term would surely be higher than the rate of inflation, so wouldn't this make matters worse or at least moot?


Here's a 40 year graph:

I'd say the average would be around 8-10% for that 40 years. But to be fair you would need to look at a longer term average

cheers

 

[johnnyg]

I'd thought I'd share a current situation my friends in, guess its all relative to the thread.

A friend of mine is currently very close to buying her first home. She is looking at the lower end of the market which where we live is $150-200K range. 6 months ago (been attending a few open houses in this price range for the time period) you would go to any open house in this price range and there would be 20-30 people at each open house, pretty much going crazy, it was almost bizarre.

Fast forward 6 months and the property she is thinking about which is in the price range only attracted 5 people through on open house, a huge contrast to 6 months ago. She feels that the demand for these lower prices homes has significantly decreased, more then likely to the FHB grant being reduced.

The property she is interested in needs a reasonable amount of work, but this is not a problem as she has friends who can do 90% of the work.

She has a reasonable deposit saved, and will use this money to do the renovations if it comes off, plus leave almost a full years worth of repayments in savings should any unforeseen circumstances arrive.

After she has lived in it for a period of 6-12 months and the renovations are finished she will look at renting it out for an amount which should be reasonably close to covering the repayments. Best case scenario is that its positively geared, a bad case (being I.R's raise to 8% and the rent amount is lowered to a silly amount compared to what similar houses are being rented for) is that she has to find anywhere from $50-$150 per week.

She feels that the city she lives in has excellent growth potential, + the fact that she feels the house is cheap compared to alot of other houses on the market which helps make the decision.

Happy to hear thoughts/opinions and questions (if any?).

 

[SM Junkie]

Johnnyg, I would recommend that whilst your friend is renovating, that she considers what a tenant would need. I find most of my properties are at the higher end of rental in their areas because I put a bit more into them. This includes things like lock up garages, security alarms, reverse cycle airconditioners as an example. Tenants love security, so I find by adding these features the properties keep a good occupancy and I can get a bit more rental in return.

Providing her property is also in a good area with ease of access to public transport and facilities, she should do fine.

Wish her luck, it's great to see more women getting into property.

 

[UBIQUITOUS]

Johnnyg, I would recommend that whilst your friend is renovating, that she considers what a tenant would need. I find most of my properties are at the higher end of rental in their areas because I put a bit more into them. This includes things like lock up garages, security alarms, reverse cycle airconditioners as an example.

...and GAS COOKERS! Can anybody please explain to me why so many rental properties have old electric hotplate cookers? Surely people don't like cooking with electricity as a fuel source? I would have thought having gas cooking available is a worthy investment. Surely a rent hike of $10 per week to cover this 'luxury' wouldn't mean that the property would go untenanted?

Landlords must really be 'doing it tough'.

 

[cornnfedd]

when a 'life time home loan' becomes normally in Australia I will start to worry about the price of housing.... right now I am bullish on realestate simple because of a few different factors, population growth, economy etc

 

[moses]

Your friend sounds very conservative and appears to be taking a very low risk. So low that my caution alarm comes on and says "are the prices and the risks so low because the house is in an area/city that isn't worth anything and has no future?" If so, then the apparent low risk may be a high risk in fact.

So the answer to that would be to ensure she is doing a realistic assessment of the potential for capital growth.

 

[johnnyg]

Thanks for the replies so far, I'll be sure to pass them on.

Moses - Area is pretty good, is on a main drag ~ 2 kms to CBD. House is set nicely off the street and has ample off street parking. House in Double Brick, is in need of resto work however this is of no concern.

As for the town/city (pop ~ 25000) we have a number of major employers, along with retail majors buying up and developing large amounts of land in the CBD, also is situated in a growth corridor between 2 Capital cities. Hopefully there is a bright future ahead.

Regarding Capital Growth, if she can get the house for the price she is hoping too, and spend 20-30K getting it upto standard I feel she would have no trouble making 10-15% in 12 months, however this is not her thinking, its more so a long term investment, with a great opportunity for the house to go pretty close to paying for itself.

 

[Mofra]

Yes, but the cost of the debt(ie interest rate, fees, mortgage insurance) over the repayment term would surely be higher than the rate of inflation, so wouldn't this make matters worse or at least moot?

Only during the initial term of the loan - eg. 20 years ago Melbourne's median house price was $140k. A debt of $140k today, at rates of 8%, would equate to $933 pm which would either be easily affordable for the majority of wage earners or covered by current rental income.

Without this debt deflation, in most cases the numbers simply don't stack up for property as an investment class.