Aussie House Prices

Real Estate 101 – Lecture 1: Never use the "F" word

2011-11-18T21:00:00.002+11:00

Have you ever wondered what happens at training courses for people joining the real-estate industry? Well I can’t be 100% sure, but I reckon the first session would go something like this:

~ ~ ~ ~ ~ ~

Good afternoon and welcome to this first lecture on real estate. In today’s session we look at the golden rule of the industry: NEVER use the “F” word.

That’s right – you can wipe the “F” word from your vocabulary because you’ll never need it again. I assume you all know which “F” word I’m referring to? I’m not allowed to say it myself, but as a clue, it starts with “F” and rhymes with “mall”.

When used in relation to house prices, the “F” word gives people the idea that property is like any other asset class and that it can go up AND down. Of course, this must be avoided at all costs.

So what CAN you say to describe when house prices are, er, malling?

Well, you could try to get away with saying that house prices have “plateaued”, “flat-lined” or “stabilised”, or that “growth has slowed”.

If price drops are a bit more obvious, you might need to say that house prices have “moderated”, “eased a little” or “come off a bit”.

And if there have been large price reductions, simply turn it into a positive by saying that “affordability has improved” or “rental yields have increased”.

Regardless of which phrase you use, always follow up with “now is a great time for buyers”, or “for sellers” if you are talking to a vendor.

Well, that’s probably enough for the first lecture.

For your homework tonight, I’d like you to think of, and write down, three of the most important factors when it comes to choosing a property. And for those of you struggle with this task, and can only think of one factor, feel free to repeat it three times.

Definition of a bubble (part 3)

2011-09-12T17:14:00.004+10:00

In Definition of bubble (part 2), I ended with the question:

“So if higher prices leads to more demand, which feeds into higher prices, what’s to say this cycle can’t continue indefinitely?”

Well, the cycle of rising prices can, and did, continue longer than most of us (including myself) imagined. But for the housing market to keep rising beyond wages and rental growth, there needs to be ever-increasing debt and a never-ending stream of new buyers. Both of these have limits.

At some point, everyone who is going to get on-board the boom will have done so. And those who are buying multiple properties will, at some stage, reach their limit of risk.

And when these limits are reached, prices plateau. But after a boom, prices can’t plateau for long because when they do, the feedback loop starts to works in reverse. Here's how:

Fear
For speculators, greed turns to fear when prices stop rising. Investors who are getting a sub-5% rental return (a loss after expenses) are relying on capital growth to make the investment worthwhile. So when prices plateau, fewer investors are tempted to buy, and many start to sell.

During the boom, first-home buyers are driven by the fear of being priced out of the market if they delay. However, when prices flat-line or start to fall slightly, this pressure is taken off. Many will take the opportunity to save a larger deposit in order to reduce the interest bill and avoid paying Lender’s Mortgage Insurance. This reduces demand and has the effect of further reducing house prices.

Incorrect forecasts
While prices are going up, it’s very hard to imagine them ever falling. Then, when they flat-line, people assume they will remain flat for a while. But as I explained in Will property prices plateau, this expectation of flat prices is itself enough to reduce demand. As prices start falling in earnest, despair grows and people start to believe (again incorrectly) that house prices will never recover.

Falling equity
As the value of property goes down, people have less (or no) equity to borrow against in order to fund the purchase of a holiday home or an investment property.

Weaker economy
As home-owners’ equity is eroded, they feel poorer and the wealth effect starts to work in reverse. People spend less and focus their efforts on paying down debt in order to avoid going into negative equity – the uncomfortable situation where you owe the bank more than your house is worth.

Here in Australia, we can’t simply walk away from our mortgages, like they could in many US states. Property bulls often cite this as a reason why our prices will not crash. And I agree this might support house prices in initially. However, by definition, it means we will be stuck paying off our super-sized mortgages for years. As a result, the economy will suffer and jobs will be lost, resulting in forced sellers and more risk-adverse buyers.

Banks
During the boom, banks continually reduce their deposit requirements to ensure a steady stream of new buyers. However, when falling prices become more obvious, banks will need to increase their deposit requirements for fear of being unable to recover their money in case of default (mortgage insurance only covers them for a loss of up to 20%). As deposit requirements rise, the amount someone has available to bid on a house comes down – exponentially.

Other vested interests
Even real-estate agents contribute to falling prices while the bubble is bursting. For real-estate agents, a sale is more important that getting a good price. So, when buyers are scarce, real-estate agents subtly lower the expectations of their clients, encouraging them to “meet the market” if they want to make a sale.

Of course, the media also do their bit on the way down – this time selling papers with headlines of doom and gloom.

* * *

With falling auction clearance rates, rising stock on the market, record low growth of housing credit and flat or falling house prices, it seems as though Australia’s debt-fuelled binge has come to an end. If this is true, the process outlined above is just getting started.

Many other countries took their cue that the party was over during the GFC and started the process of deleveraging. Australians, however, kept partying into the early hours of the morning. But we won’t be exempt from the bursting of the biggest global asset bubble in history. We didn’t avoid the GFC; we delayed it. And the resulting hangover will be even worse as a result.

www.debtdeflation.com/blogs

As shown in the above chart, our property bubble dwarfs the America one. I predict the bursting of the bubble – falls of at least 40% over around 7–8 years – will be painful, especially for those who have based their decision to buy on the flawed assumption that house prices always go up.

Taxpayers will also be on the hook, funding bailouts of the institutions that are considered “too big to fail”. The crash will be accompanied by a deep recession as households focus on paying back debt for many years to come. Businesses will close and many people will lose their jobs.

But this is the unpleasant-tasting medicine that we must take in order to get our economy on a more sustainable footing, an economy where money and effort is directed towards production rather than speculation, and an economy that does not thrive on the ridiculous habit of paying each other more and more for the same thing and celebrating the fact.

Comments welcome.

Cheers,

Andy.

Definition of a bubble (part 2)

2011-07-20T12:38:00.004+10:00

In Definition of a bubble (part 1), I aimed to prove that high house prices during a bubble are not caused (or justified) by any of the ‘fundamental’ reasons claimed by spruikers.

The question then arose: if it wasn’t fundamentals, what did cause the over-valuation in Aussie house prices?

Going back to economics 101, you learn that when the price of something goes up, all other things being equal, the demand for it comes down. For example, when the price of petrol rises, public transport becomes a more attractive option. This reduces the demand for petrol, which puts downward pressure on price.

However, in a property bubble (or any bubble), something extraordinary happens. When the price goes up, demand also goes up, further increasing prices, and demand, and so on. It works in a seemingly never-ending feedback loop.

To put it another way, during a bubble, prices rise simply because … prices are rising!

But if demand falls when the price of petrol goes up, why does demand increase when the price of houses goes up?

These are the some of the factors that create the positive feedback loop, and therefore create the bubble:

Greed
As property prices rise, investors speculate on further rises. For speculators, it doesn’t matter if the rental return on their investment is less than they can get if their money was in a bank earning interest. It doesn’t even matter that, after expenses, there is a monthly loss.

It’s the Greater Fool theory: it doesn’t matter how much you pay for something, because you know a greater fool will pay an even higher amount when you are ready to sell. So rising prices encourage speculators into the market who bid up the price on properties, encouraging even more speculation.

Fear
While speculators are driven by greed during a bubble, first-home buyers are driven by the fear of being priced out of the market and missing out on home ownership forever.

During a bubble, first-home buyers notice that they are unable to save money as fast as house prices are rising, so they bring forward their decision to buy.

The fear of missing out also means many first-home buyers extend themselves and pay more than they would normally be willing to pay, further bidding up the price at auctions.

Incorrect forecasts
The emotions of fear and greed are compounded by people’s tendency to incorrectly forecast the future. Markets move in cycles; however, people have a tendency to forecast in straight lines. So while prices are going up, it’s very hard to imagine them ever falling.

This leads to irrational thinking like “property always goes up” and “house prices double every 7-10 years” which results in people feeling more comfortable about paying ever-increasing amounts for the same thing.

Rising equity
As the value of property goes up, investors and home owners can borrow against their rising equity to help buy a second property, then a third, and so on. This perpetuates the increased demand / rising prices cycle.

Strong economy
During a property bubble, the broader economy gets a huge boost as demand increases for construction, furniture and other property-related products and services.

Indirectly, the economy benefits because of the wealth effect. People feel richer (as the value of their houses goes up) and they then spend more on other things. This extra demand results in more employment, which enables more people to borrow to get into the property market.

Banks
Because wages cannot keep up with house prices, a property bubble must be fuelled by debt. Banks have played a major part in supporting and encouraging the bubble by constantly reducing deposit requirements.

Economist Steve Keen recently used this example: Say you walked into the bank thirty years ago with $30,000 saved. They required a 30% deposit, so they would lend you $70,000 and you would have a total of $100,000 to bid on a house.

These days, the deposit that banks demand can be as low as 3%. So, if you walk into the bank with the same $30,000 today, the bank will loan you $970,000 – and you’d have $1,000,000 to bid on a house!

Government
During a bubble, people who have already entered the property market will be buying and selling their homes in the same market, so sky-rocketing house prices don’t affect them too badly. But housing affordability becomes a major issue for potential first home owners, who haven’t as yet participated in the boom.

The government’s solution to this was to increase the first home owner’s grant. First home-owners took their $15,000 grant to the bank and, thanks to the power of leverage, used it to borrow an extra say $75,000, which went straight onto the sale price. The seller then took the extra $75,000 to the bank and was able to borrow an additional $300,000 for their next home, and so on.

The first home owner’s grant, therefore, dramatically pushed up prices throughout the housing-market ladder and ultimately harmed the very people it was supposed to help (as government tends to do so well).

Other vested interests
Of course, there are other entities with a vested interest in propping up property prices, not the least of which is the media, who are in a powerful position to do so. Newspapers make more money from advertising when the property market is booming, so it is in their interests to report a positive spin on the situation.

Also, headlines such as “White hot property market” and “See how much your suburb has risen” go a long way to selling more newspapers and further stoke the emotions of fear and greed for anyone sitting on the property sidelines.

So if higher prices leads to more demand, which feeds into higher prices, what’s to say this cycle can’t continue indefinitely?

I’ll attempt to answer that next time. In the meantime, do you agree with the above points? Can think of any other factors that have contributed to the bubble? Please comment below.

Cheers,
Andy.

The familiar path to financial crisis

2011-04-12T08:52:00.004+10:00

Critics have been vocal about the efforts by government to pump up the property bubble – including the doubling of the First Home Owner Grant, negative gearing and the halving of capital gains tax.

However, there's another measure that seems to have been overlooked.

In a statement on Friday, Treasurer Wayne Swan said:

"Today I announce that I have directed the Australian Office of Financial Management (AOFM) to invest a further $4 billion in high-quality, AAA-rated Australian residential mortgage-backed securities (RMBS) to help smaller lenders continue to offer competitive loans to families and small businesses."
Source: www.news.com.au

Sounds innocent enough. No one would criticise the government for helping families and small businesses, would they? This blogger would!

The government’s meddling in the property market is going to end in tears. And it will be tears of those families and small businesses (or at least their owners) that the government is supposedly trying to help.

Let me explain:

Banks are in the business of giving loans and collecting interest. Without going into the details of fractional-reserve banking, in order to make a loan, banks need to find money to loan out. Ideally, this would come from other people depositing their savings. But because saving is out of fashion, banks need to find the money from elsewhere. They could borrow it from another bank, but this is expensive because then the other bank can’t make as many loans of their own.

So this creates somewhat of a natural limit which prevents debt from growing too quickly. If people are not saving, lending is automatically constrained.

American banks weren’t happy when they came up against this restriction in the first half of the last decade. So they invented a product called collateralised debt obligations (CDOs). This complicated derivative involved bundling up existing home loans and on-selling them to institutional investors. The banks got cash up front. And the investors got the promise of on-going mortgage repayments from American home owners.

Because it was believed that house prices could never go down, and that Americans loved their homes so much that they would do whatever it took to continue paying off their mortgage, the rating agencies gave these bundles of goodness the highest possible credit rating, AAA.

The banks used the extra income from selling CDOs to make more loans, which they on-sold for more cash, and so on. Finally, they had found a way to make an almost endless number of loans.

More importantly, they were able to do so without risk – because this was transferred to the investors (who weren’t too worried because the CDOs were rated AAA because house prices can never fall and Americans love their homes). The result of this transfer of risk was that home loans were given to families that could never afford them.

Of course, house prices in America did eventually fall, home owners defaulted on their loans, the AAA-rated CDOs become worthless and the institutions that bought them filed for bankruptcy. Banks could no longer transfer the risk and so stopped lending to families, to small businesses and to each other. Credit ground to halt. The punch bowl had been taken away from the debt party that had been keeping the American economy going and the resulting hangover is what we call the GFC.

Fast forward to the present day and Aussie banks are now falling over themselves (and even breaking up with each other) to give out home loans. And, as happened in America, they can’t find enough money from depositors.

So they too have bundled existing mortgages in the hope of on-selling them. In Australia, these bundles are called residential mortgage-backed securities (RMBS) and are also rated AAA (because house prices cannot fall and Aussies also love their homes). Even so, Australian investors are not keen to buy them.

This is the market’s cue that we’ve reached out natural debt limit; that we in fact need to reduce debt in order to get the economy on a more stable footing. Or going back to the party analogy, it’s time to go home and sleep it off.

Enter the government who doesn't want the party to end on their watch. So they’re buying another $4 billion dollars’ worth of punch – or so-called high-quality, AAA-rated residential mortgage-backed securities … with tax-payers’ money.

The result:

Banks are able to continue lending without risk;
More first-home owners are encouraged to buy into one of the most inflated property markets in the world – with virtually no deposit – to keep the property Ponzi scheme going a little longer;
Over-indebted households and taxpayers are left to suffer the consequences when the bubble inevitably bursts.

We’re repeating the mistakes of America. The only difference is that in America, the taxpayer bailed out the banks after the crash, while in Australia, it’s happening in a futile attempt to prevent it.

Comments welcome.

Cheers,
Andy.

Click here to vote for the GetUp campaign to stop tax-payer funding of the housing bubble.

Definition of a bubble (part 1)

2011-03-29T21:16:00.003+11:00

The first step in defining a bubble is to identify that price rises are not driven by “fundamental” reasons.

Property bulls and spruikers claim that Aussie house prices are not in a bubble and are, therefore, not going to burst. They argue that high prices are justified due to fundamentals such as population growth, a “chronic” housing shortage, the mining boom, low unemployment, dual-household incomes etc. etc.

The problem with these arguments is that, if they were the factors that pushed up house prices, they should have also pushed up rents by an equivalent percentage.

As Adam Schwab over at Crikey explained:

“Given that renting is a reasonable substitute for owning a home, the cost of purchasing a property should reasonably resemble that of renting a dwelling. There are various reasons for disparities (for example, government interference in the housing market or lax bank lending standards) but overall, one would expect the cost of buying a property to roughly track rental costs over the long-term. For example, even if buying a property attaches a slight premium (due to tax and lifestyle advantages) in 1995, that premium should remain relatively constant over time.”
Source: http://www.crikey.com.au/2010/07/28/housing-shortage-no-its-a-debt-fuelled-bubble/

Earlier this month, The Economist explained it another way:

“In theory, the price of a home should reflect the value of the services it provides. People who choose to rent their homes buy those services on a monthly basis. Home prices should therefore reflect the rents that tenants pay.”

Yet house prices have dramatically escaped rents over the last 15 years. As The Economist went on to say:

“Our index calculates the ratio of prices to rents in 20 economies. Hong Kong’s price rises are the steepest in our index but it is not the most overvalued housing market. That honour remains with Australia, which is overvalued by about 56%.”

Source: http://www.economist.com/node/18285595?story_id=18285595&fsrc=rss

Interestingly, if house prices are overvalued by 56%, it is wrong to assume that they need to fall by 56% to get back to fair value. Due to a maths quirk, the percentage up is always larger than the percentage down. For example, if something goes up by 100%, it only needs to fall 50% to get back to where it’s started.

Therefore, The Economist’s estimate that house prices are 56% overvalued means that they would need to fall 35% to get back to fair value. Of course, markets have a habit of over reacting and therefore over correcting. Let’s say the market over corrects by 20%, it would need to fall 55% in total. However, if rents continue rising during the course of the crash, this would do some of the leg work in reducing the price-to-rent ratio. Taking all this into account, I am predicting an average 40% fall over a 7-8 year period.

But back to the point ... a quick look at the ratio of house prices to rents (when compared to Australia’s long-term average and to 19 other countries) confirms the first step in defining a bubble; that house-price rises were not driven by fundamentals. So if we can agree on this (which I’m guessing not all of us can) the question arises; what did cause the over valuation?

I’ll attempt to answer that next time.

Comments welcome.

Cheers,
Andy.

The median folly

2011-03-18T08:48:00.000+11:00

Hypothetical scenario: the newspapers report that median house prices rose 10% in your suburb last year.

As a property investor or home owner, do you celebrate the fact that you’re sitting on a 10% profit? As a renter, do you lament the fact that you’ve missed out?

Before you answer, the issue I’d like to address in this post is whether it is reasonable to assume that property investors and home owners in the above scenario are in fact (on average) sitting on a 10% profit. In other words, can we assume that a 10% increase in the median house price means a 10% average return?

Let’s work through a very simple example. We’ll put aside the issue of dodgy stats provided by vested interests, and assume that the stats are 100% accurate. OK, here goes:

There are three properties for sale in your suburb. This is what they sell for in Year 1:

Property A: $500,000

Property B: $635,000

Property C: $700,000

The median (which is the preferred measure) is the middle number in the list when placed in order. Therefore, the sale of Property B gives the suburb a median price in Year 1 of $635,000.

Now, for simplicity, let’s assume that the exact same three houses are sold again one year later. Let’s also assume that house prices remain flat over that year. Before selling, the owner of Property A knocked down his dump and re-built a brand new home. He spent $300,000 which, let’s assume for simplicity, added exactly $300,000 to the value of the property.

Therefore, in Year 2, the three houses sold for:

Property A: $800,000 ($500,000+$300,000)

Property B: $635,000

Property C: $700,000

If we were to re-order the above list, we’d find that the middle value is now Property C at $700,000. Therefore, the median house prices has “soared” from $635,000 to $700,000 – a 10% increase in just one year and everyone in that suburb thinks they’re now sitting on a gold mine. Of course, in actual fact, no one made a paper or real profit – all three property owners above actually broke even.

The point is that all the millions of dollars spend on renovating, maintaining and re-building property artificially inflates the index. In the above example, even if property prices had fallen slightly over that year, the index would still have shown a gain.

The same principal applies to an individual property. You often hear people saying “I bought a property 10 years ago for x amount and sold it for x (higher) amount”. Of course, that’s only half the story. Then again, it wouldn’t sound as impressive if they said “I bought a property for x amount, spend x on stamp duty and other costs, spent x on repairs and renovations, then sold it for x (slightly higher) amount.

Interestingly, the same issue doesn’t apply to share indices, which is an important point for those comparing the performance of house prices to shares. With shares, investors cannot tip extra money into a company and inflate its share price. When a company asks shareholders for more cash, they want something in return – more shares, which dilutes the value of existing shares, lowering the average price.

So next time you hear that house prices rose by a certain percentage, don’t assume that the increase in median sales price is the same thing as profit. There’s that pesky detail of expenses that should also be factored into the equation.

Although I suspect that property investors suddenly remember this fact come tax time.

Comments welcome.

Cheers,

Andy.

REIV capitulates

2011-03-11T13:31:00.001+11:00

This is the moment I’ve been waiting for. The biggest property spruiker in town, the Real Estate Institute of Victoria (REIV), has admitted that house prices are set to fall! No, they didn’t say there would be an “easing in prices”, or an “improvement in affordability”, or “slower growth”. Yesterday, they announced that:

“Members report positive expectations for market activity in the March quarter at the same time as a drop of 3–5 per cent in the median house price is expected.”

http://www.reiv.com.au/news/details.asp?NewsID=1049

What’s not clear is whether they are expecting a 3-5% fall over the quarter or over the entire year. It certainly sounds like the former. If so, and if that can be annualised, that’s a 12-20% fall over the year. They’ve become even more bearish than me!

Of course, they do regain their composure to finish with the obligatory spruik:

“The outcome of these factors is good buying conditions.”

Buyers – you’ve heard it from the REIV, start buying property – prices are about to crash!

Comments welcome.

Cheers,
Andy.

Can our leaders save the property market again?

2011-03-10T17:49:00.002+11:00

In my last post, "The crash has begun", I posed the question to myself:

"If the government and RBA managed to save us from a crash in 2008, what’s to say they can’t do it again?"

Well that question assumes that the government and RBA did save us from a house-price crash. I don't believe they did. So in fact it was a trick question ... to myself. But I didn't fall for it.

As previously mentioned, the “bull trap” and “return to normal” phase usually follows the first dip, so the only credit (blame) I give to the government is for amplifying the false rebound and delaying (not avoiding) the inevitable crash.

However, even if you believe that the government and RBA prevented the crash last time round, there are few reasons why it won’t work a second time:

Boost the First Home Owner Grant

The boost to the First Home Owner Grant encouraged a record 190,000 first-home owners to take the property plunge in 2009, before they otherwise would (or could) have. If those buyers were required to save a decent deposit themselves, their purchase may have been delayed by several years. So even if the government re-introduced the bribes, not nearly enough time has passed to accumulate enough new potential first-home owners to prop the market up again.

In addition, as I explained in "Will property prices plateau?" house prices cannot simply flat line after a boom. So to avoid a crash, prices need to keep rising. A one-off boost to the grant can only boost house prices by so much (specifically by the grant amount plus leverage). Therefore, if relying on government stimulus to achieve house price rises beyond this, the First Home Owner Grant would need to be continually increased.

Boosting the grant was always bad policy - it encouraged the most financially vulnerable section of the community to enter the property market at the top of the biggest asset boom in Australia's history. Even the government would be clever enough to realise they cannot continue to increase the amount of handouts indefinitely.

Slash interest rates

The RBA could slash official interest rates again in an attempt to encourage people to borrow. Granted people have short memories, but they are not that short. Many will remember that not too long after interest rates were slashed, that they were pushed up again (plus a few bonus increases from the banks). Therefore, people will be acutely aware of the risk that any cuts could be short-lived.

However, even if rates were to stay low, as we’ve seen in America and Japan, nearly 0% official interest rates does little to draw buyers out of the woodwork while prices are plummeting.

Turn sentiment around

Markets are driven by sentiment. Last time the Government and RBA acted, they did so pre-emptively – thanks to the GFC. They "stimulated" us before any real downturn in sentiment had even kicked in. But it is rare for such an obvious warning bell to be given. And so when sentiment turns south during the upcoming “fear” and “capitulation” phases, by the time our government realises it, just like all governments around the world, they will be powerless to stop it.

The realisation that it is not different here, and that house prices do not always go up, will be a shock to many Australians. Potential home owners will have to re-evaluate the assumptions that go into the rent vs. buy decision. Negatively geared investors will re-evaluate the logic behind buying a loss-making investment. When greed turns to fear, no amount of government bribes, stimulus payments or offers of cheap and easy money will be able to convince people to board the Titanic.

Comments welcome.

Cheers,
Andy.

The crash has begun!

2011-03-03T12:45:00.002+11:00

It’s official - the crash has begun!

Let me explain using the following chart. It was developed by Jean-Paul Rodrigue, Ph.D. who studied 500 years of bubbles and found that they all look remarkably similar.

In 2007, as the 15-year Mania Phase of Australia’s property bubble came to an end, we hit the “New Paradigm”!!! (as shown above). This was categorised by claims that ridiculously high house prices were justified due to a supposed housing shortage and the not-so-easy-to-disprove argument that “it’s different here”.

Many people think that the subsequent slump in house prices in 2008 - the Bull trap - was due to the GFC. I say it was going to happen anyway. Interest rates were steadily climbing in order to slow Australia’s record run of economic growth. This was starting to hurt home owners and negatively geared investors in the Greed and Delusion phases. Even though mortgage rates were “only” 9%, people were paying as much interest (as a percentage of their household income) as when interest rates were 17% in 1990 - because the amount of debt was so much greater this time.

However, the GFC did have an effect, and that was to exaggerate the Return to “normal” upswing. In contrast to the theoretical bubble shown above, it pushed house prices even higher than the “New Paradigm”!!! peak. Of course, this was thanks to the government’s first-home-owner bribes and the RBA’s drastic interest rate cuts.

People then thought (and many still think) that the house-price falls during the GFC were the end of it; that we had avoided the dramatic crash that had occurred in the USA, and that prices would resume their march upwards at a rate faster than inflation, rental returns and wages - as they had done for the previous 15 years.

But now the cracks have appeared once again. Over the last few months, sellers have been slowly coming out of the woodwork and buyers are biding their time. As a result, auction clearance rates have plummeted and prices have once again started falling. According to RP Data, there has been no capital growth since May 2010 and capital city values fell 1.6 per cent (seasonally adjusted) in January.

But that’s just the start. Next up, we have Fear, Capitulation and Despair. The Blow off Phase will be slow and steady, but brutal – wiping out all the gains of the last 15 years and not just returning to the long-term trend, but falling below it.

You may then ask: if the government and RBA managed to save us from a crash in 2008, what’s to say they can’t do it again? I’ll attempt to answer that next time.

Comments welcome.

Cheers,
Andy.

Never-ending capital growth

2011-02-21T21:42:00.008+11:00

In my recent post, "Rent money is dead money", I highlighted that fact that there is lot more dead money when owning a house in comparison to renting. In the ‘Comments’ section, some people acknowledged this extra cost, but argued that house-price growth would more than offset this.

Anonymous, for example, said:

“Either way, a gap of $17,000 or $7,200 is a far cry from the appreciating gains a $500,000 property on average will give you. You do the maths!”

and…

“If you want a good cost analysis of rent vs. buy, check out http://www.yourmortgage.com.au/calculators/rent_vs_buy/
Even in as little as a 7 year period, you will have a higher net wealth buy investing/buying a property compared to putting those savings into the bank.”

So I plugged some figures into the calculator and sure enough after just 7 years, I’d be better off owning, even after buying at these inflated prices.

Suspecting that a site called ‘Your Mortgage’ might be biased towards buying, I massaged the figures and still couldn’t find a scenario where renting was better. Getting desperate, I entered $0 as the rent amount. The result: “You need to buy a house now!!” – or wording to that effect. So even if I could get free accommodation for the rest of my life, apparently I’d still be better off paying for it!

Just as I was about to delete my internet browsing history so that my better half would never find this calculator to use against me, I scrolled down to the “assumptions” area. And sure enough, they make the same mistake that Anonymous made, and that is to assume that house prices always go up – and not just at the rate of inflation (as occurs over the long term) but at a rate higher than both inflation and wages. The website says:

“The appreciation rate on residential property is assumed to be 8%.”

You’ll often hear a similar claim from property spruikers – that house prices double every 10 years (which works out to 7.2% growth per year). And over the last couple of decades, this has been true.

But is it reasonable to assume that this will continue indefinitely?

Well, let’s see what would happen to affordability if house prices continue to rise by 7.2% per year, while wages continue to rise by their long-term average of 5%. Here’s a spread sheet I whipped up.

You can see in the first row that the average wage is currently $60,000, and the average house price is $500,000. This means that you’ll need to work for 8 years in the average job to pay for an average house (up from the long-term average of 3 years). Of course, after first paying income tax on your salary and then adding all other costs associated with home ownership (and living), it would be about 3 times longer than that. But let’s keep this example simple.

Now let’s fast forward 100 years (the next highlighted row). You can see that the average wage has grown to $4.8 million, while the average house price is $512 million – 106 times the average wage of the time. We will need some major medical advances to allow our great grandchildren to live long enough to pay back their home loan!

Fast forward another 100 years, and if house prices continue to outstrip wages growth by just 2.2% per year, the average wage will be $484 million, while the average house price will be $524 billion – or 1,363 times the average wage!

Of course that's ridiculous - but continual growth along the lines of the last 20 years is exactly what property spruikers are predicting and what the YourMortgage calculator is assuming.

Over the long term, house prices cannot rise faster than inflation and wages. True, they have over the last 20 years – resulting in house prices increasing to 8 times the average wage. But as the above example indicates, to assume that gap will continue to grow indefinitely when calculating whether it’s better to rent or buy is simply ludicrous.

Comments welcome.

Cheers,
Andy.

There's no bubble after all

2011-02-19T17:38:00.002+11:00

Sorry everyone, I was mistaken. There's actually no house-price bubble:

"Buyers have been told that Melbourne is not suffering from a house-price bubble. Property valuer Greville Pabst, of WBP Residential Advice, said that although property prices were higher than 10 years ago, these prices had become the new norm."
http://www.heraldsun.com.au/news/victoria/telling-weekend-for-property-market/story-e6frf7kx-1226008425010

Greville doesn't actually provide any reasons why high prices are here to stay, but he's in the real-estate industry so he must know.

Sorry about that. I will shut down this blog straight away.

Comments welcome.

Cheers,
Andy.

Confident property investors rush the exits

2011-02-17T09:18:00.002+11:00

In his weekly property ~~spruik~~ summary, Enzo Raimondo from the REIV said:

“The next three weekends will see significantly more auctions with 695 next weekend followed by 980 and 910 in the following two weekends. The high number of listings shows that sellers have a reasonable degree of confidence in their prospects, reflecting the overall health of the national and state economy.”
http://reiv.com.au/home/inside.asp?ID=162&nav1=1226&nav2=162

You’ve got to admire Enzo’s glass-half-full attitude. I probably would have written the second sentence to read:

“The high number of listings shows that greed it slowly turning to fear, reflecting property investors’ realisation that the biggest asset bubble in Australia’s history has started to burst”.

Comments welcome.

Cheers,
Andy.

"Rent money is dead money"

2011-02-11T17:30:00.002+11:00

It’s been drummed into us by the real-estate industry, by the media and by family and friends. It’s the catchphrase ‘Rent money is dead money’, meaning that if you’re renting, you’re wasting your money.

Interestingly, you rarely get advised that you’re wasting your money buying food from the supermarket, or by going to the movies for a night out. But when it comes to providing shelter for yourself or your family, you’re apparently throwing your money down the drain.

Of course, the implication is that if you were to buy a place of your own instead, there would be no wasted money. I have to disagree.

In Melbourne, for example, renting will currently cost you about 3 per cent of the property value per year. It’s true this is dead money. But if you keep in mind that home-loan rates are currently around 8 per cent per year, and that this money goes straight to the bank, this is also dead money.

To put it another way, if you want to live in particular house, you can either borrow the money for that house at 8 per cent (interest) or you can borrow the house itself at 3 per cent (rent). So for a house that’s worth say $500,000, with a 20% deposit, interest would cost $32,000 in year one, whereas rent would be $15,000.

To be fair, if you are renting, rents would likely rise with inflation, while if you owned the property, interest would fall as the mortgage is repaid – so there would come a point where rent would be more expensive than interest charges.

However, interest is not the end of the dead-money trail when it comes to owning your home. You’ll also have to fork out more dead money for:
- stamp duty
- conveyancing and legal fees
- valuation fees
- loan application fees
- search and building inspection costs

as well as for ongoing costs such as:
- council rates
- strata fees
- insurance
- repairs and maintenance

At this point in the conversation, the well-meaning friend, relative or real-estate agent will usually come back with “But at least you’ll own something after 25 years. If you rent, you’ll have nothing.”

Well it’s true you’ll have a house – but this is after paying for it - via principal repayments, on top of the 8 per cent interest and on top of the other extra costs listed above. If you choose to rent, you could put the saving in costs and the lack of principal repayments towards anything you choose – so that after a lot fewer than 25 years, you could have bought investments, a yacht, even a mortgage-free house if you so choose.

Once you realise it will cost you a lot more to own a house than it would to rent the same house (at least in today’s market), you can decide whether that extra cost is worth it to you. But don’t let the misleading line ‘rent money is dead money’ sway you.

Comments welcome.

Cheers,
Andy.

It’s different here

2011-02-05T13:13:00.003+11:00

If I had a dollar for every time someone said to me: “It’s different here; we didn’t have the dodgy lending practices that they had in America”, I reckon I would have a good $12 by now.

So what do you consider to be a conservative requirement for a deposit for a potential home owner? 10 per cent? 20 per cent?

Well, just last year, we had lenders who were asking for no deposit – not one cent – and on top of that, they handed out an extra 5 per cent spending money to fill the new house with furniture!!

“Next month, non-bank lender Mortgage House will offer a home loan equivalent to 105 per cent of the property's value - the most generous deal since the global financial crisis kicked in three years ago. The company also offers a 99 per cent loan-to-value ratio loan, which it launched last month, and says applications have been flooding in.”
http://www.dailytelegraph.com.au/property/lenders-throwing-cash-at-buyers/story-fn3006z3-1225918973988

While house prices are rising, this kind of reckless lending goes largely unnoticed. If the homeowner can no longer pay the mortgage, they simply sell their house for a profit and pay back their loan – everyone’s happy.

It’s when house prices start going down, and homeowners owe more than they own, that we’ll discover it’s not different here after all.

Comments and queries welcome.

Cheers,
Andy.

Australia vs. America

2011-01-30T20:53:00.005+11:00

I thought it might be fun to see what around $1 million gets you in Albert Park (Australia) vs. Atlanta (USA).

The results are pretty interesting.

Note, for each link, it might be easier to right click and select ‘Open in New Tab’.

Albert Park - click here
Atlanta - click here

OK, that's the top end. Now, let’s go to the budget end to see what $30,000 - $50,000 can buy in New York State vs. Victoria.

I couldn’t pick just one of the over 400 family homes available in Buffalo NY in that price range, so check out this list of properties yourself - click here.

As to what you can get in Victoria, click here.

Because house prices have been so high in Australia for so long, we start to see them as “normal” and assume they are here to stay. Now, I know you can’t draw too conclusions by comparing two completely different cities. But this comparison might at least make us question whether our house prices are in fact normal.

What do you think? Are Australian house prices justified? Please comment below.

Cheers,

Andy.

Will property prices plateau?

2011-01-28T22:41:00.001+11:00

In 2010, the media was reporting that house prices will keep rising indefinitely due to population growth and the supposed housing shortage. More recently, they have been saying that there will still be growth, but it will slower. Well it looks like they’ve changed their tune again. No, they are not yet brave enough to predict falls. Here’s what they said:

The Age reported that:

“Australia's home prices are expected to remain flat this year” and that “house prices will plateau this year, at just over $550,000 on average”.
http://www.theage.com.au/business/house-prices-to-flatline-this-year-anz-20110124-1a28u.html

The Australian took it one (albeit tiny) step further:

“National house price expectations have now turned negative, with falls of 0.5 per cent over the next 12 months likely.”
http://www.theaustralian.com.au/business/property/house-price-expectations-turn-negative/story-e6frg9gx-1225994177425

Hahaha, did they put their decimal point in the wrong spot? Half of one percent? I would hardly call that a fall – it sounds more like a plateau to me.

But regardless, here’s the problem with their findings – house prices cannot simply plateau. Look at any chart (shares, economic growth, mixed lolly prices) and you won’t see a horizontal line in sight – markets are either going up or they are going down. That’s just how they work. It’s due to the human conditions of fear and greed.

But here’s the interesting part; it’s this belief that prices have now flat lined, that will cause them to fall. Here’s why:

Potential home buyers will now feel less pressure to buy (witnessed by my better half’s reaction to the above articles - that maybe we could hold off for another year). This causes demand to drop.

For property investors, rental returns are well below what you can make in the relative safety of a bank. Therefore, most investors are not buying for income. In fact, after costs, the majority of Australian landlords are making a loss. But they haven’t minded – firstly because the tax man gave them a nice tax deduction and secondly because the value of their property has been increasing faster than they could lose money. (Anyone see something strange about a loss-making investment continually going up in value?) But now, with predictions of no capital growth, many potential investors would be turned off the idea of negatively gearing into property, which would further reduce demand.

And those investors already in the market, who were relying on capital growth and now realise they will not get it, will become skittish and sell. There won’t be a stampede for the exits, like you might get in the stock market. However, there will be slow jog for the exits as sentiment turns and people start to realise that Australia is not different and that our house prices do not always go up.

Finally, we’ve got the property flippers – these are the people who buy a knock-down job, knock it down and re-build with the hope of selling for a profit. This is fairly easy to do during a boom. But it becomes a much more difficult task when prices stop rising. Again, this will reduce demand. But also, as flipping activity reduces, suddenly all of those vacant blocks that were being built on will become available, increasing supply.

Lower demand and higher supply will trigger prices falls, which will in turn cause even lower demand and higher supply, and so on.

They say there is no warning bell to signal when sentiment turns and the bubble bursts. But I’d say the above headlines claiming that house prices have flat lined is as close as you’ll get.

Comments and queries welcome.

Cheers,
Andy

Keep the champagne on ice

2011-01-24T03:56:00.003+11:00

Right, that’s it! I’ve had it up to here* with both Enzo Raimondo and the Herald Sun (*blogger’s note - I’m pointing to my forehead).

Let’s start with Enzo Raimondo. He’s the CEO of the Real Estate Institute of Victoria, whose “institute” relies on the voluntary reporting of sales results from real-estate agents. Anyone see the credibility problem there?

Anyway, Enzo says house prices in Melbourne rose 7% in the last 3 months. What?? Anyone watching the market knows that is crap and that the market flat lined, if not fell slightly, in the second half of 2010.

But whether you believe Enzo’s stats or not, my other problem is the media’s reporting of high house prices as a good thing. The Herald Sun announced yesterday that:

"Melbourne home owners can pour the champagne - the median house price has smashed the $600,000 barrier for the first time."

http://www.heraldsun.com.au/news/victoria/melbourne-house-prices-through-the-roof/story-e6frf7kx-1225992595269

This euphoria about rising house prices is either misguided or a sinister attempt to keep the bubble going a bit longer (an effective attempt, if my better half’s reaction - that we need to buy NOW - is anything to go by).

I mean, how often do you read the headline:

"Melbourne drivers pop the champagne corks – petrol prices rise 20%" or

"Melbourne shoppers rejoice – grocery prices through the roof!"

How is paying each other ever-increasing amounts for shelter a good thing? Well, let’s have a look at how it affects different groups:

Potential First Home Owners - Even the media understands that high house prices are not good for people trying to enter the market. Although, property spruikers, with their love of metaphors, use this to claim that you’d better get on the ‘merry-go-round’ and start climbing the ‘property ladder’ before you ‘miss the boat’.

Existing Home Owners - I don’t understand why this group is supposedly popping the champagne corks. Sure they might feel richer but this wealth is illusionary. What is real is that when they come to upgrade, their rising house prices will just make this harder.

For example, say you buy your first home today for $500,000 and have your eye on your dream home which is currently $1,000,000. If prices rise 20%, you’ll sell your first home for $600,000 and buy your dream home for $1,200,000. Therefore, you’ll need to find (or borrow) an extra $600,000.

However, if prices had fallen by 20%, you’d sell your first home for $400,000 (a loss) but your new home would now cost $800,000, not $1,200,000. So you’d only need to find (or borrow) $400,000 – and have $200,000 extra to spend on other necessities … such as mixed lollies and chocolates.

Property Speculators - Along with the media, banks and real-estate industry, property speculators, are the big winners when house prices rise. Of course, if house prices unexpectedly fall, property investors who are negatively geared and relying on capital gains could find themselves in trouble.

The Economy - People feel richer as their house price rise, encouraging them to spend more and go further into debt. However, when the party eventually ends, people will feel the need to pay down their debt as quickly as possible, in order to avoid going into negative equity. While this is a smart move, it will have a damaging impact on the economy.

I predict a house price crash in Australian will cause a painful recession – but this is the unpleasant-tasting medicine we must take in order to get the economy on a more sustainable footing, rather than one reliant on ever-increasing debt.

To conclude, when house prices go up, home owners should not be celebrating. The economy should not be celebrating. We might feel richer but we are actually poorer. The longer we pump up this housing bubble, the more painful the inevitable burst will be.

Comments and queries welcome.

Cheers,
Andy.