Interesting article from Philip Soos charting Australian residential property history. Such debates often become polarised between those who own property (“prices always trend up”) and those who don’t (“housing bust!”). Typically what follows is degeneration into cheap shots (cf. “landlords are parasites”, “Soos is a uni student”), but there’s plenty of that dirge on the internet already.
I’m a reasonably intelligent bloke and well aware that when the easing cycle reverses prices might fall, but I challenge whether the close to 70% who are property owners are necessarily the “greater fools” that they’re portrayed to be in Soos’ article and scores of appended comments.
Before delving further, I’ll clarify that I’m not simply suggesting placing an enormous leveraged bet on Australian residential property at today’s prices. A holistic financial plan should involve an element of averaging as the average investor is notoriously poor at market timing.
In my book I also discussed the importance of diversification and noted that a sensible portfolio should include a range of asset classes e.g. Australian property, UK property (close to London), an averaging strategy into UK index funds, holdings in Australian equities and cash. Diversification into non-correlated asset classes such as precious metals and art, may also be preferable.
Graphs from 1861…
As a historian specifically interested in industrial and economic history from this era, I take interest in charts detailing trends from 1861. However, let’s be frank, residential property trends of 1861 bear zero relevance to the modern era.
As compared to my native UK, Australia achieved high rates of home ownership in the 19thcentury. My adopted city of Sydney had home ownership rates reaching 28% in 1891 as compared to only 10% in the Britain of 1900. However, data from the era of the horses and cart era pre-dating WWII is not relevant.
As a Pom I was often presented with such charts in the 1990s past as irrefutable proof that property is wildly over-priced, but over a reasonable period of time homeowners and property investors remain way ahead of those in other asset classes (and in and around London prices simply continue to increase).
Of more relevance is the significant increase in household debt, particularly the gearing up in response to banking deregulation and the structural shift to lower interest rates.
Admittedly, when I first got into property, I hadn’t considered whether it is an ethical practice. It’s common to vilify owners of property as leeches, but we can’t have the milk and beef from the capitalism cow. If Australia continues populating at a frantic pace someone needs to own rentals or the system fails.
If you're taking aim at the cost of land/dwellings/renting, you’re picking the wrong target: the only route to change is through amendments to government policy, regulation and tax laws. Carping at landlords alters nothing.
It’s immature when faceless Tweeters dismiss Soos’ theories due to age (if you want to see what genuine student tripe looks like track down my analysis of Sheffield’s steel industry history/welfare state – utter dross). However, when it comes to finance and investment, there IS a key difference between theory and practice.
My suggestion for the long-term future of residential property has been that since interest rates fell from the nosebleed ~15% level, over an extended future time horizon prices are likely to some extent correlate to the growth in household incomes. Over the short term I’ve no more idea than Keen or anyone else what lies ahead.
Household incomes have flown along in Australia in the modern era, in part due to high inflation in recent decades and an increase in the number of two-income households. Absent a return to high inflation it’s likely that household income growth will be lower in the future, although it’s a fair bet that Australia’s moderately inflationary environment will prevail given that is the Reserve’s stated target.
Suppose you buy a home today for $300,000 and take on a mortgage of $240,000. If price growth does correspond to a growth in household incomes of, say, 4% per annum, what do you think that property might be worth over a working lifetime of 45 years?
I won’t type the number (it’s close to a sixfold increase) as I’d doubtless be certified as a raving loon. Run some numbers and you’ll note that due to compounding growth even if the estimation is wildly over-optimistic by a staggering percentage, the vast implied margin of safety determines that you still don’t lose out. More pertinently, you will OWN an unencumbered asset which you may choose to sell and downsize to assist in funding your retirement, or rent out at tomorrow’s doubtless exorbitant rental values.
An alternative to “buying now” is renting and investing in a diversified portfolio of ‘productive assets’. My suggestion in this case is to implement a prudent averaging strategy into a well-diversified LIC which invests in the industrials index with its superior dividend streams.
Two problems. Firstly, the spiralling cost of renting a decent property (if you believe that rents will become reasonable as the population booms you retain greater faith in political leadership than me). Secondly, in today’s world of overseas travel, credit card binges, impulse-buying and rampant consumerism, do Australians tend to diligently set aside a sizeable percentage of their income into a diversified portfolio of assets? Erm, no.
We might reasonably expect to live in retirement for 20-30 years. If you’re to remain financially secure through such a time horizon you require a material retirement lump sum or annuity, and, ideally an unencumbered dwelling.
Debate continues on the impending fortunes or otherwise of our economy. However, if you believe interminably in the ‘Mad Max’ scenario that capitalism fails and only farmland and guns retain value, then unless you’re a trained mafioso, you’re doomed regardless. In a variation on Pascal’s wager, the only rational investment approach is to believe that capitalism continues to re-invent itself and prevails. You need to own income-producing assets, be they equities, real estate, commodities or cash.
Now, suppose you'd taken the market-timing advice of the purveyors of doom since 2008, when Keen made his infamous “house prices will crash by 40%” prediction. Over the last half decade you'd have sold your house, watched the cost of renting increase horribly, and, following the more recent dreadful advice to short-sell the world’s fourth largest iron ore producer, sent yourself into a financial tailspin (if undertaking a leveraged CFD play, perhaps bankrupt). Worse still, property prices have tracked upwards.
Let’s be absolutely clear: if your financial plan involves owning nothing and then speculatively selling shares you don’t even own (into a raging bull market and without using a sell-stop order) in the vain hope of buying them back cheaper down the road – your destiny is likely to be drawing the Age Pension and adding to the Government’s pre-existing headaches. To build a sound financial future you need to own income-producing assets with a longer-term growth component.
Speculation: looking out
Are property owners "speculators"? It’s true that in the short term property ownership often involves holding cost (even with mortgage rates dropping to ~5.00%) . But over time rents tend to increase. Investment properties generate income as well as long-term compounding growth. As Ben Graham highlighted, the word 'speculation' comes from the Latin noun specula, a “look out”. So let’s “look out” at what’s on the horizon for Australia:Click to enlarge
ABS projections will not be accurate and nor do they profess to be, but the populations of Australia’s four major capital cities look likely to skyrocket. Again, we turn to policy: what are we doing to hold down the cost of land and new developments? Unless I'm missing something: nothing.
A major problem will unfold during Australia’s “Great Rebalancing”. It’s hoped that low interest rates and housing construction will plug the gap/hole/crater left by the phenomenal boom in mining investment, but who’s going to buy the new housing? If no-one, then who will construct it?
New developments are expensive and often inappropriately designed or located. Thus both homebuyers and investors clamour towards the “better value” established dwellings, particularly those located in comfortable, commutable proximity to the four major capitals.
Naturally, prices will continue to peak (cue high-fiving property owners) and trough (self-congratulatory squeals of delight from renters) cyclically and much depends on the success of the mining boom transition from construction to production, but will capital city prices collapse permanently to well below where they were before the financial crisis? With the prevailing levels of intervention, that seems unlikely. The housing affordability debate will never go away, of course - even if prices and interest rates fall it will continue as it does in every decade.
This will be dismissed as a spruik, but if you’re genuinely concerned about the price of Australian housing you need to pick the right target: the Australian government. The challenges facing leadership with regards to housing are vast but not insurmountable: improved transport links, increasing the supply of appropriate land and dwellings, reforming the tax laws. If you think our leaders are equal to the task…you have more faith in them than I do.
Pete Wargent holds a range of finance and property qualifications and is the author of Get a Financial Grip – a simple plan for financial freedom.