Hello,
the myth busting post seems to have turned decidedly nasty, so I’m scared to raise this question in there[blush2] My friends and I have been discussing this lately, during our afternoon coffee breaks. I would like forum input, so please rebuke [biggrin]I posit, that there is no fundamental reason for an indefinite appreciation trend above inflation.
That is I propose that long term property should only return inflation + rent. E.g. 4% + 5%. Ouch I’m going to be hurting now, I know it. Before you jump in, please know that, yes I own property. I want an objective discussion, don’t shoot me down for not being a “true believer”, etc.
Here are the main thoughts from which I have derived my conclusion:
- If property appreciates long term above wage growth (as our measure of inflation, for simplicity sake), then fewer people will purchase and the percentage of renters will increase.
- Rent cannot appreciate long term (indinitely)above wage growth or noone could afford to live in the area. High rents are an economic handicap that would bring demand down and return balance to the system (e.g. the exodus from Silicon Valley if you know some US demographics).
- If you will accept that rent is fixed to inflation (wage growth) over a long enough horizon, then a long term trend in RE appreciation would be a long term trend to lower returns. If you take the “… doubles every 10 years example” that is roughly 7% appreciation per year, which is 3% above the long term average inflation. A 3% real (inflation adjusted) increase in prices, with a 0% real increase in rent would mean that in 50 years returns will be ~1/4.4 of what they are now. The average Australian rental return I’ve read is 3.1%. Now given these assumptions in 50 years residential real estate will return 0.7%! Who would buy this? Noone, it makes no sense. Yes the numbers can be argued, but only to the effect of protracting the time frames.
- There are other assets, the stock market is currently returning 5.2% (franking adjusted), which already puts it above the 3.1%, let alone the 0.7%. I’m not saying put your money in there, what I am saying is, if the returns on realestate hit 0.7% people WOULD put their money in their. This would in turn drive the real price of houses back down.
[*]There is a parallel to this in the stock market. It is generally accepted that stocks cannot long term appreciate greater than their earnings growth. The earnings growth is in turn related to the GDP growth. These terms (earnings growth and GDP growth) correlate to rental growth and wage inflation, for the sake of my argument.[*/]
[*]If you don’t accept that rent must grow with inflation and not above, run this scenario: over 50 years rent grows 2% above inflation, this will result in it composing 2.7 times what it currently does, of a tenant wage. Will that work? No, they will demand more money, i.e. wage growth. Let alone the fact that if the fed gets whiff of wage growth they’ll pump rates up and plumet prices.[*/]
[*]One final point, there is acutally an additional downward forces on prices I’d like to mention; that being, technology. Automation reduces the cost of manufacturing a house and the steps (labor) required. [*/]End result you have a stable system that I suggest can only appreciate with the long term wage growth.
Now from the previously posted website http://www.vw-organics.com/real_house_prices.htm (keeps getting linked in, thanks whoever first posted, this is amazing stuff), you can see there is a gradient to the second graph. There are two obvious reasons for the last hundred year blip: long term interest rates have trended down (that might be over) and the move to high density living. But these are blips! That is the prices have trended above inflation, but should return to inflation with these factors now priced in.
So now, please pick the argument apart. Do you believe in long term appreciation above inflation? I cannot see HOW it will work (yes this will ire you “10 year double” people), but I’m open to objective and logical reasoning
, but lets try and keep this nice [blush2]. Let me put it this way, I WANT to be convinced, I WANT to believe I’m going to do better than inflation. [biggrin]No time for review
hope it was not too incoherent.Hi Superman,
An incredibly lucid and logical post, well done. Increased demand from population growth can in theory put upward pressure on HPI.
Your inflation + rent theory is a little difficult to verify given the difficulties in obtaining a true inflation figure in this day of high technology, and given the broad downward trend in inflation over the last 30 odd years, surely HPI would show some correllation with that trend?I have an alternate view of the Wages vs House Price graph thanks to CommSec:
http://www.abe.org.au/papers/David~Rees~Presentation.ppt
Page 13.
Of course, this was in mid 2002.Originally posted by foundation:Hi Superman,
An incredibly lucid and logical post, well done.Ditto!
Yeah that was my link.
FYI it was from the head economist at the AMP…can’t remember his name off the top of my head.
Cheers
Great link Foundation.
This caught my eye.
“Real housing prices will fall by a total of 47 percent…the housing boom of the past twenty years will more than reverse itself in the next twenty.
Even if the fall in housing prices is only one half of what our equation predicts, it will likely be one of the major economic events of the next two decades.”Whoa!!!
Ta Foundation,
actually I was going to add a bullet point on demographics. The official forcast is for 25 million people by 2050 and very little, if any growth there after. I do no believe that a 25% increase is enough to strain supply. Australia is 98% the size of continental USA, which has ~300 mil, albeit Aus is a little less temperate, read habitable. But furthermore, I am not even convinced that lack of supply could result in prices breaking free of the controlling economic bounds hilighted in my previous post. E.g. If Australia WERE to grow to 50 million, does that then mean we can afford higher housing as a % of our income? I don’t think so, but again, this is up for discussion. [eh]You bring up an interesting point about inflation trending downward and RE appreciation trending upward. But I believe this is just a short term demographically influenced blip. That is national supply, as discussed above, is effectively unbounded. Whereas capital and coastal cities have been inundated. They are of only short supply. This has resulted in the short term (5 year) spike of late. If you look at the second graph on http://www.vw-organics.com/real_house_prices.htm again, I suggest there is NO trend (gradient) up until about 1990. That is, if the graph only included ’26 to ’89 data one could only draw a straight horizontal line.
So now housing is 10 times the average salary (from the graph), quite possibly this is the new base, having appreciated faster than inflation this century (all in the last 15 years). So then my theory would be, if this is the base, that in 50 years, houses will be 10 times the average salary. But not 16.5 as would be the case for 1% more appreication than wage growth and 26.9 for 2%. But again, keep in mind, that if you take away the last 15 (even 5) years the long term average would be less than 6 times! Maybe 10 is the new base… maybe 6 will return?
Looking forward to your Comsec graphs. [exhappy]
Hehe I’m too slow, you already updated with link
wow, this looks like good stuff… time to read the whole thing. Thanks also wayneL [blush2]Now… how about some opposing views? I love understanding (or trying to understand) both sides. I usually google one bias, then the other to try and get a balance. Actually that is one of the reasons I’m back here, was looking for the “long live real estate” perspective (no insult implied).
Wow look at page 13, “Sydney House Prices” they did exactly what i said, a straight line up until 1990!!
:D:D hehehe I’m happy about that that was independant thought [blush2]Originally posted by wayneL:Great link Foundation.
This caught my eye.
“Real housing prices will fall by a total of 47 percent…the housing boom of the past twenty years will more than reverse itself in the next twenty.
Even if the fall in housing prices is only one half of what our equation predicts, it will likely be one of the major economic events of the next two decades.”Whoa!!!
Bear in mind this (admittedly incredibly bearish) scenario would not necessarily require a house price crash. 20 years of 3.45% inflation would have the same effect on static nominal house prices!
Originally posted by superman:Wow look at page 13, “Sydney House Prices” they did exactly what i said, a straight line up until 1990!!
:D:D hehehe I’m happy about that that was independant thought [blush2]Ha! Count yourself blessed with a logical mind then. I needed to read and re-read all manner of statistical, investment and economics articles and books before it finally sank in that the only variable with a correlation to nominal house price is income. [blush2]
There is a very strong argument that in 20 years the median house price will be around 4.7 times average income.Cheers,
F.[cap]Yes this is what I often tout as the most likely scenario (in additional to a small initial drop, say 5-10%). Unfortunately 3.45% + 3.1% (average rental return end of ’03) is less than the new rates will be, i.e. negative investment returns (on the geared component) for years to come.
Yes this is the average and yes everyone hopes (or knows) they can do better. I actually take a different road. I always assume my returns will be the average. I aspire for more, but accept that self delusion is human nature and fundamental to our success. That 80% of people people think they are smarter than average (and 92% of statistics are made up on the spot). Well after all, who wants to admit to being below average?
So what do you do? Throw your money at realestate? Beat the dead horse? It does have a huge benefit in that it allows the highest gearing, usually 80% for IP’s. Shares only go to 70% with the added complication of margin loans, but are useless if not geared. Return are 5.2% dividends (incl. franking creidts) + capital gains. I’ve got a bet each way atm. I tell you, wouldn’t be fun if we knew the answers [biggrin]
I am not really sure about property having a return greater than inflation. But I invest in areas near the beach, public transport and within metrolopoitan Melbourne. So I know they will exceed the rate of inflation. As for affordability and wage growth – these areas will require a higher income to live there.
But the best thing I like about property is the time value of money.
When I buy a property today that is the price I pay for it. In 5 years time you will think how cheap that price seems today. You will say I should have bought more of those properties. It looks so low today compared to what a similar property costs now. Do you remember as a kid how many mixed lollies you got for 50 cents. You can also compare the cost of that property to what your income is 5 years later. You will be able to service that debt easier as your income would also have gone up in 5 years.
Originally posted by yack:I am not really sure about property having a return greater than inflation. … So I know they will exceed the rate of inflation.
Yack, aren’t these two statements sort of conflicting? Or have I misread you completely?
While slightly off topic (sorry!), I think it is interesting to consider household indebtedness when looking at the graph of income vs house price.
A graph of household debt as a percentage of annual household disposable income can be found here under 01/12/04 Household debt in perspective 161KB
House prices broke their strong historical relationship to income in the mid to late 80s. Until this time household indebtedness was at relatively low levels. From the early 90s, the indebtedness statistics also broke trend and at a casual glance appear to be accelerating at similarly unsustainable levels:
30% of annual income in the 60s
40% in the 70s following inflation in the high teens
45% in the 80s
90% by the end of the 90s
and now at a whopping 140%!!!One interesting result of this is that an interest rate rise now packs 3 times the punch of the early 90s:
thanks to the rise in debt levels, moves in interest rates are three times as potent as they were in the early 1990s.Is there a relationship between household debt as a proportion of disposable income and house prices as proportion of (gross?) income?
If so / not then what are implications for house prices over the near to medium term?Any thoughts?
Cheers, F.
thanks to the rise in debt levels, moves in interest rates are three times as potent as they were in the early 1990s.Fortunately I think this is the reason we won’t be seeing 80’s-style interest rates within the next decade or so. Because the RBA (nearly said Fed, I’m stuck in US atm), can now pack a more concentrated punch, i.e. 0.25% increases.
Indebtedness broke the trend the same time the real RE values started to move up, in 1990. It would seem the relationship is; household debt is growing at the rate of (house appreciation) – (wage appreciation), which would explain the exponential growth. Of course, our lax attitudes toward saving, induced by the booming economy, would also be a contributing factor.
So in order to support RE doubling every 7 years indefinitely, this debt must continue to grow exponentially… again… this will not work. Prices cannot appreciate above inflation indefinitely.
Great link!
I KNOW YOUR TALKING TO ME BUT I JUST DON’T HEAR WHAT YOU’ARE SAYING…….
I have such a long way to go! Is this Double-Dutch-Anglo-Chinese economics talk? Or something far more specific?
Cheers
C@34
Thanks again for your insight and carefully considered thoughts superman.
Originally posted by superman:thanks to the rise in debt levels, moves in interest rates are three times as potent as they were in the early 1990s.Fortunately I think this is the reason we won’t be seeing 80’s-style interest rates within the next decade or so. Because the RBA (nearly said Fed, I’m stuck in US atm), can now pack a more concentrated punch, i.e. 0.25% increases.
I wonder whether the AMP link may have understated the interest rate rise issue. Not only do Australians hold almost 3 times more debt, but a .25% increase from 7 percent is more significant than a .50% increase on 12% is it not?
So in order to support <edit – That which must not be named> indefinitely, this debt must continue to grow exponentially… again… this will not work. Prices cannot appreciate above inflation indefinitely.I agree, but what factor will be the ultimate constraint on this growth? I naively thought it would be when the savings level hit zero, but people are still consistently spending more than they earn!
I think this could potentially be the million dollar question.[wink2]
The Reserve Bank has released some interesting information here:
http://www.rba.gov.au/rdp/RDP2003-08.pdf
but I have not yet fully read and digested it.Cheers again,
F.[cap]The means RBA controls inflation by removing money from the economy. For larger national debt, a smaller rise is necessary, for the same effect. So no matter what the initial rate (7% or 12%), assuming the same level of debt, a 0.50% would remove more money. But then we can’t really compare like that because we’ve never seen rates of 12%, while being this far under water.
The house hold savings rate mustn’t take into consideration superannuation, so I think it’s a little rosier than it sounds. But what is the limit? Maybe when debt servicing obligations begin to drain on consumption, spirally the economy down; instigating fear, that in turn is conducise to savings. 13 years without a recession is a long time, touch wood, cause I’ll be returning to look for a job over there in a year.
The more optimistic outlook is that the system (I like to call the economy a system, that is how I think about it) will self-right. And by self-right I mean, RE returns must increase and the dollar must go down. How can an ‘export’ economy in good conscience run a deficit? I’m babbling…
Ah Calvin, I think it supports why we can’t rely on capital gains and therefore should be looking at +ve cashflow!
Either that, or I’m lost with you. It’s been very interesting reading though, well done on strting on this thread.
Some really interesting discussion in this thread and foundation’s Myth Buster series.
Imagine the Comsec prediction is correct and real house prices will fall back to the historical norm compared to wages over the next two decades (47% decline in real terms!). How will the nature of the “median house” change over this time? What is the likely impact in terms of individual investor’s experiences?
In 20 years if you could buy a house for the same nominal price as you can now is it not likely that the future house will be smaller, on a smaller piece of land than the 2005 property? This would be one way that median prices could remain consistent with wages/affordability and could easily arise from a continuation of existing trends of subdivision/development and smaller land parcels on new developments. It also fits with the forecast of smaller households in the future and is not too hard to conceive of if you compare the current size of houses in Australia to those in other parts of the world.
For the individual property investor this means that as long as your blocks are large enough you can realise a capital gain above the median by subdividing/developing at some point in the future. Alternatively you could sit back whilst others subdivide/develop around you and watch your large block increase in value faster than the median due to increasing scarcity.
So my question is, perhaps median values will stagnate or fall in real terms but is this more likely to be due to falling values on a like-for-like basis or due to an inevitable change in people’s expectations of what they can afford and hence a change in the nature of the “median house”? And what is the opportunity for investors?
FINALLY!
A post I agree with. This “median house” phenomenon is exactly the point I was about to bring up.
Prices cannot appreciate above inflation indefinitely.Of course they can! If you are talking about a ‘house’ being a 3 br detached dwelling on 600sqm when everybody else in 50 years time is stuck in a high rise apartment, that property will look like a mansion and of course it will apreciate way beyond inflation…
-Ian
Originally posted by ian_from_brisbane:Prices cannot appreciate above inflation indefinitely.Of course they can! If you are talking about a ‘house’ being a 3 br detached dwelling on 600sqm when everybody else in 50 years time is stuck in a high rise apartment, that property will look like a mansion and of course it will apreciate way beyond inflation…
You should review this post in light of Monopoly’s post regarding baby boomers, the house price affordability index and the population growth discussion in the Myth Buster series. Then answer the following questions:
– When 4 million baby boomers die over 15 years, who will be demanding their houses?
– If wage inflation matches general inflation, who will be able to afford the millions of “3 br detached dwelling(s) on 600sqm” when they have “apreciated way beyond inflation…”Remember, these average houses you speak of remained around 4-5 times average income for many decades until the baby boomers started buying…
Cheers, F.[cap]
, but lets try and keep this nice [blush2]. Let me put it this way, I WANT to be convinced, I WANT to believe I’m going to do better than inflation. [biggrin]
:D:D hehehe I’m happy about that 
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