Tuesday, 9 February 2010 / 2 comments Property value never falls? Dont put the house on it by Adam Schwab
While markets may not be perfectly efficient, they tend to deliver the correct result eventually. This may take some time, especially when the market in question involves an asset indelibly linked to human emotions and shelter like residential property. But as Benjamin Graham once noted (albeit, referring to a different market), in the short term the market is a voting machine, in the long term it is a weighing machine.
Most metrics indicate that residential property is overpriced. The most recent data suggests that the median price of an Australian property is $450,000 in capital cities, the median is far higher than that (in the United States, the median property costs about $200,000). That means not only is Australian property double to price of that in the US, but Australians pay about 5-6 times their household disposable income for their median dream home about double the historical ratio. Similarly, net yields tend to be less than 3% in many areas with purchasers simply assuming that property always goes up.
As a result of such willingness to buy property, Australians household debt levels are world leading as the Australian Bureau of Statistics last year noted in its Social Trends publication:
Over the last 18 years, the level of household debt grew twice as fast as the value of household assets, as the ratio of household debt to assets doubled from 9% to 19%
Housing debt as a proportion of housing assets rose from 11% to 29%, which means overall, households have come to own a relatively smaller proportion of their houses. On the other hand, the total amount of equity households hold in their houses increased by 62%, from an average of $185,000 to $299,000 per household.
In other words, the more housing prices have appreciated, the more Australians have needed to borrow. The most commonly propagated justification for ever-increasing prices (and willingness to assume more debt) is that Australia is in the midst of a housing shortage. This is allegedly the result of increased birth rates and rampant levels of immigration. The theory (commonly sprouted by estate agents, a willing media and almost every Australian real estate pundit) appears to be that Australia because has a shortage of property, and ever-increasing demand (due to immigration), equilibrium prices will continue to outstrip inflation indefinitely.
The problem with this theory is that it assumes that the supply curve is fixed. In other words, the market is broken. However, if data released by the ABS is accurate, it appears that rumours of the flexibility of the housing markets death has been greatly exaggerated.
The ABS stated that during December 2009, 14,869 dwellings were approved (on a seasonally adjusted basis). This is a substantial increase on the prior year (in the midst of the financial crisis) when less than 10,000 approvals were granted. On an annual basis (and annualising a single months result can be misleading, especially given the lumpiness of approval dwellings), if that rate of construction is sustained about 180,000 dwellings will be constructed next year. Why are more dwellings being approved? Most likely because higher property prices mean that developers have been able to expand their profit margins especially apartment builders. The lure of greater profits encourages more development.
Given that each Australian dwelling houses 2.6 people on average, that means properties for more than 460,000 people will be built next year based on the December figures.
Now let us consider the demand side. The Department of Immigration and Citizenship stated on its website that 2009-10 immigration is expected to be 168,700. (Further, it is highly likely that temporary immigration, especially in the form of student visas may drop as the Australian dollar increases and violent attacks against Indian students garner widespread media coverage).
As for organic growth the ABS found that for the year ending June 2009, there were 300,900 births in Australia and 143,100 deaths. The natural rate of population growth was therefore 157,800. Combining natural growth and immigration, that gives an approximate permanent population increase of 326,500. This figure is substantially less than the rate of dwelling approval based on December 2009 data. (The ABS noted that total population growth in 2009 was 443,800, with the ABS having a different net migration figure to the Department of Immigration, even using the higher figure there does not appear to be any actual shortage).
Further, the increase in Australias population growth is unlikely to be sustainable. The rate of growth in 2009 was 2.1% almost double the international average of 1.1%. The decrease in growth rates may come from reduced immigration, lower birth rates (as unemployment increases and the baby bonus is reduced) or even higher mortality rates as the population continues to age. On this point, Immigration Minister Chris Evans is expected to announce today that the list of jobs that receive immigration preferences will be slashed, making it far more difficult for overseas students to obtain residency after completing tertiary education. This will further reducing the demand for housing.
Last year, as construction slumped and migration boomed, it appeared that after decades of net dwelling growth, Australia may be encountering a shortfall. Not only does it appear that this has not eventuated, but the market is reacting to ensure that more dwellings are constructed while political and economic factors may lead to reduced population growth in future years.
What this means is that all those so-called experts who continually claim that Australia is suffering a housing shortage have never bothered to calculate the real shortage or simply turn a blind-eye to the reality because it suits their property never falls argument. No housing shortage exists the market has reacted with great speed to changes in price by increasing supply. The reason for the increase in property prices is not due to any economic factors such as supply shortages (yields have dropped and income to price ratios increased) but rather Australians use more debt than anyone else to purchase their dream.
Property never falls in value? Dont bet your house on it.
