THE FAMILY HOME

Why are prices rising so fast?

Will this trend continue?

What future home prices expected to be?

Chapter 2 - Homes as investments

The Real Estate Institute of Australia (REIA) reports that at December 1980 the median home price in Sydney was $76,000. The median home price in Melbourne was $43,000. In June 2015 the median home price in Sydney was nearly $930,000 and the median home price in Melbourne was $688,000 (The true extent of Australia’s rising property prices, 13 June 2015 www.news.com.au). That’s a significant increase in value over three decades! The increases are even bigger in the ‘better’ (ie more desired) suburbs. The entry price for the fashionable inner, eastern and bayside suburbs in Melbourne is now over $1,000,000, and the entry price for the fashionable Sydney suburbs has been over $1,000,000 for years now. In fact, more than 100 Sydney suburbs have entry prices above $1,000,000.

 

The prices in other capital cities are not as high – but the growth in prices has been pretty similar in all major cities, especially across the longer term. For example, Perth prices have actually fallen in the last year or two – but this has followed a period before that when prices rose by more than the rest of the country.

The point is this: over the past 20 years, housing has been a good investment.

Share prices have risen a lot, too. The Russell Investments ASX 2015 Long-term Investing Report (one of the most reliable and bias-free reports available on the market) says, at page 9, exhibit 7, that the 20 year average for Australian shares to 31 December 2014 was 9.5%, which is only a smidge behind residential property at 9.8%.

Russell Investments/ASX graph showing the performance of different investment types for the 20 years to December 2015.

Why are prices rising so fast?

 

The media is full of theories and explanations. The best include the following elements:

  1. record low interest rates combined with a record 25 year period without an economic recession;

  2. rising international interest in Sydney and Melbourne as cities, and investment centres, connected to a (correct) perception of Australia as a safe haven. Australia is a stable political and economic environment where property rights are protected by the law;

  3. population pressure. The national population is increasing by around 220,000 people per year. Melbourne’s population alone is increasing by more than 90,000 a year, every year. Most new arrivals are from Asia and South East Asia and are eager to enter the property market, as home owners and investors;

  4. negative gearing by high tax rate individuals;

  5. SMSF gearing;

  6. concerns that the share market is too risky. It’s been a very volatile few years. For example, the ASX fell by more than 8% in August 2015; and

  7. a sense of being left behind, ie that prices are rising and if you do not act now you will end up paying more later.

Will this trend continue?

 

Home values can’t and won’t go up every year. One of the key measures of the relative value of housing is the housing affordability index. As the name suggests, as housing affordability falls, homes become less affordable. Economic theory, and economic history, both suggest that this will dampen demand for housing. Lower demand has the effect of not putting pressure on house prices, which restricts the growth in those prices, such that affordability increases. The basic point: things simply cannot stay unaffordable forever. If they are unaffordable, no one can buy them, and the price falls – back to where things become affordable again.

 

Affordability – and therefore home values – are particularly sensitive to interest rate increases. For example, if a new home owner borrows say $1,000,000 at 4% pa to buy a home, they have to pay $40,000 a year interest. If interest rates rise by say 2 percentage points to 6% pa, this increases by $20,000 a year to $60,000 a year. This interest is not tax deductible, so at the 40% tax rate they have to earn an extra $33,000 in pre-tax income just to meet the increased interest expense. (Even more when Medicare, 9.5% super, workcover and payroll tax is factored in.)

 

In June 2015, the Housing Industry Association reported a fall in housing affordability. In mid-September 2015 the real estate agents were saying auction clearance rates were less than they were in September 2014. On 16 September 2015 the Australian Financial Review said that Chinese purchases of Australian property have dropped significantly in the previous month as buyers encounter new rules in China designed to stop money being moved out of that country.

Home values don’t go up every year. But history suggests they do go up every decade. When you look at home values over the decades there is a significant upwards-sloping trend line.

What are future home prices expected to be?

 

Fifty years is a long time. But many say this is how long property should be held for. Property is an inter-generational asset (see chapter 6) and over multiple decades and generations property will typically produce excellent rates of return. Obviously precise predictions of future prices over such a long timeframe are not possible. There are too many variables in the equation. But let’s stick to the basics, and look at what is expected to happen to Australia’s population over the next fifty years. This can help us then make an educated ‘guess’ about home prices.

insert table

 

Income levels will rise too. Inflation runs at roughly 3% a year, as a long-term average, so a $1,000,000 home in 2012 will be worth at least $4,384,000 in 2062 if it simply appreciates with inflation.

Much of Australia’s population growth is driven by immigration. More than 220,000 people arrive each year. Most are well educated, reasonably well off, and aspirational: they want to get ahead in the Lucky Country and they work very hard to do so.

These aspirations are shared by older Australians too: just listen to talk back radio for a day to witness the energy and effort put in to buying and keeping a home. Over 80% of people aged over 65 own their own home – the highest rate for any age group. It’s an intrinsic part of the Australian culture and psyche, and there is often a stigma attached to not owning a home.

 

Obviously the more fashionable suburbs will be in more demand. They are privileged locations and people will ‘fight’ to buy there.

There is no precise formula, and it’s a very simplified model, but if you combine cultural preferences (obsessions?), dramatic population increases, privileged locations and prolonged inflation you get significant home value increases across the coming generations.

1. Choosing the family home
3. Pros and cons

 ©2016 WHOLE WEALTH

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