The property market is right

One of the best stockbrokers I have ever known once said to me, in characteristically gruff fashion” “Mate, the market is always right. Even when it is wrong, it is always bloody right.” He was a great broker because he understood crowd psychology and the limited utility of numerical analysis. A great lesson in humility. Now, like most of my fellow bloggers on macrobusiness, I am a bear on Australian property. Have been for a decade. So why have I been wrong for a decade? I can highlight three reasons which I don’t think have received much attention.

The first reason is the extremely narrow range of investment options in Australia (assuming one does not venture overseas or into more exotic areas). Take the stock market. About half the Australian stock market is miners and banks. According to The Age, BHP Billiton, NAB, Westpac,  ANZ and CBA account for 37% of the market.  What happens if you don’t like banks and miners? Sure, its a nice cosy relationship between a few cartels and a constant flow of superannuation money which always goes to the big end of town. Nice for franked dividends. But it is extremely narrow. And the results are terrible. As any number of studies have shown, over the last decade superannuation returns have been worse than putting the money in the bank (after taking out all the gouging by fund managers and financial “advisers” of course).

Then we have bonds. To invest directly in corporate bonds you need about $500,000. In other words, as a retail investor, you can’t. After the GFC there was some muttering about retail bonds, but it never happened. Or say you want to invest in venture capital. Not much about. Worse, the smaller end of the stock market is continually penalised by the bias of the institutions towards arbitrage in the big cap stocks.

You could put the money in the bank, but it will be taxed as income. You could start up a business, but if you do will have to mortgage property to get a business loan. Ninety per cent of business start ups in Australia have the family home, or similar property as collateral. Disguised property investment in other words. Is it any wonder that there is a massive bias towards property investment, especially when it is protected on the downside by negative gearing? And that is not going to change any time soon. The gearing argument, by the way, does not stand too much scrutiny. In America, the deduction of interest costs applies to the family home as well as investment properties, but that did not prevent a property collapse. But in America, of course, investment opportunities are far more extensive.

That is the investment scenario. A second factor is changing consumption patterns. A home is a far bigger proportion of a good lifestyle than it was even 20 years ago. The reason is that all the other parts of a modern lifestyle – cars, fridges, TVs, computers, clothing, to some extent food – have been getting cheaper and cheaper in real terms. As a recent article in The Economist points out, capitalism is at a late stage in developed economies. Most innovations are refinements of something that already existed.

Mr [Tyler] Cowen reckons that the gains from two centuries of rapid technological innovation are largely exhausted, and that new discoveries lack the same revolutionary quality. To take one example, a kitchen from 1973, complete with refrigerator, microwave oven and dishwasher, would strike a person living in 1900 as a marvel. A time-traveller from 1973, on the other hand, would find a modern kitchen fairly ordinary. The world has gone from great leaps to refinements, and the refinements are petering out. Mr Cowen cites Charles Jones, an economist who uses deconstructed growth statistics to determine the drivers of progress across eras. Mr Jones reckons that 80% of the growth between 1950 and 1993 came from the new application of old ideas, and these old ideas are now mostly wrung dry. Other data point in a similar direction: rich economies spend more than ever on research, but the number of new patents has plateaued.

As innovation fades, the importance of the family home rises. That is not to suggest that there is no housing bubble in Australia – there unambiguously is – but it does suggest that there is a changing relationship between incomes as house prices. More household income can be spent on homes if less is needed for other things. (I know some are going to tell me it is all about an explosion of capital into investment properties – but see reason one).

A third factor, for which I have no quantitative evidence other than brief acquaintance with the portfolios of new wealth in this country, is the effect of high migration. Australia has the second highest migration in the world (behind Israel) since the Second World War. Many of these people came from countries where property investment is the most reliable and tangible investment play. Banks collapse, stock markets are tiny, what is a bond? But property is something on which you can rely. Plus it is also strong evidence of having made a place for yourself – literally – in your new country. Chinese investors have also skewed much of the market in some areas (paying in cash) but that means if there is a massive correction coming in the Chinese property market, it will spill over here.

None of this suggests that a property correction is not imminent. I am usually the kiss of death, so this blog might be the straw that breaks the camel’s back. But the three influences will not go away. The Australian bias towards property will remain. The market will still be right, even when it is wrong.

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Comments

    • hard to be Zen

      in other words, markets are right until they are wrong – but being wrong is also right, in the case of markets.

      To win then, you have to think neither right or wrong – allow yourself to be ‘Zen’ and let your rational intelligence equal your emotional intelligence.

  1. Depends on your definition of ‘truth’… there is always more than one truth.

    🙂

  2. Good article.

    I look forward to the day when Australia looks to the small business entrepreneur for innovation, rather than to the powers that be (corporate or govt, or whatever), property investment, etc.

    We have a lot of good minds in this country, and that is a greater richness than minerals, grain and houses…

    Shame that a lot of that is, really being put to waste in many ways.

    We need to support investment in the small entrepreneur; particularly, IMHO, engineering (but i am a biased engineer!)

    My 2c

    • Top post S.O.N!

      Agreed Stewart – I’ve come up with the idea of “research” bonds that may fill a massive gap in investment opportunities for the average punter. The basic idea is the investor provides the capital, the government pays the coupon, whilst the money goes to CSIRO or another board (or private R&D companies) to be allocated. It would be a hybrid – if nothing results because of the research (this happens most of the time), the investor doesn’t get the capital back. But if it does, the bond converts to equity in whatever returns on the future development/sale of technology/research.

      The bonds would be 10 year minimum for a variety of reasons.

      If I may be so bold, I think this has drastically more merit than any sort of reverse mortgage, shared equity or property CFD type product that seems to be the only type of financial engineering the mainstream are able to come up with.

      I also think we should change super slightly to allow anyone to access it for start up funds for their own business (instead of relying upon a mortgage) or indeed parents to be able to put some of their super into their children’s business (again to lessen reliance on property as a “sinkhole”)

      I also would expand that to maternity leave: let young mothers access super to pay for their time off to raise a child, instead of the government reliance on handouts (entitlements) and slugging the corporate sector.

      Super should change from being a simple retirement scheme, to a nation wide “personal” sovereign wealth fund. This would encourage younger people to save more – instead of wasting it on a house deposit and paying double (in mortgage repayments) to live in a house – and provide a much larger savings pool for the country.

      Voila!

  3. BS
    The market is made by stockbrokers for stockbrokers, they are in noway the best qualified to value/allocate/judge all elements of the society.the current “capitalism” Is a mess

  4. Great idea, Prince. Solves the problem that funding sometimes gets good ideas to a certain point, but then all the money dries up and they are left to sink when they are in development phase. Because of the bizarre aversion to “picking winners” I suppose. That 10 year time period and equity conversion are spot on.

  5. Considering the low success rate of small business start ups, surly accessing super to gamble at roulette would be a better option!

  6. You have identified three good reasons why Australia’s housing continues to attract demand. The obvious question to ask is will these issues continue to support prices?
    With respect to your reason one, investment, uncertainties in the financial world will only serve to enforce the belief that property is safe and other forms of investment are more risky. The public has been able to purchase small parcels (as little as $1000 face value) of government bonds directly from the RBA for years but their involvement remains slight. Other countries like the UK and US make the purchase of their bonds much easier eg through Post Offices, but the Australian government still has very little need to market its relatively small issues of bonds. The great majority of super holders saw a big chunk of their only serious savings disappear with the GFC whilst property held much better. Right or wrong, people will take messages from that.
    Your second point about the rising share of expenditure on housing is very important. Whilst most other household items (excluding energy, water etc) have become cheaper, the production cost of housing is actually being forced up, not only by rising government takes, but by higher insulation and other standards being imposed on house building. Also, homes are becoming more important as entertainment is brought to the home rather than people leaving their homes for entertainment. I see nothing on the horizon to reverse the trend.
    On your third point, immigration, it does appear that this is slowing. However, the level of immigration is entirely at the whim of the government. If the government (led by big business) sees that lower immigration is happening and that it is a threat with an ageing population then it can raise immigration at the stroke of a pen by increasing the quotas and lowering the points required.
    Overall there is little chance of reversal of the factors you have bravely identified. I say bravely because, as you acknowledge, this is largely a bear superblog and I’m sure your highlighting of these bullish factors will not be universally welcomed. But your action clearly shows the openness of this superblog which I applaud.

    • You are absolutely correct on the control of immigration. However, it must be understood that the types of immigrant are changing. It is far less attractive for Brit’s and American’s etc., to come over for two reasons. The primary reason, particularly for Brit’s, is that the reduced amount of liquidated assets(ie. home equity) is worth a further 30% or so less than pre-GFC (forex rate). (I don’t think that the effect of “cashed up” immigrants on housing markets should be underestimated). Secondly, the cost of living here is greater. In the past it was not so.

  7. IMHO, the most important factor is the bias in the banking regulatory framework – the mis-pricing of risk and capital in the banking regulatory framework (namely Basel II) where banks have an incentive to lend out more money in the form of mortgages as against business lending, at a time when virtually every major economic crisis in the world today can be traced back to the mortgage lending bias in the risk management framework.

    Deep T has made some good informative posts on this subject.

  8. Tks Sarah P, and I quite agree about the messages that are being taken out after the GFC. It is ridiculous that direct investment in bonds starts is so hard to get for retail investors.
    Quite agree with Mav, too (just to keep my bearish credentials intact — don’t want my co-bloggers thinking badly of me).

  9. Good article. I hate being labelled a ‘perma-bear’ because I don’t believe that I am one. I only turned bearish after Oz house prices rose so strongly post-GFC on the back of Government stimulus. Had prices not risen then I doubt I would have started blogging.

    In my suburb, where I purchased my house in 2006, prices skyrocketted from around $500k median to over $850k in less than five years! Crazy stuff.

    For what it’s worth, my view is that there is little upside potential for Australian housing but lots of downside risks. Accordingly, it is a poor bet right now. But whether we will experience a prolonged period of stagnation, a long slow melt, or a correction/crash remains to be seen. The severity of any house price fall would depend largely on external factors, most notably China. If the external environment remains stable, expect stagnation. If China experiences a hard landing, a correction/crash is probable. Either way, I see very little upside potential for housing and there are better opportunities elsewhere.

    On your second point – that non-housing related goods are getting cheaper – I am not sure that I agree. You are absolutely correct with respect to tradeable goods, but non-tradeables are in my view getting more expensive. Take services – the cost of going to the movies, out to a restaurant/cafe, buying a haircut, or a beer at the pub has risen significantly over the past five years. And utilities costs are on the rise too. Australia has become a very expensive place to live not just because of our exorbinant housing prices.

    Finally, high immigration is only an issue because Australia’s planning/zoning laws are so restrictive, resulting in escalating land prices as more demand has met unresponsive supply. Places like Texas and Georgia in the USA have experienced far higher population growth than anywhere in Australia without any increase in housing costs due to their liberal land-use policies.

  10. Housing has been such a solid and reliable investment for Australians for decades. Which makes it all the sadder that we succumbed to the same credit binge as so many other countries did and it will take many years, if not decades to reset the balance again.

  11. Can’t believe you entirely missed THE elephant in teh house price room – the labour market. If you want the principal reason why the housing market hasn’t deflated or crashed, there it is right there. Sure, you’ve had the FHBG and so on, but that has merely been icing. The simple fact is that, in a economy that hasn’t experienced recession in 20yrs, unemployment hasn’t risen enough to strain personal finances in aggregate. Look at the RBA chartpack and you’ll see how how the consumer debt load is. Right now, consumers and mortgagees can afford their debt repayments. If we had the US labour market on the other hand……

    • Adonis. I believe that you have cause and effect the wrong way around. The housing market tends to lead the labour market. As explained here, house prices in the US fell for a year before unemployment began to rise.

      • that’s an awfully optimistic correlation in that graph you linked me to…..I can’t see a reliable correlation at all.

        however, at the end of the day, both are driven by the state of the economy…..the downturn in the economy a couple of years ago didn’t quite take, and I’m convinced that if the u-rate had reached the 8-9% area some were predicting, all hell would have broken loose in the housing market, even at the more benficial rates at the time. Of course, rates are a fair bit higher now, which lowers the bar on how high the u-rate needs to get to.

        • Guys its not about whether unemployment leads housing or vice versa, its all about China. China leads everything. China sprays money into our economy supporting jobs and confidence. Mining company tax receipts supplied much of the funds that paid for Australia’s fiscal stimulus in the wake of the GFC, including the First Home Owners Grants to support the housing market.

          China is the key to everything.

          Without a bust in China the worst we will see in Australia is higher interest rates, and a plateauing of the housing markets (with perhaps some localised busts in tourist areas like the Gold Coast).

          With a Chinese bust confidence in Australia’s economy with utterly shattered. Anything could happen. We are totally unprepared for this scenario.

          • The economy will go into a recession unless we continue to build houses and keep over paid tradies in a job. They tend to have more spare cash than the average PAYE worker.

      • Dave From Pakenham

        UE – The US housing bubble and some other historical examples of housing bubbles had relatively greater endogenous factors driving it, therefore inevitable it unravelled under its own weight from within, house prices lead unemployment because of the reversal of wealth effect.

        In Australia, while the bubble may at least on some metrics be greater, unlikely it unravels the way it did in the US because of the greater relevance of exogenous factors and second order effects e.g. China, TofT and immigration.

        In my opinion here in Australia it is more likely to begin with rising unemployment as a result of reversal of exogenous factors…

  12. And as an omen for us, the chart in that link ends in June of last year, where prices appeared to have stabalised after a severe fall. However, they then turned down yet again – and are still falling today.

  13. You make a really interesting point about the lack of attractive investment alternatives in Australia.

    As you say, the stock market is extremely concentrated, half made up by miners and banks. An investor in the US has a lot more options in defensive stocks that are less correlated to the economic cycle (in theory at least!). Pharmaceuticals, etc etc.

    Furthermore, the variety of index funds and ETFs in Australia is severely limited compared to the US, and fees are higher. (around 1,000 ETFs listed in the US vs less than 50 in Australia).

    Here in the US, a retail investor can get reasonably cost effective exposure to virtually any asset class through these instruments. (not to get into a side debate about how appropriate some of these ETFs are for the average punter).

    • You can get 6.5% in a bank deposit FFS!!!

      Not happy with 6.5%? I mentioned it to a mate in Toronto and he was aghast as to why you’d speculate when a bank would give you those returns.

      • Good point, as here in the US I am lucky to get even 0.25% in a bank deposit!
        Problem is, in Australia you will get taxed on the interest at your marginal rate which means that after inflation your real return on cash is still only 1-2%.

        That may be a decent option if you’re an imminent retiree, but it’s no way to build wealth over the long term.

        • Its a decent way to protect your wealth in the short term though, and if you can manage your income you can keep the tax paid on interest under 30%.

  14. Debt Saturation

    Since negative gearing, there is no doubt that housing has been viewed as an investment vehicle. Everyone has been piling in and the accelerator is hard against the floor. With the other conditions you mentioned, the last say 15 years has created an inflated asset class that has gone into uncharted waters. Like the booms in the markets, booms take on a life of their own before reality sets in. The Dot com bubble is a prime one – how the markets got that so wrong (well right eventually) is interesting. Then theres realestate in the US and again the markets ignored reality until pop. Why would Australia be any different? Sure, there are underlying conditions for RE to be higher but at these levels its insane. Reality hasn’t set in yet. Denial can last for some time.

  15. An interesting thesis SON. I’d love to see the breakdown of the typical family budget 30 years ago vs today. A counter point would be that service costs have increased – no mobiles phones 30 years ago, but they are a basic necessity these days.

    In any event, I think Debt Sat is right. No mater what the cause, the Ozzie consumer is up to their eyeballs in mortgage debt. As the debt increase slows or reverses, the economy will sag (outside the resource areas). As soon as this affects house price sentiment, I think the rush to exit will be overwhelming. Same as the US – low areas one day, massive negative equity the next.

    It’ll probably be a Today Tonight or ACA piece on house price falls that starts it all.

  16. One huge difference between the dotcom boom and this housing boom, is that during the dotcom boom I remember economists and radio and TV commentators warning everyone to be careful, and that this could end badly, even though at the time it seemed as though everything one invested in was a winner.

    With this housing bubble we have the whole real estate industry, and most economists (still), and of course the government, behind it all, telling us that “you can’t go wrong in real estate”. If and when the bubble pops, there will be a lot of people out there who will get a huge shock. After all, this bubble has been going on for so long that ridiculous prices are now the norm.

    A bursting of the bubble would have to go in tandem with loss of jobs. Whichever comes first probably doesn’t matter, because it would be a downward spiral. Until now, we have been able to absorb huge numbers of immigrants, even though it has pushed housing higher, but if there is a lack of jobs, then that might put them off.

    I guess we are waiting for a “perfect storm” of a whole lot of factors to come into play to burst this bubble properly.

  17. Surely house prices going nowhere over the next few years will in itself cause a housing crash.
    If you have borrowed $500K and have just lost the $50K annual capital gain and all that you are left with is the $20K rental income and $40K interest payment.
    That’s a loss of $20k per year. How many paypackets can take a hit like that and keep surviving. Especially in our area where residential streets are festooned with ‘For Lease” signs.
    Looks like many investors can now kiss the rental income good-bye as well.
    Spells crash to me.

  18. Personally, as long as housing prices were “required” to keep increasing at a higher rate than wages (or whatever) in order to keep it as a “good (solvent) investment”, then it was always simply going to fall over under its own weight – ie. Ponzi style.

    Hence, IMHO, invoking all these “other” reasons, is, really, just about the timing of the inevitable collapse of the scheme.

    My 2c

  19. My non expert thinking about this is. If credit cards didn’t exist and we had to pay cash at retail shops I think 30-40% of shops would not exist today. Credit cards increase demand, retailers easily open new shops or sell online to meet the demand. Price of goods stays fairly stable.
    I think similar applies to housing where you can borrow more (relative to your income) than every before. This has driven the demand up but it is much harder to get new land and build new houses than it is to open new shops. And prices go up.
    But easy credit driven growth is not sustainable. As eventually we reach some sort of a peak of how much debt we can take on and there are more people paying debt off or defaulting than people getting new debt. And some shops will close.