How high can the house price boom go?

In the last three years, Australian houses have gone from boom to bust and now back to boom again. I have written in the past about how crazy the property cycle is, and recently, a buying frenzy has pushed prices back toward previous highs. Many are calling the market up 10% over the next year, but property is not a short-term trade. If you buy today and sell in a year up 10%, you would be lucky to make anything after paying entry and exit costs.

So, the real question from here for all residential property investors, is how much can you expect house prices to rise over the next 5-10 years.

A bold prediction

I’m going to make a brave call. My call is there are limits to how high housing prices can go. I know, I know. I sound crazy. Especially given Australian house prices over the last 30 years. But hear me out.

If house prices grow at 10% p.a. for the next 20 years, and wages/rents kept going up at their historical rates then:

  • The median Sydney house price would be over $7m
  • The median Sydney house price would be 45x higher than the median wage. 
  • Even if you managed to scrape together the 5% deposit (only twice the median annual pretax salary) to qualify for one of #ScottyFromMarketing’s 95% mortgages, the mortgage payment would come in at almost 3x the median pretax salary

If that is a realistic vision of society to you, then you can stop reading. Gear your heart out and buy a house. Hell, grab a bunch. 

If you are interested in looking at what the limits could be, then read on.

Some assumptions 

There are significant links between property prices and the availability of debt. The financial crisis showed this internationally. The Royal Commission into banking showed this in Australia. Even the Reserve Bank agrees. When the amount of debt available rises, so do property values. When debt slows down, property values fall. 

The Federal Government seems hellbent on forcing more debt onto borrowers. So, I’m going to assume that credit is available for the moment.  I do have some concerns that Australians generally are close to their debt limits, and I have even more significant concerns over COVID-19:

Australian Consumer Debt extremely high

But ignore my fears for the moment.

There are a host of other factors that can affect property prices. I am assuming none of these change significantly: generous tax breaks, limited supply, historically high immigration levels, high stamp duty, limited land taxes, continuing to tolerate money laundering, foreign demand.  

What are the limits to residential property?

I’m going to argue four other factors constrain how high property prices can go:

  1. The relative cost between renting and a mortgage. If the mortgage on the median house is (say) double the cost of renting the same home, then more people will rent.
  2. The affordability of a mortgage. If the mortgage on the median house takes up (say) 70% of the median pretax wage, then more people will rent.
  3. The affordability of a deposit. If the deposit on a house becomes too high relative to wages, then more people will rent
  4. The returns to investors. If investors are not getting an adequate return, then, in the long term, they will stop investing. 

I’m going to ignore number 4 for this post. As of the latest tax office stats, more than 60% of all investors have recorded an income loss on property each year since 2003. During two of the greatest house price booms Australia has ever seen. Clearly, most are investing in Australian property the hope of capital gain.

I’m also going to ignore number 3, deposit affordability. Not because I think it is unimportant. There are two reasons: (a) affording the deposit is less important than affording the repayments and (b) I just don’t know what levels constrain the ratio of house prices to worker incomes as the following chart for Sydney shows:

Three scenarios

I’m going to show the limits using three scenarios from this online calculator. I’m going to focus on Sydney houses for simplicity. The story is the same for Melbourne, and you can use the calculator to run a similar analysis on other states or on apartments.

  1. Economic Boom: Rents grow at 6%, wages grow at 4%, inflation 3% and interest rates rise to 7%
  2. Purgatory: A continuation of the last few years. Inflation and wage growth stay below 2%, rents grow a little lower than inflation. Interest rates don’t change.
  3. Economic Bust: Interest rates fall another 0.75%, inflation falls to 1%, wage growth falls to 1%, rents fall 1%p.a.       

Graphically, the scenarios look like this:  

Wage and rent scenarios

Limit 1: Mortgage Payments to Rent

Take the interest cost of a mortgage (with a 20% deposit) and divide by the rent. When this ratio gets high, say a mortgage was double the cost of renting, then potential homeowners will prefer to rent rather than buy.  

In contrast, when the interest cost of a mortgage is lower than the price of renting, then more renters prefer to become homeowners.

To illustrate, look at the chart for Melbourne or Sydney houses below. The median has varied between about 80% and 200% on this ratio. i.e. in 1998 if you bought a median property, then your mortgage cost was 20% cheaper than the cost of renting the same property. By 2010, the cost of your mortgage was double the cost of renting.

Median Mortgage cost vs Median Rent

It seems that anything above 150% is unsustainable – especially for units, and 200% appears to be a barrier for houses. This makes sense. Paying double the rental cost in interest should discourage buyers.

Limit 2: Mortgage Payments to Wages

Take the interest cost of a mortgage (with a 20% deposit) and divide by the median wage. When this ratio gets high, say the interest payments on a mortgage was taking more than 70% of the pretax median wage, then potential homeowners will prefer to rent rather than buy.  

To illustrate, look at the chart for Melbourne or Sydney houses below. The median has varied between about 30% and 80% on this ratio. i.e. In 1998 if you bought a median property, then your mortgage cost was 30% of the median full-time wage of an employee in that state. By 2008, 80% of a (pretax!) wage would be needed just to pay the mortgage.

Mortgage Cost to Wages

Scenario 1: Economic Boom

The problem with this scenario is that if there is a boom then interest rates rise also which will cap house price rises.

Boom Forecasts
Boom Output

Source: nucleuswealth.com/property-calculator

Scenario 2: Purgatory

The problem with this scenario is not that house prices fall, its that they rise only a little. Which means that if you borrow against the property you will likely lose money.

Base case outputs

Source: nucleuswealth.com/property-calculator

Scenario 3: Bust

As you would expect this is not pretty for house prices. If you didn’t borrow money, you won’t lose that much as the rent you receive would offset most of your capital losses. You would probably only be out entry and exit costs (which are not insignificant). If you did borrow money, you will be a long (long) way under.

Source: nucleuswealth.com/property-calculator

 

The Upshot

The problem is house price growth has been driven by falling interest rates and there are only a few rate cuts left.

Can I engineer a case where you do make money?  Sure. But it involves unlikely scenarios where wages and rents increase rapidly while interest rates stay low. Or it involves suggesting that the median home buyer will pay all their post-tax income in interest and prepared to pay interest costs more than double the cost of renting an equivalent house.

The story is not as bad in markets outside of Melbourne and Sydney, but the theme is the same.

Just to be clear, I am assuming house prices are limited by:

  • the cost of a mortgage relative to the cost of renting
  • the cost of a mortgage relative to wages

If I am right, the investment outcome is that even in the boom conditions, you are unlikely to make a profit if you borrow most of the money.  In negative scenarios, you are likely to make significant losses. I don’t like those odds.

 

 

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Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.

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Comments

    • Strange EconomicsMEMBER

      Yes but the 200% limit on the graph for houses still gives us another 30% higher still to go for property. And consider other external items ignored above.

      And don’t forget still to come – oligarch buyers like Russians in London (or Chinese buyers to return here) – Another 50 % up

      – And no political will to implement any of the counter – responses.(so forget that option – 0% probability govt will do anything)

      and raise rents (by mass immigration even with more low wage people in each tenement flat) so that changes all the graphs – up another 30%…

      So Not looking good – another 50 % up before run out of credit…

      • Not sure if commented on the wrong post, my post was in jest referring to the first 3 dot points under the bold prediction.

  1. HNH ring the bell, I know you want to.

    Today it’s NYE the 47 days for 2020

    I’m betting T 60 to 80 you’ll change your forecast to 2020 falls

    This time next year we will be lower

    I’d also add you’ve been sitting on the fence lately especially property and ASX.

      • What odds will you give me Peachy
        I’m the one sticking my next out against the trend
        I’m the one going against virtually everyone

          • How about 2 to 1 that we will be lower than right here 17 Feb 2020 to 17 Feb 2021

            Just a little wager
            I’m happy to reduce to 3/2 for you

            I’ll put down $2,000 if i win your pay me $3,000

            I’m I allowed to do this ?

          • Peachy I was on the train, in fairness I’ve always said April
            So give me until Anzac Day, that’s always what I said it’s only 60 or so days
            Even odds that HNH will have changed his forecast to price falls
            If I lose I’ll change my name to peachyspatsy for a week

            If I lose this time next year I have to change my name to resusasbitch

          • Ok – ANZAC Day. See you then.

            Who will adjudicate? Dom? Or perhaps we can get Dave himself to advise whether forecast has changed to falls?

  2. It’s not a closed system where local houses sell to local wage earners. It’s a global labour market and a global house market that we have now. And I daresay we’re likely to get the worst aspects of both of these circumstances.

    Have you modelled how much wealthy Chinese and Indian people would be prepared to pay for a median house here over the next 20 years?

    How about the amount of rent a slumlord will be able to collect from immigrants and poor people 4 to a room?

    How many houses without an attached finance cost will become rentals (sharehouses) as boomers depart and their progeny are too loath to sell the golden egg?

    • Titanium DiOxide

      Add to that the falling AUD will make our homes seem cheaper to those from overseas, especially now scared mainland Chinese.
      Also add the fact that around 8% of rental stock in Australia has been withdrawn and is now on short-term lease via Airbnb, also paid for in USD.

      • BoomToBustMEMBER

        Will they devalue the RNB in a vain attempt to refire the economy and prevent businesses moving capacity out of China to diversify risk is another question.

    • blindjusticeMEMBER

      Tenements, re-labeled as ‘co-living’, were what the government of Ireland wanted to bring back, (100 years earlier Dublin was the worst tenement slum in Europe due to the twisting of society by the empire there – you can view Irish history and the wars there essentially as over a screwed up property market where the British made the vast majority of Irish renters to house of lords landlords and hence no political will to make things better – anyway I digress), my point being that this is how far supposedly modern first world countries governments are willing to go to keep the endless population growth nonsense and property markets going. Of course it should be no surprise that the locals then swung hugely towards Sinn Fein – the political wing of the modern era IRA. What happens next will be interesting.

      https://www.rte.ie/news/ireland/2019/0501/1046753-co-living-housing-application/

      ” non-Irish nationals represent 12.7% of the population, some 622,700.”
      https://www.irishexaminer.com/breakingnews/ireland/irish-population-rises-by-64500-bringing-it-to-almost-5m-946672.html

    • Mmmm … you’re still fixating on this idea that there are mountains for money waiting to stampede out of China and India. That these are fundamentally rich countries. (I’ll give you a clue – they’re not).

      Nice story though.

    • Damien KlassenMEMBER

      I wish I knew how to model foreign buying. Happy to take suggestions.
      Under the “greatly increased foreign buying” scenario, we would see the mortgage cost to rent over say 200% leaving most average Australians renting.
      My guess is that this scenario would lead to a political upheaval from the houseless masses to prevent foreign buying, but you can’t rule it out.

        • Damien KlassenMEMBER

          Ha! When the median income in Australia is close to the median income in Bali then we can both take a look at that.
          The better measure would be the alternatives that those migrants are looking at: New York, Singapore, London, L.A., Vancouver etc. Most of those have similar constraints on interest rates falling.

        • My point is that there are live examples of situations where housing is impossibly expensive for locals. And yet life goes on.

          Housing continues to exist, locals continue to exist, but they are pretty much permanently munted. You seemingly rule this out for Australia. Why?

          • “My point is that there are live examples of situations where housing is impossibly expensive for locals.”
            This has been typical throughout most of history. the 20th century was an anomaly and appears to be reverting back to the mean.

          • There aren’t enough wealthy people in the world to price out nearly the whole Australian population, since we’re a comparatively wealthy population. There are enough people to do that to Bali.

    • Yeah, but…

      What I know is this. For a year and a half house prices (across the board) were crashing in Australia. This is not up for debate. It was literally yesterday.

      Where were all the global hoards then? They disappeared.

      House prices only started to rise again when the RBA went on an interest-rate cut fest. And rise they did. Instantly. With fury.

      So the current house price madness is because the central bank can’t take it’s hand off it.

      This is not a sustainable strategy. The load is spent. And it seems FHB’s are goin’ blind.

      So I think we will revert to house prices crashing. (even without the fires, pandemics and the global demographic collapse)

      And it will be sooner. Rather than later.

  3. happy valleyMEMBER

    Tim is an infidel and should be locked up for being unStrayan. Doesn’t he realise that Scotty from Marketing really is burning for us?

  4. “..driven by falling interest rates and there are only a few rate cuts left.”
    In an rational thinking, yes.
    But we are now beyond rational.
    If the cash rate goes to minus 10%, then lender can issue debt to households at minus 5% – pay those who take on debt to have as much as they can get, and still make their margin “That won’t happen! It can’t!” Yes, it can.
    There is no ‘zero bound’ to interest rates as I have begun to realise, and in the World that we all grew up in; the one that formed our economic education – the rational World, those who think rates can’t go to minus 20% will get left behind.

    • Janet, if the cash rate goes to -10% (which it won’t) only a fool would buy property. The smart money would herd into proper assets like productive land and precious metals.

      Negative rates are basically saying: welcome to the end of the monetary system. Buying residential property and luxury European motors are the second last thing you’d want to do – last being holding cash.

    • Damien KlassenMEMBER

      You are right Janet that negative interest rates would change the equation greatly and would see another leg higher in house prices.
      Most countries that tried negative interest rates are now unwinding that experiment. My read of the consensus central bank opinion is that negative interest rates create problems and don’t solve the lack of demand issue. However, maybe negative interest rates will make a comeback…

      • Mining BoganMEMBER

        Come on brother, Australian governments are famous for having a crack at things that have failed elsewhere. It’s our arrogance that gets us into trouble, thinking we can succeed where others have failed.

        It’s our crowning glory.

  5. 10% on current conditions, plus 15% more if APRA returns to IO loans for all soon

    than bust in construction industry will bring all of it down

  6. Around my area most of the listings are apartments, and prices are going down, not up. Thank you Mascot Tower.

    House prices have gone up a bit, but is still below 2017.

    • Rorke's DriftMEMBER

      The whole model for locals buying houses is based on rising prices. Flat or falling changes everything. So negative gearing becomes a losing strategy – investors gone. The idea that underwrites even OO that you dont pay off a loan, if you can afford the interest then capital appreciation pays back – thats gone too. It only needs a small shift in perception from perhaps an extended sideways period. The housing market is highly vunerable to correction hence risk is very high being long property here.
      Overseas investors wanting a bolt hole excepted, but the world isnt a stable place and asset prices could slide worldwide yet, affecting that category of investment.
      That doesnt itself mean housing prices will drop, but the bulls need rising prices on top of stretched asset prices to keep the show going.
      Im betting on sharp falls from anytime now. The article in asking the question of limits to rises implies what everyone knows already that we are at extreme levels. Trend is your friend till the bend at the end.

      • How many times in the last 20 years have we had flat or falling prices? 3? maybe more. How much did it change everything?

        • There are broadly two schools of thought here:
          – the first thinks of house prices like an infinite ball of string
          – the second thinks of house prices as an elastic band (it may be able to stretch a long way but it has natural limits)

        • Rorke's DriftMEMBER

          Elliott Wave pattern. The science of bubbles. It applies to our housing market since the float of the dollar in 1983. Absolutely clear and predictable for me since about 2015 how this pattern is unfolding. We’re in Wave C downturn. Expect two recoveries on the way to bottom. First one I predicted early last year as May 2109 to Feb 2020. Hard to be precise. We’re here now. Expect falls to resume soon.

          Your comment on past flat periods is just normal unfolding of the bubble pattern. It proves the bubble to me, not disproves as you suggest.

          • Maybe understand what you are saying then.
            It completely disproves “The whole model for locals buying houses is based on rising prices. Flat or falling changes everything.”

      • darklydrawlMEMBER

        That was one of the most revealing thing I noted from studying the US housing crash back in 2007/8. Prices only need to stop rising for a period of time for the whole show to come crashing down. You’re 100% correct that the entire edifice is premised on ‘prices must go up’.

  7. What does this mean?

    Take the interest cost of a mortgage (with a 20% deposit)

    Could you give an example?

    ie if I have a 425k loan at 3.19, I am paying 1200 a month in interest, is this what you mean? Or do you mean P&I?

    • Damien KlassenMEMBER

      You are right, I didn’t explain that well. I meant Principle + Interest on a 25 year mortgage with a 20% deposit and 80% loan.

  8. This is dumb

    The “houses” get smaller
    Rents stay the same but you get less sqm for your $

    It’s the same way they hide food inflation by making servings smaller

    We can all agree that money supply is constantly increasing
    Without major changes in planning laws the available housing stock relative to demand (immigration) is not improving

    If the price of a unit of housing can’t increase, then the solution will be to make the housing smaller/crappier etc

    Barring a major change in planning laws or immigration

  9. Just my opinion. House prices are driven by emotion and how much credit is available. At the moment neither seems in short supply. Eventually one or the other gets turned off but I suspect it will be at the extreme limits when the economy collapses at a point the government is unable to do anything to keep the positive vibes alive. After the experience of the royal commission no elected government will do anything to restrict the amount big available credit. It will need to be because big a collapse so large the finance leeches are too scared to lend on thier own.

    • Credit booms end not because credit becomes scarce but because the ability of the economy (corporate or household) to service the outstanding debt reaches a limit and then demand for credit crashes, bringing an end to the boom and a cascade of defaults.

      There simply comes a point where after-tax income is insufficient to cover the mortgage (or pre-tax income for companies). Simple as that. DFA’s stats suggest that mortgage stress is increasing and that tallies with the boom being on its last legs. If wages aren’t rising strongly then it’s game over. ‘Cash buyers’ from overseas can’t keep the market propped up because they actually represent a small pool of buyers within the bigger picture.

      Nevertheless, you are probably aware that there are a number of people who think that the laws of economics can be defied indefinitely and that prices can keep heading unhindered to Mars.

      • The90kwbeastMEMBER

        Dunno about not propping up the market, foreign buyers were 1/3 of total buyers a few years back were they not and hasn’t MB articulated previously that it’s a key reason why Syd/Mel are so much higher in price than other capitals, the only difference is immigration and foreign investment activity.

        • It’s actually pretty difficult to prove as supply of property has been very high, so in order for prices to push higher, demand must be higher than the rate at which units are being supplied. Obviously there are other dynamics like demand in desirable suburbs where supply may be constrained or demand for types of shelter (houses over units). Irrespective, Chinese demand now is much lower than it was in its hey day so should be less of an influence.

  10. As said previously, the big scope for change is with the duration of mortgages.

    100 year mortgages if they need to keep the debt Ponzi alive.

    • Can’t make that much difference given hardly any principal is paid off early anyway, meaning at the start it’s almost all interest limiting borrowing capacity.

    • Strange EconomicsMEMBER

      That was what killed the Japanese market 15 years ago. When they hit 3 generation mortgages.
      Of course Japan has zero immigration or population growth.

    • The problem with that is that most people want to be mortgage-free by retirement. 100yr mortgages then mean that no one makes any serious attempt to pay them off leaving the lender at much greater risk – and possibly much higher capital charges. You may as well be paying rent as you’ll never own it.

    • Surprising they haven’t tried to move to a long term fixed model like US loans where you can get a 30 year fixed. Yes i know there isn’t the secondary mortgage market here, but surely those investors would love a cashout refinance for all that free gainz

  11. reusachtigeMEMBER

    Like I’ve told yas, it’s a mega major maniac boom and it aint going anywhere anytime soon!

  12. Really can’t see how house prices will increase, because the people have no money.
    The only way they can go up is if the treacherous government alters the corrupt immigration program to overwhelmingly favour millionaire immigrants.
    Mass imposed Third World immigration caused housing to reach unaffordable levels and at the same time pushed wages downwards, we reached the sustainability of that treacherous folly in late 2017.
    The ‘best’ we can hope for is prices remain steady.
    However, what the treacherous government should do is cut net immigration to 50,000 a year and remodel the economy…make stuff. .

    • Gillard introduced the $5m visa.

      I think that was about the time I realised Labor’s as much the elites party as is the elites party LNP.

    • Goldstandard1MEMBER

      Enter the Corona virus. That has already slowed entry big time and it is not ending soon.
      The splash that has already happened has already caused ripples that will put us in recession, add at least a couple more months and…….. well fair to say a banking crisis might be a mild result. Then where is the money coming from to buy expensive ponzi property? Our economy needs a good clean out anyway.

  13. ErmingtonPlumbingMEMBER

    Look at how all that QE was unleashed after 2008.
    They just pumped out trillions.
    Though a bit of that “trickled down” to the Plebs through house price increases, most of that “created out of thin air money” just increased the asset wealth of the already super wealthy.
    If the same can not be engineered again and debt Jubilee/write offs are off the table,…what then?
    Some Engineered inflation in the real economy through dramitic increases in minimum wages,…or a sizable UBI to pump Trillions into the Real economy,… Maybe another Hawkie style of “Accord” but this time instead of a wage pause”, a massive wage increase can be agreed apon,…mmm?

    That’d certainly eroding some of that enormous debt away with a wage/price spiral like we did in the olden days!
    Let’s just inflate that nasty debt away.

    Anything to maintain asset prices Right?

    • Yep, asset prices underpin the solvency of the financial system and the financial system props up the economy and so on …

      The government knows which side its bread is buttered – they won’t rock the banking boat too hard.

    • Fvck me has skippy got his hand up your ass roo boy the influence is creeping in to the speak when he reads the comments he chorttles while sipping corn syrup well done and spreads his wings

  14. Hill Billy 55MEMBER

    The problem is that the plebs are already earning too much. See the great and good nashing their teeth at the indignity of having to pay for superannuation. They’d be better off receiving it as wages, they say. And how much will be passed on if the super is gone? Maybe a third of it – profits you know – so don’t expect the employers to be all of a sudden generous. Look at the restauranters and how many are underpaying! Interestingly, Hayek’s book was””The road from serfdom”, ultimately, unbridled capitalism leads back to serfdom. Self Interest for the few.