What’s Quite Clear About Australian Property These Days

Reddit

We went to our first house auction on the weekend. We wanted to see just how ‘hot’ this market is. It was a beautiful sunny day in Melbourne, and there was a small crowd gathered around the ‘cosy’ (read small) two bedroom weatherboard St Kilda home.

The auctioneer gave a 5 minute introduction, emphasising the house’s proximity to cafés and the best scrambled eggs in Melbourne on nearby Carlisle Street (seriously).

Then…no bids. About 30 seconds passed…then a baby boomer made a first bid of $750,000. A few more minutes passed. More cajoling from the auctioneer. No other bids.

So the auctioneer made a vendor bid of $760k, which the baby boomer bettered with $770k. More minutes passed…no other bids. The house was passed in, and the vendor and baby boomer went off to negotiate a sale.

While waiting, we spoke to a bloke who had had previously had a housing inspection carried out on the place. He pointed out numerous structural faults that his inspector had alerted him to, which was why he wasn’t bidding.

So our first auction was a bit of a fizzer. One bidder…passed in.

We’re not sure what to make of it. Crowds in Melbourne were subdued due to the Cup tomorrow. Perhaps the focus has turned to punting on horses, not houses, for the weekend. So this was probably just an anomaly. Anecdotal evidence elsewhere suggests the boom is still, well, booming.

We’ve been wrong on the Australian housing boom (and the stock market boom) so far. After experiencing a beating after the booms of 2000 and 2007, we’re astounded that investors are back lining up for more just five years later. But they are. Animal spirits are resilient to say the least.

Despite being wrong, we’re not about to change our tune. Because like the stock market, the primary driver of the housing market is ‘multiple expansion’. That is, the price investors are willing to pay for a stock or a piece of property is rising even though underlying earnings are not.

For example, the house we mentioned above would be lucky to generate weekly rent of $650. According to the agent we spoke to the vendor reserve was ‘low eights’…let’s say $810k. But the last baby boomer bid was $770k.

Let’s assume they met half-way, with the final sales price of $790,000. Add to that stamp duty and transfer costs of $43,940 and you have a total investment price of $833,940.

Assuming the property is tenanted for 50 weeks of the year, that’s an income (before expenses) of $32,500. So the gross yield from the property is 3.9%. Taking into account things like rates, maintenance costs and real estate agent fees would reduce the return to somewhere less than 3%.

And that’s using an example on a property with one bidder…which was passed in. We can only imagine what the numbers would look like on a place subject to a bidding frenzy.

It’s quite clear that property in Australia has little to do with income anymore. Or where it is, it’s about gaining tax concessions via negative gearing. No, property is all about the capital gain. When there’s no rise in the asset’s underlying income, the ‘multiple’ that investors pay expands, meaning that it’s all upside for property.

It’s been this way ever since the late 1990’s in Australia. Why would anyone think differently? The income gains might be flat now, but they’ll come back. (This is despite a darkening economic environment as we move into 2014).

The easy way to make money is in bricks and mortar. Innovation as a form of wealth creation is hard work and too much risk…what if it doesn’t work out? No one wants to play that game in Australia. And our woeful productivity performance proves it.

We have a hare-brained theory that the Aussie housing boom — or at least this latest incarnation of it — is directly linked to China’s property boom. China’s love of property is still going strong. Bloomberg reports that new home prices jumped 1.24% in October, the 17th consecutive monthly increase.

As we’ve pointed out many times before, China’s credit fuelled economic boom from 2008 led to a massive boost in Australia’s national income, which provided a fundamental support for our housing market. (Higher incomes mean you can support a higher level of debt…and higher debt levels push up house prices).

This China boom led to a surge in mining investment which was good for employment and economic growth. But the end of the mining investment boom and a slowing of China’s economy posed a threat for Australia’s future rate of growth. So the Reserve Bank reduced interest rates to all-time lows.

It’s these low interest rates that are fuelling the property bubble, not solid fundamentals. China is now in a situation where it needs greater and greater credit growth to generate the same amount of economic growth. That’s not a good place to be and we think it’s very close to ending.

If China struggles to contain the fallout from its credit boom, foreign investors will turn on Australia. The dollar will fall and inflationary pressures will rise throughout the economy. Just last week, we got a taste of this with higher than expected producer price rises in the September quarter, thanks mainly to surging import prices, up 6% in the quarter. That’s the result of a sharply weaker dollar in the June to September period.

So when (not if) China confronts its credit demons, a weaker Aussie dollar will import inflation and make it hard for the RBA to cut further. A deteriorating economy and a hamstrung RBA is probably not what the property bulls are thinking about right now. But it may explain why so many houses are suddenly coming onto the market. While the mainstream media loves to tell you about the strength of demand, don’t forget there’s plenty of supply out there too.

Notwithstanding our experience on Saturday, this is a sellers’ market. There’s a reason why so many people are looking to sell now. It might be the best price they’ll get for many years.

Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
Reddit

Leave a Reply

7 Comments on "What’s Quite Clear About Australian Property These Days"

Notify of
avatar
Sort by:   newest | oldest | most voted
RickW
Guest

The 3% return on an inflation adjusted basis for a rental property already looks attractive alongside existing TD rates. When the RBA cash rate gets down to 0.5% and TDs are under 1% the 3% rental return will be a world beater.

You are making a good case to get into rental properties without even considering any tax advantages. If the properties are held within a SMSF then there are significant tax advantages.

As an investment analyst you should analyse the purchase from the perspective of a baby boomer to get an appreciation of the attraction for rental properties.

Jon
Guest

RickW
If a young person made house investment decisions from the perspective of a baby boomer, the young person would sell themselves into slavery, whilst their boomer split personality would pat them on the back saying well done, I am set for life selling you that, sucker.

Grayza
Guest

Looks like you got the whole property trend completely wrong just like you got the stock market trend completely wrong. At some point though there will be some minor correction and you will shout from the rooftops how you predicted this ‘plunge’ – meanwhile you’ve lost out on the profits while the rest of us have made a killing.

djnt
Guest

Grayza, you make a strong point. I listened to Terry Mc Crans column in the early noughties calling for a bust. How wrong he was, with hindsight we are experiencing an anomalous boom driven by exponential population growth. The pyramid is higher than ever before, enough time for a twit like me to stare in headlights for to long. Now it’s just better if the truck hits me!

Dulong Ttil
Guest
I believe that what the Japan’s monetary easing policy is doing to push the YEN downwards healthily is also an appropriate action for the Australian government to consider. In a layman term, just print more money to make the currency move downwards peacefully. Since the YEN is much cheaper than before, the export and tourism businesses from Japan are active again. This is exactly what we want to see. Also, if the A$ depreciate, it will show an improvement of our government’s overseas investments which are usually calculated in foreign currencies. Before A$ starts to depreciate, it should be a… Read more »
Nigelnofriends
Guest
I read your article with great interest but I still remain sceptical of “expert opinion”. I recall about 5 years ago a PROFESSOR OF ECONOMICS (I could name him but!!!!.his name starts with K) teaching at a Sydney university said that he had sold all his property including his house (He was going to rent)because property in Australia was at least 30% to 40% overvalued and we were in for a simular situation as the US housing market. OOPS wrong again. Like the Energy EXPERT from Bloomberg who suggested oil would go to $200 a barrel only to drop to… Read more »
shortchanged
Guest

An expert is someone who knows more and more, about less and less,

untill he or she knows every thing about nothing.

wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au