Meat, vegetables, gravy, salt and pepper…plus a good red wine.
A meal is made up of many ingredients.
No one ever says: ‘I might eat some meat and vegies with my salt, pepper and gravy.’
The focus of the meal is the main ingredients. The spices and gravy add flavour to the overall dining experience.
Last Friday, I wrote an article in The Daily Reckoning entitled: ‘Where to From Here for Australian Property? A Bubble in Search of a Pin’.
In response to the article, I received the following email from a reader:
‘I hope you are well.
‘In your Daily Reckoning today, you mentioned, and I quote “What’s the outlook for the twin drivers of this bubble (debt and household income)?”
‘Vern, there are a heap of people, evidenced by countless daily blogs, (Macrobusiness etc.) who would say that you are forgetting one major driver and that is foreign investment. (APRA asleep at the wheel, Politicians self-interest with massive personal property portfolios etc.)
‘Do you not consider this to be a massive driver of escalating Australian (Syd, Melb) property prices?
The impact of foreign investors wading into Australia’s property market has gained a lot of traction in the press — and among politicians too. Resulting in a tightening up of foreign investment regulations and the token foreigner being ‘hung, drawn and quartered’ to show we (as in, the political class) are acting on your concerns (the ones that might get us thrown out of office).
Politicians all play to the crowd. Especially in these times of populist politics.
This is straight from the playbook of ‘never let the truth get in the way of a good story’.
What’s the truth? Well, the most definitive research I’ve found on the impact of foreign investment on property prices comes from none other than the federal government’s Treasury Department.
In December 2016, the Treasury published a working paper (with the not-so-creative title of) ‘Foreign Investment and Residential Property Price Growth’.
Today’s article includes a liberal selection of extracts from the report to determine what the Treasury has identified as the ‘meat and vegies’ and what it has identified as the ‘spices and gravy’ of the Aussie property market ‘meal’.
Our first ingredient:
‘But despite Melbourne receiving more foreign investment approvals than Sydney, price growth in Sydney has been much stronger than in Melbourne over the period. As such, it is difficult to directly attribute price growth in Sydney to foreign investors alone.’
Source: Australian Treasury
[Click to enlarge]
If foreign investment had the major influence that popular opinion suggests it does, Melbourne property prices would be as high as, or even higher than, those in Sydney. But they’re not.
FIRB data indicates foreign investment accounts for around 10–15% of sales in new properties and 6–8% among existing properties.
When you consider the property pool we have in Australia, the number of existing dwellings far exceeds the supply of new properties being released on the market.
The dilution effect of a relatively small percentage to the overall property stock is borne out in this extract:
‘The increase in prices attributable to foreign investors is small when compared to the average quarterly increase in property prices of around $12,800 in Sydney and Melbourne during the study period. Across Sydney and Melbourne, the models which we consider to be the best specified indicate that, for a typical postcode, foreign demand increases prices by between $80 and $122 on average in each quarter… As such, it can be seen that foreign demand has accounted for only a small proportion of the increase in property prices in recent years.’
Foreign investment is really the ‘salt and pepper’ of the Aussie property fare.
What are the ‘meat and vegies’? (Emphasis mine):
‘Interest rates affect property prices by affecting the size of the loan that can be serviced at a given level of income. When interest rates are lower, larger loans can be serviced and prices are bid up, because in the short term the quantity of housing is fixed. This has been witnessed in Australia (Tumbarello and Wang, 2010; Williams, 2009; and Otto, 2007).
‘Successful inflation targeting by the Reserve Bank of Australia since the early 1990s has helped to lower nominal interest rates structurally, which has supported property price growth. The impact of interest rates on house prices is generally considered to be cyclical because interest rates typically move to help manage fluctuations in the economic cycle.’
‘Rising incomes enable more to be spent on properties and more people to enter the market for dwellings. This increase in the quantity of funds competing for the same number of properties should result in higher prices, at least in the short term before supply can respond to higher prices. This has been found to be the case internationally as well as in Australia.’
You’ve got to love the turn of phrase ‘successful inflation targeting by the [RBA]…’ Please spare me the BS. Inflation has been trending down because of globalisation…more supply being added to the global economy from ultra-low and low-cost developing markets.
The low inflationary trend is what the RBA reacted to, but most certainly did not successfully target.
Low inflation led to lower interest rates and, in turn, to higher (and higher and higher) personal debt levels.
Our so-called economic success — recession-free for 26-years — has been a result of nothing more than an ever-increasing amount of debt being funnelled (or pumped) into the economy.
This is not an economic miracle; it is a recipe for pending disaster.
The ‘gravy’ in the property feast has been population growth:
‘Population growth resulting from natural change and/or net overseas migration can increase the demand for dwellings, as can a reduction in the average number of people per household.’
However, the report noted that population growth is largely factored into the supply equation.
There are a few variables in the population condiment.
Lower numbers of births.
‘Boomerang’ children — young adults opting to move back home with their parents because of cost of living pressures, higher education costs, being unable to face the real world, or boomer parents not adjusting well to the ‘empty nest’ syndrome…whatever the reason, there’s a trend towards ‘failure to launch’. This cohort was once the homebuyer of today and tomorrow; instead, they’ve become ‘squatters’.
Immigration is a potential political hot-potato in this climate of ‘let’s blame the foreigner (and not our indulgent selves) for all our ills’. Therefore, immigration numbers could fall, and this would impact the amount of ‘gravy’ being added to the meal. But it’s the ‘meat and vegies’ we really need to focus on.
The report notes the obvious where it states:
‘…higher rates of unemployment make servicing mortgages more difficult, resulting in pressure to sell, which puts downward pressure on prices. This applies to both owner occupiers and investors.’
If there’s a disruption to household incomes, we have a game-changer.
Income is the main ingredient. Without it, the market starves.
What’s the forecast for household income? At best, we might see modest growth.
However, the world has entered 2017 in a precarious position.
The US share market is registering new highs on nothing but the ‘bigger fool theory’. Did you know that, since 2012, the US market is up 75% on nothing more than an expansion of the PE (price/earnings) multiple? Earnings have gone nowhere. Investors (and I’m loathe to use that term because no sane investor would simply bid up prices without an improvement in the basics) are paying more and more for a dollar of earnings. Madness.
The Donald’s political grandstanding is getting a lot of people nervous about trade wars.
The threads holding Europe together are fraying at the edges. Elections this year in the Netherlands, France and Germany could unravel the seams.
China is slowing down. There are a number of forecast outcomes from a China undergoing persistently slowing growth rates…and none of them are good.
The potential for disruption to Aussie household incomes from international forces, combined with the fact that we’ve pretty much reached the limits of our personal debt capacity, means the Aussie property market is vulnerable.
This illusion that our market is ‘different’ is nothing more conceit and stupidity.
We are subject to the same mathematical equation as all debt markets — income X interest rate = loan amount.
As the quantity of ‘meat and vegies’ changes, the bloated and obese Aussie property market is headed for a forced diet.
Editor, The Daily Reckoning