A simple model....

A simple theory for the support of housing prices.

Assumptions:
(1) Inflation stays at or below 3% (if it goes higher, expect a housing price spike leading to rising house prices and greater equity)
(2) Interest rates don't move much above 7%
(3) Wages rise at around 4%, made up of 2.5% CPI increases and afforded by 1.5% productivity increases.

We have therefore the following scenario - servicability rises on average by 30% of 4% annually, or 1.2%. The average homebuyer borrows at 7% P&I, which very roughly equates to 10% IO. This therefore means that 10 times the servicability can be supported, or a 12% ANNUAL house price increase. Note that this assumes that the worker is dedicating nearly the entire real increase to housing payments. This may not be too far from the truth, but sooner or later people get sick of belt tightening. It also ignores credit fuelled spending (I told you it was a simply model).

Getting back to matters at hand, however, under the above assumptions, a sustained average 7-10% increase in house valuations looks eminently feasible.

What do others think?
 
Historically true, and well described as the rationale for the past rate of housing price growth :)

Note that we are in the initial stages of a wage breakout. People are stepping around it but wages are on the increase and it's a seller's market for talent both in Australia and overseas.

This prospectively means greater wage increases over the next several years, leading to rising inflation.

Given that the property market is closer to where the Reserve Bank wants it, it may lead to them reducing interest rates in the next 6-12 months.

This would then lead to increased serviceability and the potential for some limited upwards movement in property prices across the board (not a boom, but a slow upwards incline).

IMHO assuming no major global disruptions or short-term breakouts in oil prices to over the $80 mark (a psychologically sensitive price point given the peak of the last oil shocks, though in real terms not important) this scenario is quite likely.

A few stats on the wages breakout from the AIM National Salary Survey...

Voluntary staff turn-over rate has risen to 11.1% for large companies from 9.9% previous year, and to 10.2% for small companies from 8.9% previous year.

Salaries in larger companies have risen 4.3% this year versus 4.0% previous year. In small companies the rise has been 4.7%.

Only 15% of large companies and 5% of small companies expect to decrease permanent staff members in the next year.

Cheers,

Aceyducey
 
I wish I could be more detailed in my comments but I cannot. So here, I go...

As I see it, Kerian Trass’s theory that Fear and Greed are a huge factor in the Property market is very true. Therefore you cannot assume because rates are low IP will go up. It will only go up if Average Joe wants to buy because he sees a quick gain.

You and I may be buying up on good return but Average Joe is still seeing TV doom and gloom stories and reacting accordingly. Average Joe also commutes via car to work and….

I think the price of petrol is a big factor to a vast majority of people. I class myself as pretty comfortable but $70 plus to fill my tank is starting to hurt.

I have heard of a survey saying that Average Joe is paying an extra $20 a week and it is really starting to hurt many who drive to work. Average Joe will either need higher wages or spend less.

Considering businesses are also hurt by higher petrol I don’t see business affording these increases so spending will have to slow. We are already seeing this with the lowering of prices elsewhere.

New Car Prices are staying put or getting lower for a better car and they are always offering “drive away” deals.

Clothing is always on sale and the mid year clearance is all winter long it seems.

Cinema chains are offering $8 weekend tickets and 2 for 1 deals to get patrons on seats. My local Video Ezy offers new releases for $1.95.

What does that tell you? :confused:

That Average Joe is not spending a lot of cash at the moment because he don’t have it.. That’s why the RBA is neutral.

Does that mean home prices will rise? I don’t think so. Most need a year hype and increase before they start investing via NG. Few look at fundamentals.

I will summarise with a very telling observation I made at work last week:

I run a company and emply sub-contractors. I am the boss and the best off. The subooes sometimes live week to week with bills.

The matter of what to do with a Lotto win of $10M came up. I asked what they would do. One of the worst said “travel the world with my family (of 6) , see the world”. Other “buy a new car, house, boat, etc…” When they asked me I said “buy 30 IPs, set them up and then travel, buy a new car, etc..”

As we have discussed before investing is mindset. Until the masses are investing again prices will stay flat to minimal rise.

This is not to say NOW is not a good time to invest for those wise and careful.

Peter 147
 
Hi all,

Quiggles,

An interesting take on how the continued increase in house prices could happen. However it does involve a greater percentage of average Joes household income to be directed towards property. (ie he spends most of the increased wages on property)

As the percentage of household income spent on property is still lower than it was at the height of late 80's boom (I think from memory), then there is still room to move upwards. However at the end of that boom the crash in interest rates was responsible for a large part of the increased affordability. As interest rates are already much lower, there is not the same possibility of the big fall in them.

bye
 
A couple of points in my model. First, I assume no change in the demand for housing from Average Joe. His first priority in this is to own his castle, not to listen to crap about the market crashing - most wouldn't pay that a blind bit of notice, IMHO. They are not investing. In this case I am dismissing part but not all of Trass's argument - I think he's sound in arguing that fear and greed cause speculative excess, but underlying that is a rising capacity to pay - which shows little sign of diminishing - and which moves the demand curve outwards.

Second, they are not putting every cent of their raise into housing - I was suggesting that to support a 12% house price, they would put 30% of a raise into housing - to support 7% would therefore be nearer to 18%, i.e. a declining proportion of income going to housing (most spend well over 18% of their income on their own housing). How much they have left to take home at the end of the week is not actually a variable - it is zero, for reasons we all know far too well.

Finally, housing affordability is the conjunction of two factors - price and wages. If interest payments are factored in, then it can be better expressed as payments vs wages. Even where payments are static or slowly rising, affordability rises if wages are rising faster. I recall having to explain to 'captains of industry' in the early 80s that real wages had declined for the last 8 years for most people. I don't see that happening now, and with increased employment that actually implies much stronger income growth.
 
Thanks All

I can further add to my point by highighting that Super is becoming the investment flavour of the month.

The recent 10-15% returns, Super Choice, advertising by the Industry Funds, and change by the Feds to make it even more attractive ( removal of surcharge, co-contribution) is sucking up some of Average Joes spare cash.

All good news but more money not going into property.

Regards, Peter 147
 
Now a substitutability argument I'll accept. Note that I wasn't suggesting a linear support price progression, just an underlying price increase for the market. But think about it for a second. All share buyers are investors, either directly or through super/funds. Most house buyers are not, and their motivations are different - they are paying "different" money, i.e. it doesn't come from the amount left over for investing at the end of the pay period ($0).
 
Hi all,

Quiggles, could you please give an example of what you are saying??

I have used some common numbers and I don't get the results you claim.

For example

Taking average Joe to mean a slightly below median priced house and having an average income.
Printed in a recent newspaper article from news.com....."Overall, the national house median house price fell 0.1 per cent during the June 2005 quarter to $390,600, according to the index."

I will use $350,000 as the price of the property.

According to ABS I can take Average weekly full time earnings as $1008 pw from here....
http://www.abs.gov.au/Ausstats/[email protected]/0/ba84bbb55b643021ca2568a90013934e?OpenDocument

On this calculator on the web

http://loan.echoice.com.au/calculators/loanrepayments.html

I get the following results...
loan $350000 at 7% P+I loan for 25 years = repayments of $2473.73 pm or $29684.76 pa.
This is 56.633% of yearly income.

Go forward 1 year the $1008 x 52 = $52,416 add on the 4% wage rise is now $54,512.
To keep affordability at the same level we assume 56.633% of this new amount can be used for loan repayments. This is $30,872.14 pa or $2572.68 pm.

Now when I keep the monthly repayments to this level, the calculator shows ( by playing with the loan amount numbers) that I can only have a loan of $364,000.

Now this $14,000 increase in value equates to only a 4% increase in the house Joe six pack can have.

Quiggles if you have a different way of working it out, could you please share it, with an example?

bye
 
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