Are Australian property prices going to crash?

[Nathan]

I have steadfastly maintained that inflation does not erode away debt!

All that happens is that inflation causes higher interest rates so you compensate your lender for the inflation that would otherwise reduce his/her capital investment in you each year. Do you honestly believe that your lender would allow you to cheat him that way! True, after years of steady inflation your debt reduces significantly in nominal value but you have paid the difference every month.

You can argue tax advantage if you are desperate but I am talking about pre-tax advantage.

I leave tax out always.

As for inflation, it means your cashflow gets inflated, therefore better cashflow...

 

[Sunfish]

As for inflation, it means your cashflow gets inflated, therefore better cashflow...

You might explain that for me, I'm not sure how that happens. But what I'm saying is that inflation doesn't magically make your debt vanish as the popular belief here says it does.

Ausprop said:

the debt is deflating

 

[bene313]

I leave tax out always.

Why? Perhaps it's practical for you to do so.

Generally though tax needs to come into any investment equation. In comparing the potential return on two investments, it's the after-tax return which should be used.

 

[Ausprop]

I have steadfastly maintained that inflation does not erode away debt!

you and I stronlgy difffer here, like black and white. and i couldn't care less about tax deductions - I have 20 years of tax deductions to work thru! (i wonder if treasury accoutns for all the losses on peoples balance sheet in their forward tax collection projections?).

the main reason is because the depositers are getting sub standard returns on their cash, which banks then multiply out thru fractional banking, but the key point is the return on asset types is not fixed - so yes if you are yielding 1% then you wont get ahead, if you yield 5% i think you will get ahead on your balance sheet but cashflow will be hit, when you start getting baove prevailing IRs then you are kicking huge goals (you are even without inflation)

 

[Ausprop]

net yield - interest + (debt x CPI) = net profit

 

[Sunfish]

you and I stronlgy difffer here, like black and white.

That's OK. As long as both points of view get voiced.

 

[Ausprop]

That's OK. As long as both points of view get voiced.

I would love for someone to prove me wrong. there are some investments i need to dump if i am wrong.

surely it's as simple as this: if someone else pays for all or the majority of your holding costs and it is cheaper to repay your debt tomorrow, then you must be getting ahead?

i think what you are saying is that it is unlikely you will get such a free ride, but clearly a comm property say that yields 9% is just such a ride. Een a resi yield of 5% is half of a free ride - which is better than full price!)

 

[Sunfish]

I would love for someone to prove me wrong. there are some investments i need to dump if i am wrong.

Sorry, I can't. I have stated my case as well as I can. If you are relying on this for your investments to work, just look at interest rates and inflation over time. Rates always rise to compensate the lender so there is no free lunch.

If, having tested your own theories, you still believe you are right, Go for it! Don't mind me.

 

[Value Emperor]

Sorry, I can't. I have stated my case as well as I can. If you are relying on this for your investments to work, just look at interest rates and inflation over time. Rates always rise to compensate the lender so there is no free lunch.

Thats how I have always understood it.

Its all relative. Interest rates are virtually always above the inflation rate.

If inflation increases significantly, interest rates have to go up, but the cashflow from property investments does not go up by the same degree.

Last time we had high inflation in the 80's, properties that had been cashflow positive, were still making 8-10% gross yields but because interest rates were above 12% they suddenly became negative. I recall there were a lot of desperate sellers and this forced down prices. This has happened in most countries where inflation shoots up.

This time round, it wouldn't even take the same increase in interest rates or inflation to get a similar difficult scenario as yields and interest rates are starting from an even lower base, credit was even more readily available and high property prices have left a lot more people overexposed.

 

[travelbug]

I have steadfastly maintained that inflation does not erode away debt!

All that happens is that inflation causes higher interest rates so you compensate your lender for the inflation that would otherwise reduce his/her capital investment in you each year. Do you honestly believe that your lender would allow you to cheat him that way! True, after years of steady inflation your debt reduces significantly in nominal value but you have paid the difference every month.

You can argue tax advantage if you are desperate but I am talking about pre-tax advantage.

But the interest rates don't keep going up and up.

It's not the actually $ it erodes, it increases your REAL money (i.e what it can buy).

Eg you buy a unit worth $200K. You borrow $180K. Inflation causes your property to double so it's worth $400K. Now your $180K debt would only buy half a unit.Yes I know there are costs along the way but if you bought well with good yield your would be CF+ now.

 

[Deltaberry]

I have steadfastly maintained that inflation does not erode away debt!

All that happens is that inflation causes higher interest rates so you compensate your lender for the inflation that would otherwise reduce his/her capital investment in you each year. Do you honestly believe that your lender would allow you to cheat him that way! True, after years of steady inflation your debt reduces significantly in nominal value but you have paid the difference every month.

You can argue tax advantage if you are desperate but I am talking about pre-tax advantage.

That's certainly not how I understand debt and it almost seems there's a confusion about the concepto f debt here... just because your property goes up in value doesn't mean you're 'cheating' your lender. Why would your lender care whether the asset goes up or goes down in value? Debt is a participation with quasi-fixed returns, not an equity participation.

Because of the fact that debt is prioritised ahead of equity in the event of default, the lender's risk is compensated by quasi-fixed interest rates. It does not not equity participation and it does not give a crap whether your property is going up or down and as a result, even if it does goes up, the lender does not need higher rates to compensate him. Rather interest rates reflect the cost of borrowing overnight and by being able to vary interest rates the lender is simply offsetting ITS cost of borrowing...

 

[Sunfish]

... just because your property goes up in value doesn't mean you're 'cheating' your lender.

Of course not. That's not what I said. But your lender is not going to allow you to "cheat" him with deflated dollars. Why should he?

If looking at this from the borrower's angle confuses you, look at it from the lenders'. For you to gain, they must lose. (I'm talking about the value of the A$s in which you conduct the transaction, not the asset) They make the rules and have highly qualified staff so why would they allow it?

But I don't give a rat's if you see this or not. Why should I?

 

[Ausprop]

this is being over complicated. borrowings tend to be a great deal vs. inflation because depositers are so royally done over. but the point is, the borrower isn't the one paying the interest anyway, it's the consumer of the asset.

keep it simple: if you have a debt that someone else is servicing and there is inflation in the system, then obviuosly you are profiting by any deflation of that debt.

 

[Ausprop]

net yield - interest + (debt x CPI) = net profit

sorry... a rather obvious error in my formula. should be:

net yield - interest + (debt x CPI) + (cap gain - (asset value x CPI)) = net profit

 

[WinstonWolfe]

I would love for someone to prove me wrong. there are some investments i need to dump if i am wrong.

surely it's as simple as this: if someone else pays for all or the majority of your holding costs and it is cheaper to repay your debt tomorrow, then you must be getting ahead?

i think what you are saying is that it is unlikely you will get such a free ride, but clearly a comm property say that yields 9% is just such a ride. Een a resi yield of 5% is half of a free ride - which is better than full price!)

AP, if you attribute so much of an IP's net profit to inflation, then you are saying property growth at the rate of inflation is a sound investment. And remember, the RBA aims to keep inflation between 2 and 3% via rates.

In focusing on inflation, you are erring in believing cash flows and growth have a linear positive correlation with it. This isn't so. When inflation is up, rates go up, and growth is restricted.

Are you mistaking property growth to be solely an effect of inflation?

It is true, inflation fuels a portion of growth, but remember higher rates try to offset that......

The growth that makes an investment a good one, is the portion of growth above the inflation rate.....and that is provided by

Loose Credit

...and loose credit tends to occur moreso in low inflationary environments....though credit has been loose for the last 12 years, which I'll address below.


Where you are right in your thinking, is in the effect of inflation on cash flows:

- Holding costs normally escalate at the rate of inflation.

- Rents escalate at a rate somewhere between inflation and property growth, as rent has to strike a balance between maintaining yield on current value, and inflation's effect on wages.

- Interest is a function of inflation.
If inflation goes up, interest goes up.
BUT, importantly, and in support of your views, when inflation goes down, interest goes down.


These effects are better appreciated when cash flows and net worth are charted. When you do so, sensitivity analysis shows net returns are most influenced by that portion of property growth above the inflation rate. And growth above the inflation rate is possible how?????

BY LOOSE CREDIT

Admittedly, over the last 10 years, growth has been strong. IMO, that is very much due to loose credit via looser DSRs and LVRs. One has to ask whether these can be loosened further in the future.

The argument that undersupply and population growth are the prime drivers of property growth, is shot down when credit it tightened. No matter how many people want houses, if they can't pay cash, the houses don't get built.

Below is property performance over 2 economic cycles.
Average cpi, property and rent growth are 4%.
Rental yield begins as 5%, and retains that on average.
Interest rate averages 3% above cpi.

Hopefully it is evident this investment has weak returns, and most likely underperforms cash in (term deposits or bonds)

To summarize and simplify,

property performance is dependent on the degree combined cash flow and growth outperform inflation.

In the real world, this reduces to how much the combination of rent (and initial rent yield) and growth outperforms cpi.

 

[BayView]

Hopefully it is evident this investment has weak returns, and most likely underperforms cash in (term deposits or bonds)

I disagree.

Let's assume your average wage earner on $55k who wants to begin investing at aged 20. The choice is cash, or an IP. The example person has $10k to spend.

Don't know about bonds, but I'd say that dollar for dollar invested in a TD and an IP, the IP would leverage into a far better return than cash.

Taking away the amount of cash required to buy even you cheaper IP's if you are using a 10% deposit (easy when lending is loose).

Cash is usually deposited into a TD with after tax income, as is the deposit for the IP, but this is where the similarity ends.

With a cash deposit, you are reliant on the interest rate paid to you by the Bank for the return, but then you get taxed on it. You will be re-investing the returns. Over a year, the value of the cash will diminish at the rate of inflation, so the "asset" is worth less each year.

Now, with your IP there is the rent, the deductions for interest on loans and depreciation to offset the wage earners's tax bill each year, and of course; the capital growth of the property.

The tax return is also re-invested to decrease debt.

In our own personal case, we had a cash amount of $100k approx in 1998 to invest in something (it was another PPoR as a deposit). That was our combined total nett worth (not including doodads). We both took a major drop in income at this time with this PPoR purchase (left the full time jobs to do the B&B).

Now, fast forward to today 12 years later; we have done a lot of things wrong , and that $100k nett worth is approaching $1.5 mill. No boast; just stating a fact WW.

Would $100k in cash in TD's alone have produced the same result?

 

[Sunfish]

Now, fast forward to today 12 years later; we have done a lot of things wrong , and that $100k nett worth is approaching $1.5 mill. No boast; just stating a fact WW.

Would $100k in cash in TD's alone have produced the same result?

If we are allowed to cherrypick examples, I have 1,800% gain in shares in 7 years. (In the last 10 years the results of my property investing has been disappointing.)

I may never repeat that, and it is unlikely you would be able to repeat your experience, starting today either.

 

[WinstonWolfe]

With a cash deposit, you are reliant on the interest rate paid to you by the Bank for the return, but then you get taxed on it. You will be re-investing the returns. Over a year, the value of the cash will diminish at the rate of inflation, so the "asset" is worth less each year.

Mark, my workings above ignored tax and deductions just to simplify things. Ausprop, High Equity, and I have been debating the pre tax scenario for a week or so, trying to refine formula for how inflation effects net profit.

Yes there are benefits from tax for IP, moreso than cash.
Using another xls, I have modeled cash and IPs after tax, and there is still a breakeven point with investment property. Cumulative after tax -cf has to be offset by increase in equity. If not, you are going backwards. Yes, there are savvy ways to reduce -cf like fixing rates when low, and escalating rents with small outlays on facelifts etc. However, passive growth is more difficult to engineer. It's strength is a function of loose credit.

A term deposit won't necessarily deflate after tax. It depends on the relationship between interest rate, inflation, and tax rate.
If interest is 6%, cpi 3%, and tax rate 40.5%, the value of the term deposit is not deflated. There's enough after tax growth to counter inflation.

Now, fast forward to today 12 years later; we have done a lot of things wrong , and that $100k nett worth is approaching $1.5 mill. No boast; just stating a fact WW.

Would $100k in cash in TD's alone have produced the same result?

Your returns validate what I am saying Mark. If you look back, your IP capital gain has far exceeded the rate of inflation. Try spreadsheeting your investments with cg equal to cpi.

Finally, my modeling highlights that timing the market is a superior strategy to B&H. Sitting on -CF property for 5 years underperforming cash, leaves you in a weaker position than if you timed the market. And that is what you have done Mark. You got in right at the beginning of a strong growth period. If you had got in in 1990, your annualized percent yield would be lower because growth was weaker in the 90s. Someone who bought an IP in many parts of the gold coast 2-3 years ago would be behind cash currently, because growth has been below inflation and even negative. You can't just consider inflation's effect on your debt is going to make an IP perform better than cash. An IP's ability to outperform cash is dependent on combined net cash flow and growth.

 

[Value Emperor]

Hmm yes..
The taxed return from a Term deposit has beaten:

An index fund of the US share market bought 10 years ago
Virtually any property in Japan bought 20 years ago
Gold that was bought 40 years ago
Almost all blue chips in the Aussie sharemarket purchased 5 years ago
Almost all Western Sydney properties purchased 5 years ago
and much much more.

Term deposits must be the best investment of all.

 

[Deltaberry]

Of course not. That's not what I said. But your lender is not going to allow you to "cheat" him with deflated dollars. Why should he?

If looking at this from the borrower's angle confuses you, look at it from the lenders'. For you to gain, they must lose. (I'm talking about the value of the A$s in which you conduct the transaction, not the asset) They make the rules and have highly qualified staff so why would they allow it?

But I don't give a rat's if you see this or not. Why should I?

The fact that you post suggests you do care whether or not people get what you're saying... but I usually don't like to take low angle shots like this, but since you don't seem to shy away from them...

Anyway no I really don't get what you're trying to say. A lender is essentially an investor looking for fixed returns. I am one such investor, when I invest in Mirvac high yield convertible notes for particular projects or Becton high yield bonds. The success of my investment depends on Mirvac etc being able to develop their project on time and on budget so that:

a) I get my fixed returns; and
b) I get my equity upside

You make it sound like the lender (which is really an investor) is hell bent on seeing you fail or something like that, which is obviously not the case, but I do enjoy conspiracies that the banks are out the get you every now and then. And no, banks don't really employ that many smart people when dealing with a few house loans. You ever wonder why your loan officer is paid $50k or $60k pa? Or perhaps why Northern Rock had a bank run?

But I do agree with you that when interest rates hit 15%, even the poeple with 10% yields and positive cashflow are going to struggle. Oh in fact when interest rates hit 90%, I think even you would go bankrupt unless I underestimated you and you have no debt. And probably anyone who has any form of corporate debt such as News Corp, Woodside Petroelum and Grocon would go bankrupt too.