Are Australian property prices going to crash?

[Sunfish]

Why was your last 10 years investing in property disappointing? The last 10 years has seen some good increases in many areas.

This is the frustrating part of a property forum: If I say that my property hasn't increased in value for three years (and it hasn't) you can, reasonably, say The last 10 years has seen some good increases in many areas. If say that Sydney 3br BV houses without harbour views (the largest single market, which was being called the best market until well after then) has been stagnant since '03, the same answer. But If I say that the market as a whole is doing something I am told that I am in error because there is no "one market" and that (insert the "flavour of the year" city here) is powering ahead.

I don't really claim to know a lot about shares but clearly I know more than you and most other rusted on property investors. I'm not the only one who owns significant shares here but we are in a distinct minority and cannot refute the hogwash which is presented as fact in the Are shares like gambling? threads where (was it you?) someone steadfastly maintains the share market is a zero sum game and that the majority of players lose.

My property has more capital tied up for smaller returns than my share portfolio (GFC included). That's a fact!

 

[Sunfish]

But many times people trot out the "cash is king" statement and it's not that simple.

I may be getting my threads mixed up but didn't this debate start with my assertion that inflation doesn't "inflate away debt", that there is no free lunch? I know I have never said "cash is king" and I don't remember WW doing so either.

 

[BayView]

I may be getting my threads mixed up but didn't this debate start with my assertion that inflation doesn't "inflate away debt", that there is no free lunch? I know I have never said "cash is king" and I don't remember WW doing so either.

WW didn't say it, but the theme was similar - he intimated that cash is better performing than property.

But, in a purely dollar for dollar comparison, using all the available investing tools associated with each asset class, my belief is that cash is 4th out of cash, shares, IP and businesses.

BTW; I never said you were "wrong" SF.

You gave your view based on your own personal experience, but that has not been my experience. I gave my view based on mine, and what everyone knows; that there are a myriad of micro-markets within the (property) market.

Doesn't mean you are wrong and I am right.

I've bought IP's that have sat flat both in rent and cap growth for over 2 years, but on the whole they have all done ok for me.

I've also got IP's that have never been below 9% rent return, and yet we hear people complaining they can only get 3-4%. Where are they looking?

Admittedly my view is more simplistic; if I put down X dollars today, what will be the nett worth of those dollars in 10 years?

What will it have grown to?

What it is worth, or it's buying ability in 10 years is not in my control. All I know is that my IP will provide me with more folding stuff after 10 years than a Bank book will.

To start computing into it the intrinsic value, and so on is interesting, but it would lead to becoming so stuffed up with data that you wouldn't pull your wallet out of your back pocket.

There are a fair number of people on here that are in this exact boat; all data and no Land Titles.

 

[Sunfish]

To start computing into it the intrinsic value, and so on is interesting, but it would lead to becoming so stuffed up with data that you wouldn't pull your wallet out of your back pocket.

There are a fair number of people on here that are in this exact boat; all data and no Land Titles.

Back off Marc! I detest the "theory" of "intrinsic value" as much as anyone. And it is grossly unfair of you to suggest that I'm so stuffed up with data that (I) wouldn't pull (my) wallet out of (my) back pocket. In fact I take it as a serious slur on my efforts as an investor and you should be more careful with your words. I have the guts to pull my wallet out of my pocket to buy shares that would make you you guys crap your pants. But I am still investing.

 

[WinstonWolfe]

WW didn't say it, but the theme was similar - he intimated that cash is better performing than property.

But, in a purely dollar for dollar comparison, using all the available investing tools associated with each asset class, my belief is that cash is 4th out of cash, shares, IP and businesses.

BV, the point I am making is that whether IP beats cash, is dependent on the relationship between interest rate, starting yield, and escalation rate of growth and yield.

If you buy a property where initial yield, and escalation of growth and yield are 3%, and rates average 3% above rent, it doesn't beat cash at 6.5%.

I am trying to identify the breakeven point of IP vs cash under a range of likely future scenarios, as I don't anticipate the future will be the same as the past. I accept 3% escalations are below the historical average, but I believe the risk of reduced credit is growing, and the historical average growth escalation for the next 10 years will be much lower. If it is, rent escalation and/or the margin between inflation and interest rates, will have to compensate.

Having a clearer understanding of compensatory yield escalations and the margin between yield and interest rate, when growth escalation is low, will help me with feasibilities on build to rent and desirable initial yield on passive B&H.

If you anticipate things in the future will be much the same, then I presume you will buy whenever you can afford the debt serviceability, even if initial yield is 3%.

 

[Deltaberry]

My interest in inflation and investment performance is leading me down another path for the time being. What I believe is official inflation rate seriously underestimates inflation, hence why the ABS is looking at a major review of it and the RBA are looking at asset price inflation in addition to general price inflation.

My argument is that property that grows at general price inflation, as recorded by cpi, performs poorly. In fact, when general price inflation goes up, performance is worse. It is growth above inflation rate that makes a property investment a strong performer. However, all this is contingent on cpi actually representing general price inflation accurately, and I am doubting it does.

Bill's IP example obviously has performed well in the long term, but how much of that performance is due to growth attributable to cpi, depends on how much inflation cpi represents.

What you're talking about is just real returns...

If CPI = 5%
Property Gains = 3%

Real Gains = 1.03/1.05 = 98%

The maths is easy. I guess the bigger question is this. Going forward, is property going to outperform inflation? If not then where are you investing your money? Is that asset class you're investing into going to outperform inflation? Are you telling me term deposits outperform inflation?

 

[Deltaberry]

BV, the point I am making is that whether IP beats cash, is dependent on the relationship between interest rate, starting yield, and escalation rate of growth and yield.

If you buy a property where initial yield, and escalation of growth and yield are 3%, and rates average 3% above rent, it doesn't beat cash at 6.5%.

I am trying to identify the breakeven point of IP vs cash under a range of likely future scenarios, as I don't anticipate the future will be the same as the past. I accept 3% escalations are below the historical average, but I believe the risk of reduced credit is growing, and the historical average growth escalation for the next 10 years will be much lower. If it is, rent escalation and/or the margin between inflation and interest rates, will have to compensate.

Having a clearer understanding of compensatory yield escalations and the margin between yield and interest rate, when growth escalation is low, will help me with feasibilities on build to rent and desirable initial yield on passive B&H.

If you anticipate things in the future will be much the same, then I presume you will buy whenever you can afford the debt serviceability, even if initial yield is 3%.

That's precisely what an IRR analysis does. And to be fair, using your assumptions of 3% rental growth and 3% capital gains makes property a crap investment. But you know what, same with shares. Or anyting. A piece of rock that gives me 3% growth and 3% capital gains is also crap.

Also to be fair in the property vs shares comparison, you'd risk-adjust the 'inflation rate' (ie discount rate) you apply to shares with a beta. If you're investing in particular stocks, you'd have to do that and if what you're doing is punting on FMG Number 2, then perhaps your beta will be 2.5 and your discount factor should be more like 15% rather than the CPI index of 3%.

But when my piece of rock is doing 6% initial yields plus 5% growth, the numbers are also entirely different. 100bps movement is very significant in these modelling exercises. So, once again, the question is back to this. Where do you see future initial yields and future growth?

At the end of the day, I do similar analysis to what you're trying to do, but for a living, albeit not specifically with property... in fact with corporations and public-listed companies. We all know how the numbers work. The hardest part is to stake a claim on what will happen to forecast CPI, interest rates, growth rates, yields etc based on some loose statements like credit is tightening. To me, coming up with an extreme view like that is as reckless as people who say "population is increasing", "there is a housing shortage" and it's simply the same thing but at the other extreme.

Over the course of the past 6 months I've seen ridiculous views from some CFO claiming parity in AUD/USD to some mining CEO telling us fines prices of US$200/dmu by the end of 2011. At the risk of sitting on the fence like most research analysts from the big houses, I'd rather be moderate.

 

[WinstonWolfe]

That's precisely what an IRR analysis does. And to be fair, using your assumptions of 3% rental growth and 3% capital gains makes property a crap investment. But you know what, same with shares. Or anyting. A piece of rock that gives me 3% growth and 3% capital gains is also crap.

Not necessarily crap DB. depends on cpi and the interest rate:yield differential. IRR doesn't know what the discount factor is, so you have to subtract it from IRR. However, NPV does. What I am driving at here, is to look further upstream to discover what drives investment performance, especially on leveraged assets. At the end of the day it isn't growth or cg or rates or yield on their own.....but rather, the differentials between them...

Also to be fair in the property vs shares comparison, you'd risk-adjust the 'inflation rate' (ie discount rate) you apply to shares with a beta. If you're investing in particular stocks, you'd have to do that and if what you're doing is punting on FMG Number 2, then perhaps your beta will be 2.5 and your discount factor should be more like 15% rather than the CPI index of 3%.

But when my piece of rock is doing 6% initial yields plus 5% growth, the numbers are also entirely different. 100bps movement is very significant in these modelling exercises. So, once again, the question is back to this. Where do you see future initial yields and future growth?

.....and don't forget the differential between yield and interest. we have just been through a period where the rba dropped the spread between IP yield and interest close to 0. i.e. bank std discounted variable rate was 5.15% in June 09, and it was possible to get 5%+ gross rental yield. Since, rates (and the spread) has moved back up.

I believe that spread will have to find a new lower average in the future, as credit contracts. If it doesn't, property prices will have downwards pressure. The RBA and govt will do all they can to stop house price deflation. Their tool will be a lower cash rate. However, that will be challenged by the premiums our foreign credit maestros demand. And imo, bank margins are going to get jammed in between those two forces.

At the end of the day, I do similar analysis to what you're trying to do, but for a living, albeit not specifically with property..

Hey, wish I was sitting in an office paid for by someone else, on their time, doing this.

 

[Deltaberry]

IRR is more a cashflow analysis which coincides with the phrase "cash is king". DCF is fine too but too many difficulties estimating WACC. Anyway I've always used IRRs when I'm looking at exits (as that's how I look at MBOs and LBOs) and where it's a going concern I use a DCF.

Actually I bought a place last year and I'm yielding 7.5% (don't ask me how). I punched out a DCF (assumed 2% growth in rent, 3% growth in most of the operating costs and used a terminal growth rate of 3% assumming it's a going concern for an infinite amount of time) and got an NPV above my purchase price with a WACC of 8.5% (high gearing, hence much has been captured by 7% cost of debt). Anyway you're absolutely right. Twig the differentials (ie assumptions) and you can change the outcome dramatically.

I absolutely agree the spread has to be lowered otherwise numbers don't make sense. That said I'm also a believer that low yielding places (eg Toorak and Double Bay) don't necesarilly go by these figures... people buy them because it's more than just an investment asset. That's the conumdrum I have with these property investments . For investment class property, I believe spread will catch up through increased rental demand. I'm a believer in market within markets, a big believer in high yield + high growth, hence why I debate with the less financially-attuned members here about inner vs outer suburbs and so forth. I personally believe yields will catch up over time and will be towards the higher end of inflation (relative to other commodities, such as food etc).

But yea getting paid to do this stuff is pretty good. Maybe you should do this on a contracting basis. The other day I heard some oil and gas analyst who was contracted to build some oil and gas models (which is pretty easy compared to other resource commodities) was charging $3k per day. That's pretty high in my opinion.

 

[WinstonWolfe]

IRR is more a cashflow analysis which coincides with the phrase "cash is king". DCF is fine too but too many difficulties estimating WACC. Anyway I've always used IRRs when I'm looking at exits (as that's how I look at MBOs and LBOs) and where it's a going concern I use a DCF.

Actually I bought a place last year and I'm yielding 7.5% (don't ask me how). I punched out a DCF (assumed 2% growth in rent, 3% growth in most of the operating costs and used a terminal growth rate of 3% assumming it's a going concern for an infinite amount of time) and got an NPV above my purchase price with a WACC of 8.5% (high gearing, hence much has been captured by 7% cost of debt). Anyway you're absolutely right. Twig the differentials (ie assumptions) and you can change the outcome dramatically.

I absolutely agree the spread has to be lowered otherwise numbers don't make sense. That said I'm also a believer that low yielding places (eg Toorak and Double Bay) don't necesarilly go by these figures... people buy them because it's more than just an investment asset. That's the conumdrum I have with these property investments . For investment class property, I believe spread will catch up through increased rental demand. I'm a believer in market within markets, a big believer in high yield + high growth, hence why I debate with the less financially-attuned members here about inner vs outer suburbs and so forth. I personally believe yields will catch up over time and will be towards the higher end of inflation (relative to other commodities, such as food etc).

But yea getting paid to do this stuff is pretty good. Maybe you should do this on a contracting basis. The other day I heard some oil and gas analyst who was contracted to build some oil and gas models (which is pretty easy compared to other resource commodities) was charging $3k per day. That's pretty high in my opinion.

There's not much discussion at this level on SS DB. I appreciate your input.
Several years ago, there was some good analysis being done. Guys would disagree about some point, then go away and come back with a xls model showing timing was superior to b&h, or some such thing. Timing consisted of switching most or all capital between property and shares or cash. See_Change was good at this stuff, as was Pete from Perth (an xls guru contractor who the last I heard was driving a new ferrari), Mark_B (ex economist with RBA), GreatPig, and Sim (the forum administrator). It's worth a squiz at some of the threads from 2003-4, when many of us thought the market had peaked for the time being.

BTW, when talking about spreads, I presume the higher the spread the higher the risk, which is why I put it as rate:yield, rather than vv.
We better agree on terminology.

What I am moving towards here is a form of cap rate forecasting for resi IP, but using gross yield rather than net. I'll use the figures to guide offers on IPs. I think we are moving into a structurally different leverage climate, and it is going to become more important to focus on yield.

I'll post a link to the xls I am messing with to model this stuff. APpreciate your opinion on how to better develop it. You obviously have a handle on the 'greeks'.

Re me working as a modeler, I wouldn't have the confidence. I've met some of the best in Australia and the US (maths PhD's), and I know how quickly and confidently they can complete a project. At this point, I am more interested in minimizing gigo, by improving my undestanding of bank credit and floating exchange rate mechanism on the economy, current account, balance of trade, BOP, etc. Hard to model well without realistic interpretations of this stuff. I talk about this stuff with two mates (an ex trade commissioner to the UK and a CFO for a large insurance company) and am surprised they don't understand it at a deeper level. Presume BHP has a large room full of guys to analyse/hedge risk 24/7. I wonder how much Rudd has changed their beta gradient?

edit: btw, when I first read up on the greeks, I got the impression everyone used parametric stats, including capm. I couldn't believe it. I presume things have moved on and non parametrics is more the go. Presuming normal distributions in the presence of fat tails and high kurtosis can kill.

 

[Deltaberry]

I'll keep this short as I need to dash off to meeting in 2 minutes. BHP certainly has a large room full of guys analysing this stuff. They do prop trading on commodities so they obviously look at this stuff. Need to dash off to a meeting.

Want to flick a model or two you think is the ultimate way to look at things (only if you don't mind)? I'd love to play around with it and see where you're coming from (ie what assumptions you're using and what basis are you analysing things at)? I'm sure I would learn a few things here and there too about different ways of looking at things.

PMing you my email.

 

[Intrinsic_Value]

There are a fair number of people on here that are in this exact boat; all data and no Land Titles.

Great phrase i have to remember that one.

 

[Intrinsic_Value]

My interest in inflation and investment performance is leading me down another path for the time being. What I believe is official inflation rate seriously underestimates inflation, hence why the ABS is looking at a major review of it and the RBA are looking at asset price inflation in addition to general price inflation.

You raise a very interesting point here.
I think inflation has been 'held down' over the last 10 years through the hollowing out of western industries to china.
The benefits of this seem to becoming to an end now.

Its curious that the ABS is looking at a major review of it. Do you know the details, are they looking significant changes in the composition?

 

[BayView]

Back off Marc! I detest the "theory" of "intrinsic value" as much as anyone. And it is grossly unfair of you to suggest that I'm so stuffed up with data that (I) wouldn't pull (my) wallet out of (my) back pocket. In fact I take it as a serious slur on my efforts as an investor and you should be more careful with your words. I have the guts to pull my wallet out of my pocket to buy shares that would make you you guys crap your pants. But I am still investing.

Calm down SF.

I wasn't referring to you at all with those comments. It's general.

You are becoming quite a testy old geezer of late.

 

[BayView]

If you buy a property where initial yield, and escalation of growth and yield are 3%, and rates average 3% above rent, it doesn't beat cash at 6.5%.

This figure pops up from time to time as a perfectly acceptable yield. Who in their right mind would buy an IP with 3% yield?
And, if the escalation of growth and yield is only 3%, then yes; they need to put their funds into cash, because they are a lousy investor.

Having a clearer understanding of compensatory yield escalations and the margin between yield and interest rate, when growth escalation is low, will help me with feasibilities on build to rent and desirable initial yield on passive B&H.

Low growth escalation is precisely why we should all look to properties with a decent yield first, good depreciation and cashflow after. if you have IP's with no growth, then yes; cash is better because at least you know there is no growth there.

If you anticipate things in the future will be much the same, then I presume you will buy whenever you can afford the debt serviceability, even if initial yield is 3%.

I have never, and will never buy on a 3% yield.
But to clarify; are you talking nett or gross?

 

[cadence]

We have a steady and increasing stream of immigrants coming into Australia. Given the population is guaranteed to increase and most skilled immigrants prefer to reside in the big cities, I find it difficult to see how the Australian property market will 'crash'.

Those suburbs within 10km to the CBD in established areas, eg: Cremorne and Balmain in Sydney, the demand will always be greater than the supply. The worst that can happen to property prices in those areas is for them to not increase in the short term. Given property should be a long-term investment and the trend for median price to double every ten years, even if prices do not increase in the short run, they will over the course of the decade. If you can hold out for that long, you will reap the rewards.

These are my personal views obviously ....... based on my very limited experience in property investment.

 

[WinstonWolfe]

You raise a very interesting point here.
I think inflation has been 'held down' over the last 10 years through the hollowing out of western industries to china.
The benefits of this seem to becoming to an end now.

Its curious that the ABS is looking at a major review of it. Do you know the details, are they looking significant changes in the composition?

I agree totally IV. Our shifting of most goods manufacturing to SE Asia has held Australian CPI down artificially. This is the ABS overview. Results won't be out until dec 2010. I don't know which spin they'll put on it. Govt likes to underpredict cpi to suppress wage inflation. But asset price inflation cannot be ignored. And the price of imports like oil should have less influence, especially if the rba wants to raise rates to suppress inflation....that's a ridiculous situation. Further, when a banana shortage is used to justify a rate hike, it's pretty obvious the spin is thick and fast.

I just plotted cpi index figures (ABS 640107) for goods vs services and services have inflated 33% faster since 1990. Services obviously rely more on local labor, and presumably exclude the cheap import factor moreso.

Further, rents in inner northern brisbane are available via postcode via the rental tenancies authority. rents increased between 2005 and 2010 by 7.3%pa. Considering rent constitutes a significant portion of household spend, cpi increase in the same period is a joke.

I've been looking at rents to see the strength of their correlation with cpi and property growth.....and I think cpi is a seriously unreliable figure to predict future rent growth, or even investment property holding costs. Probably the most reliable figures in qld anyway , come from the RTA.

 

[WinstonWolfe]

I have never, and will never buy on a 3% yield.
But to clarify; are you talking nett or gross?

Talking gross BV. Many up market areas where investors chase short-medium term growth don't do much better than 3% gross. This strategy imho, won't be as rewarding for some time.

 

[james_w]

I just have one thing to say I also said this when we got tonnes of D&G talk from some here if you think your house is going to crash I will buy it for 30% under market value few years later and not 1 person has taken up this offer
pretty sure you lot were saying we would see 50% drops I had a mate thinking the same thing he waited and waited and waited... to buy houses real cheap guess what he has now bought a house and that area had no crash next we will see oh this property dropped 10% in this quarter or this month etc hint properties fluctuate and consintently move up and down in the 5-10% level through the year it's not new it has happened for many years.
can't be to sure the property markets going to crash now can we

 

[Sunfish]

Great phrase i have to remember that one.

Big hat, no cattle.