Originally posted by Kevmeister
OK. I have a really dumb question, but I can't see the answer.
Measured long term, I must presume that property growth will exceed inflation. Am I right or wrong on this, firstly?
If property prices continue to grow, but rent increases only by inflation, this tells me Yields will continue to drop forever and, in theory, they will one day approach zero.
But they don't [seem to].
Even in Jan's book she talks about rents taking a while to "catch up" during a property boom because wage earners incomes are not increasing at the same rate and I thought "Yeah, that makes sense".
But if they do "catch up", either:
1. Long term growth is the same as inflation, if it is *true* that rents generally increase by inflation. OR
2. Rents actually do grow faster than inflation, to catch up to the long term property growth.
Can someone offer me an opinion/explanation on this?
Well I consider this for a number of months and asking questions on this forum. Here is a summary.
- E typeThere will be a bulk of properties owned or rented by salaried/wage slaves. ie. Out west in most capital cities (maybe out east in Perth)
- B type. There will be a smaller percentage of high end properties owned or rented by people not dependant on salary or wages. eg. Mosman, Double Bay, Toorak etc.
- EB type. There will be a percentage of properties which have some characteristics of both.
Let me bore you with my ideas.
Lets divide the property market into three overlapping market segements.
First the high end "B" properties. Nobody on normal PAYE salaries generally can only dream to own them. There price is dependant more on the price of the stock market and the general money in the economy. I am a strong beliver in the "Rich getting Richer", this law seems to have held true for a long time, the rich will find a way of "accumulating" a larger proportion of the money in the economy to them. For example if another 10Billion of wealth is generated in Australia next year 9 Billion of it will be in the hands of the the top 3%. Thus high end properties will keep going up by a much greater proportion than the average growth of the economy. Rich will get richer, and they will spend some it on nice places to live. So expect in the long term for those suburbs with $1M or more average prices to increase at a rate much exceeding the growth in the economy. (B properties will also loose badly when the economy goes backwards). These properties grow at a rate exceeding inflation, basically I think you will see they they will grow at a mulitiple of economic growth.
"E" type properties. The bulk of properties are owned by employees, I think these properties must be tethered to the ablity of employees to pay for them. Exceptional price growth in recent history seems to much more a function of improved affordability due to low interest rates than by improved salaries/wages. In a low interest rate environment where rates can only go up, maybe this is something we need to be very carefull not to pay over the odds. I cannot believe that these properties can exceed inflation over the long term, price increases must have a strong relation to the wage earners salary growth. However as we have seen, interest rates also play a big part of the affordablity.
"EB" type properties. These are those properties owned by profesional people, small business owners, people with jobs and other assets (and the group AL wants to join!). Basically not B type and not E type. So these properties will exceed inflation over the long term, but not to the extent that B type properties will.
For most capital cities there is also population increases, meaning more land is required for houses/units of the same size or more houses/units need to be built on the same amount of land. Result, prices of most existing land will increase in price as the general population competes. So owning land will over time be expected to increase in value above inflation. 10 years ago I was ripped off and purchased a house for $88K (I was told that I paid 8K too much!) , now inner city melbourne, Seddon is full of middleclass and the price has increased to the affordabilty of the middleclass. The same land has become more desirable.
So I believe long term land prices will increase at least above inflation and the more desireable the location/land the more the property will grow above inflation!.
Now what about the relationship between rents and property values? I suggest a more meaningful question be first asked; "What is the relationship between mortage affordability (the function of purchase price AND interest rates) and rental returns". Last year Michael Yardney suggested that he has noted that rental returns are generally average around 1.5% below the current interest rates for well located properties. Meaning investors like me can afford to contribute 1.5% (plus costs) above interest rates to get our hands on blue ribbon property. So if interest rates are 6% expect well located property to return 4.5%.
So I think that
- Average rental returns will be related to affordablity in the long term. Average rental returns will not continue to fall over the long term. I think it is dangerous to buy a property returning 2% at the bottom of the interest rate cycle. If interest rates are 6% now and in 2 years are 9% I doubt you could expect that the tenants will be able to afford to pay 50% more in rent! How many people will buy a house in Sydneys Mosman for $3M 90% financed at 9%pa and be able and happy to suck up the difference in costs considering a tiny 1.5% rental return (ie $1200pw - costs).
- The land compent of your property will exceed inflation in the long term, buying houses on good blocks of land will result in better than average growth but lower than average returns. Plan to capitalize on this one day by building units or changing getting delopment permits and on-selling to a developer!
The core of my belief is thus, to take care not to pay to much above the value of the rental returns. In Melbourne and Sydney this means that there is very little quality properties available. My stratagy is thus to first create equity, create income by development of units on existing land (ie. land that is returning 3%pa, build units and then boosting returns to 6.5-7%, gaining equity in the process). Others will buy and do a renovation or "make-over" but same result, better returns on the $ invested!
That's my 1cent worth. In November I will know if my development plan meets expections.
