Logic Police Thread - the really DIFFICULT questions ...

[yieldmatters]

Hi all ...

Cut and paste from the general thread:

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I have had an absolute blast debating the issues with people on this forum. People on the whole are pretty accomodating and interested to chat. But at the same time I've also go on people's nerves and I can understand why.

This section of the forum is clearly for people who aren't questioning the benefits of property as an asset category. They already believe in it and want to discuss issues at a lower level. For example (and I lifted this from the description) ... advice and strategy discussions, negotiating techniques etc. For example if there was a forum about the love of snowboarding and it was constantly bombarded with facts (albeit logical 'facts') as to why snowboarding sucks it would tend to irratate people right?

But at the same time I think some opposing views on the future of this asset category is useful. Especially for potential new entrants who might be sucked in by the 'hype' - they need all sides of the story. There are some clear problems of logic at a macroeconomic level that people can't explain and it indicates some real problems moving forward. For example,

* How can house prices always outstrip wages?
* How can house prices always outstrip rent?
* Why should house prices ever rise in real terms (> CPI) ?
* What is the limit to household debt?
* How can you always sell an economic loss making asset for a higher price to a future buyer?

So I'll start a thread in the "Property Market Economics" section called "Logic Police" and we will try to keep it to these big macroeconomic problems.

I can't control the other 'bears' out there but I'll be confining my big picture questions mainly to this area of the forum in the future. Hopefully some pro-property people will turn up and deliver some good answers - otherwise it will be boring!

 

[Twitch]

Increasing population chasing fixed supply (of inner/middle city)

Increasing non-wage income & wealth

Increasing wages

A resulting disproportionate increase in money for discressionary spending (if you need $100 for essentials and your wage increases 50% from $120 to $180 your discressionary income has gone from $20 to $80, ie 400%).

Strong Australian cultural bias towards owning vs. renting

Discressionary spending being funnelled into increased mortgage payments to fund better PPOR


That's why IMHO land costs will continue to rise above CPI.

 

[jrc]

This could be an interesting thread. Over the last 6 years I've done quite well out of property (and I am quite aware that timing was part of this) and am intending to keep property as my main focus of investing - mainly for ethical reasons. It is hard to find shares where at least some part of the company is not involved in something I don't want to be. At least as a landlord I have the option to make decisions that I believe are ethical.

There is one issue that for many properties might give a rosier picture of growth than might otherwise be the case both in comparing individual properties and say properties in a location over a long period eg 20 years. This is are we comparing apples with apples
eg if Property A sold for $X 3 years ago and for $Y yesterday, how much of the chnahge is due to the market and how much to the new kitchen, extensions and extensive landscaping
on a general level if the average price for propertties in Location Z was $A 10 years ago and the average price now is $B how much is due to market changes eg better transport links etc and how much to the actual improvements that have been made to the properties in that location

Rather than how much household debt can grow maybe we need rough rules of thumb eg if your loan, HP, payments exceed F% of your income the average person will be in trouble. I know Westpac with primary producers in the late 80's early 90's had a rough rule of thumb that you were sustainable if total debt did not exceed annual turnover

 

[yieldmatters]

What about art, antiques, vacant land?

YM,

In the flood of your 12.75 posts per day I may have missed your answer to my previous question relating to art, antiques, wine and vacant land as a successful investment for many. 0% yield, negative cash flow. This contradicts your view that yield is required for growth.

Any thoughts?

I did miss it. Sorry.

Over the long term if everybody HAD to buy art, and the price of art (in aggregate) just kept growing above wages then eventually we would be living naked, starving in the bush with only a piece of art to show for it!

I actually don't think too differently to all of you at the micro level. Things such as art, antiques, wine, and property can attract money and grow without any yield if people are attracted to it and are prepared to hand over their cash to buy it. But at the macro level when you add all of this up the money has to come from somewhere and there are eventually limits (hence my somewhat ridiculous example above!).

New money for purcahses either comes from new income (wage growth), declining consumption on other things, or it comes from debt (which isn't really new money). So I think wine and antiques could keep rising at a fast pace for hundreds of years before it impacts the macroeconomy. Property on the other hand is such a big item the limits to finding the cash will be hit quicker.

Anyway - love the discussion so can't help the 12.75 posts a day! I will cut and paste this response into my economics thread if anybody wants to continue it.

 

[DavidMc]

Hold on a minute... you're changing things now...

Over the long term if everybody HAD to buy art, and the price of art (in aggregate) just kept growing above wages then eventually we would be living naked, starving in the bush with only a piece of art to show for it!

Yes, probably so. But people don't have to buy art, nor did I say 'what if people did have to buy art'. People don't have to buy property either, but I don't think it's relevant to what I was trying to get at.

The main point I was trying to make is that yield 'doesn't' matters (as much as some think) in an emotionally infused asset class such as residential property. Especially people such as yourself who probably spends lots of time analysing investment classes where yield not only matters but is almost everything. Capital growth can exist without a good yield or even a yield at all - proven. Will strong property growth continue forever and ever, in the short term, year in year out and under any circumstances - of course not. I don't see many experienced investors on this board arguing that it does. I've satisfied myself that it will happen in Australia over the long term (i.e. in 20, 30, 40 years time - my investing time frame), so I'll continue to do what I've been doing.

I actually don't think too differently to all of you at the micro level. Things such as art, antiques, wine, and property can attract money and grow without any yield if people are attracted to it and are prepared to hand over their cash to buy it. But at the macro level when you add all of this up the money has to come from somewhere and there are eventually limits (hence my somewhat ridiculous example above!).

Of course, there are eventually limits. The million dollar question is what are they? Whatever the limit, if you agree that it does slowly increase over time, then couldn't property prices keep increasing too?

 

[DavidMc]

Awww, damn it... I'm getting sucked in. Anyway, here goes:

To add to what Twitch has listed, another reason 'property investing can work' (which I'm assuming is the underlying concept you are attacking) is because the definition of a 'house' (i.e. a median priced property, from which 'house prices' are measured) changes over time.

Years ago it was a house on a 1/4 acre. Today it's something smaller. In the future, it'll probably be something smaller again. So even if everything else stayed the same (including 'house prices'), property investing would still work.

We can see this in the Melbourne marketplace now. A nicely renovated but otherwise unspectacular 2 bedroom unit sold last weekend in Elwood for just over $500k (it was talked about in another thread). The market has determined that the price of a 'nice place' in inner Melbourne is $500k (well, what I would consider to be a nice place for me to live in). Recently $500k was an OK single fronted house. Now it's a nice unit. As you know in many cases the price of an item is determined by most someone is willing to pay, rather than the true value of the item.

Now, if you owned a large house in this area and had scope to subdivide and build six of these units...

 

[yieldmatters]

Of course, there are eventually limits. The million dollar question is what are they? Whatever the limit, if you agree that it does slowly increase over time, then couldn't property prices keep increasing too?

Glad to see you here! Don't be ashamed!

People do have to buy property - well they have to buy or rent property - the only other option is a tent. So it is a much bigger chunk of the economy than other items such as art and the question is how far can it increase in real terms before something cracks? It could very well be many years off or it could just around the corner. Clearly though more money has been flowing into property than people can fund through increasing wages (or increasing dividends / yields on capital) alone. The gap is being filled by debt - household debt has been growing for a very long time. So I think this is the limit to increases - when the marginal buyer can't get any further credit. Maybe this is 10 years away and I am worrying too early? I'm not sure though - the signs are fairly strong that debt is starting to break us.

I guess where yield matters is if the asset isn't paying it's own way but is relying on an increasing transfer of wealth from others then eventually that has a limit. If the yield was solid then it would be paying its own way and there would be no need to worry.

Regarding the smaller blocks - if the government maintains its current urban planning rules then yes there is money to be made there for sure. But that is not new economic growth for the country - it is just a rearrangement of wealth within the country - not that matters if you are on the receiving end though! Also this effect is not eternal - eventually you hit a new point of equilibrium where demand equals supply and things level out again.

 

[DavidMc]

It could very well be many years off or it could just around the corner. Clearly though more money has been flowing into property than people can fund through increasing wages (or increasing dividends / yields on capital) alone. The gap is being filled by debt - household debt has been growing for a very long time. So I think this is the limit to increases - when the marginal buyer can't get any further credit. Maybe this is 10 years away and I am worrying too early? I'm not sure though - the signs are fairly strong that debt is starting to break us.

Agreed. I have no idea either. The recent inner Melbourne boom is really blowing me away. All I can do is keep spending less than what I earn, ensure buffers are in place, stick to the fundamentals for asset selection, be a good employee, maintain a long term focus and invest regularly (for habit and for increased experience). The property market has been defying logic for years.

I guess where yield matters is if the asset isn't paying it's own way but is relying on an increasing transfer of wealth from others then eventually that has a limit. If the yield was solid then it would be paying its own way and there would be no need to worry.

Well, it also doesn't matter if you love the asset and enjoy it's usage (as is with 70% of the Australian market). Property investing leverages this concept.

Regarding the smaller blocks - if the government maintains its current urban planning rules then yes there is money to be made there for sure. But that is not new economic growth for the country - it is just a rearrangement of wealth within the country - not that matters if you are on the receiving end though! Also this effect is not eternal - eventually you hit a new point of equilibrium where demand equals supply and things level out again.

It will be interesting to see where this equilibrium will end up for Australia. We've got a long way to go before our capital cities look like Hong Kong, London or Manhattan (I'm thinking it will be similar to the US or UK).

Good thread.

 

[DavidMc]

A side note...

I'm reminded of the AMF bowling center jingles when I was a kid.

'For $7.50, you get two games, shoe hire, hot dog, fries and a coke'
'For $8.50, you get two games, shoe hire and a coke'
'For $9.50, you get two games, shoe hire and a coke'

I think now it's $11.50 for a game and shoe hire. Extra game $2. I'm waiting until it's $11.50 just for the coke.

AMF teaches young David inflation.

 

[yieldmatters]

Well, it (yield) also doesn't matter if you love the asset and enjoy it's usage (as is with 70% of the Australian market). Property investing leverages this concept.

I have travelled down this road a bit to solve the mystery of property investing. I think it is safe to say that Australians will pay a premium to own their own house - these days it is a large premium to renting. Why? The enjoyment I guess - social status - some bloody reason but it is definetly there.

So if it is the OO that is at the margin and sets the market price then it actually doesn't matter what the yield is for the investor. The increased price is not driven by the asset's earnings but by the marginal OO's increasing love of the asset. Now this theory fits the facts for me ... while the premium an OO will pay is rising anyway. The investor buys in at a crap yield - they sell out at a crap yield but make money because the OO's ownership 'premium' has risen.

BUT the blocker for me is this - what happens when the OO's premium stops rising? What happens when they think "OK - yeah I want a house of my own over renting but not badly enough to pay that gap". When that point comes the investor if behaving rationally would sell out. The possibility of future gains is gone (at least for a long while) and he is stuck with an asset that makes less money than he could get by selling and cashing in the current OO ownership premium.

Anyway - looking for logic in property markets is a lost cause - I'm just crapping on here for my own entertainment. Somebody mentioned on one of the other threads that looking for logic in the property markets would make a good PHD topic which is absolutely true - you would need to be an expert in economics and psychology to even get close to working it out.

 

[DavidMc]

So if it is the OO that is at the margin and sets the market price then it actually doesn't matter what the yield is for the investor. The increased price is not driven by the asset's earnings but by the marginal OO's increasing love of the asset. Now this theory fits the facts for me ... while the premium an OO will pay is rising anyway. The investor buys in at a crap yield - they sell out at a crap yield but make money because the OO's ownership 'premium' has risen.

Yes.

BUT the blocker for me is this - what happens when the OO's premium stops rising? What happens when they think "OK - yeah I want a house of my own over renting but not badly enough to pay that gap". When that point comes the investor if behaving rationally would sell out. The possibility of future gains is gone (at least for a long while) and he is stuck with an asset that makes less money than he could get by selling and cashing in the current OO ownership premium.

Sounds like parts of Europe. I don't know when we will be there. It's emotional. It's psychological. It's that feeling you get inside of your body when you OWN the place you live in. You can't graph that.

In the meantime there will be ups and downs. Booms and busts. Different areas will have different equilibriums. I'm confident I'll be financially free before then so I guess it doesn't bother me when.

Your analytical mind is hampering you here. I see it all the time. Doctors, economists, engineers and scientists all afraid to move forward unless they are 100% sure of the outcome and as a result don't move far financially. 80% confidence is fine for me. Can you tell that I work in IT?

 

[WASP]

Wheres spiderman i'm sure he could add some great information & discussions to some of these threads

 

[Able]

BUT the blocker for me is this - what happens when the OO's premium stops rising? What happens when they think "OK - yeah I want a house of my own over renting but not badly enough to pay that gap". When that point comes the investor if behaving rationally would sell out. The possibility of future gains is gone (at least for a long while) and he is stuck with an asset that makes less money than he could get by selling and cashing in the current OO ownership premium.

I think an interesting factor in this equation is the changing demographics. What happens when Gen Y are in their 30's, an age that typically provides a lot of first home buyers. We have already seen that Gen Y have different attitudes in many ways and it may be that they will not have the same attachment to owning their own home.

Regards
Able

 

[lizzie]

BUT the blocker for me is this - what happens when the OO's premium stops rising? What happens when they think "OK - yeah I want a house of my own over renting but not badly enough to pay that gap".

this is a good discussion - kudos to ym for joining in, in a constuctive manner.

okay - what might happen when the oo's stop wanting to pay the premimum? they will still need somewhere to live, and will not be willing to take a massive reduction in lifestyle, imo, so the rise in cg will decrease (as demand decreases) but yeilds on rental income will increase (as demand for rental accomodation increases).

eventually, when rent becomes to high for comfort the oo's will move back into the purchasing market and drive up the cg again.

the rental section of this is the cycle is were we are currently situated here on the east coast - and have experienced for the last 12 months. rental vacancies are hovering around 1% (and that 1% are generally the slums of the slums), rents have increased by 10-15% (or more) and if they continue to increase at that rate, in a few years we will shift back into the "purchasing" section of the cycle. probably in another 2-3 years, so now is the time to buy, imo.

the secret is to jump on the bandwagon, and hold on. those who own investment property on a low lvr when the cracks start to appear, and the rental market subsequently booms, will be the ones who come out wealthy ... rents will increase, the underlying mortgage remains the same (or decreases), property prices will remain stagnant as rents and wages catch up so you use your current equity to buy more (of which the increased rents improve your yeild and pay for your mortgages) - and off we going again.

 

[yieldmatters]

okay - what might happen when the oo's stop wanting to pay the premimum?

It's not so much about not wanting to pay the premium. I think there will always be a premium - owning just 'feels' better.

To me the turning point is when the growth in that premium stopping. So the premium is still there - it just has stopped getting bigger.

Then the cycle may move as you describe. Investors cash out - rents go up - owner occupiers buy and so on and so on.

 

[yieldmatters]

The debt angle

Firstly - a disclaimer - everything I am about to say is at the MACRO (aggregate) level - I'm not talking about individual areas.

I have commented regularly that the growth in debt is a big blocker to further long term property values. But I notice the RBA deputy governor in a speech today thinks that debt growth has some life left in it yet. He does acknowledge though that eventually it will hit a ceiling - he just doesn't know when that is. He is not overly concerned by the debt blowout because economic conditions are good and household balance sheets (Assets less Debt) are still healthy. There are lots of good charts in this link so his speech is worth looking at.

http://www.rba.gov.au/Speeches/2007/sp_dg_250907.html

I am not so comforted as the rise in asset values is predominately 'existing' houses and are only worth more money due to increasing levels of debt bidding them up. There is something very circular here which he either chooses to ignore for other purposes or maybe he is just clueless. I find the latter hard to believe.

Anyway - we will see. The debt brick wall to further price growth could be a while off yet if he is correct.

 

[JIT]

To me the turning point is when the growth in that premium stopping. So the premium is still there - it just has stopped getting bigger.

This is part of the normal property cycle.

But what about the 10-40% or so property crash you were talking about before???

Are you finally acknowledging that, broadly speaking, residential property is not so volatile an asset class as to be prone to such large, widespread, prolonged and catastrophic price falls...???

YM, either you're just being polite so people won't ignore you, or, you're slowly starting to form a less distorted view of residential property investing...!

GSJ

 

[Land]

Spot On

Lizzie,

You are spot on! It's called a property cycle, and this is what yieldmatters is missing. People either have to rent or buy, and when the cost of renting is cose enough to the cost of buying...then they will buy.

The other factor which seems to have been ignored is the simple supply vs. demand equation. I think this is very easily overlooked, but it is this little gem which will drive prices higher and higher in our cities.

Take New York for example. I would imagine that not a lot of people would expect to be able to buy in downtown NY city, but does this stop the prices? No - because there are always those who can afford it, and that's all that matters. So long as the demand is increasing beyond supply, then so will capital growth.

The two biggest factors which continue to drive demand in Australia are immigration (i.e. population growth) and the trend towards smaller households, which is increasing at an astonishing rate compared with only 10-15 years ago, therefore creating the need for additional 'households'.

The fundamentals are there for sustained growth, which will occur in a normal economic cycle.

Speaking of which - bring on the next cycle in Sydney!

 

[JIT]

Yes, if you understand supply and demand as it pertains to residential property in your local areas, this residential property investing stuff is much, much easier.

GSJ

 

[pendo]

To quote Michael Yardney. "You also have to consider that the entire banking system is underpinned by the continuing growth of property. Which is why they will lend 90% of the value, because they know that property values have never fallen over the long term". Apparently the size of the Australian Residential market is $2.5 Trillion of which 70% are Long Term owner occupiers.
'houses don't go broke!. Companies do, even blue chip ones have in the past.'