"Market Direction: Lower rents, Higher Prices"

From: Always Learning


Dear Forum

I have 2 IP's both had long term tenants! Within 2 weeks of each other both recently both decided moved on. It would appear that Melbourne has a glut of rental properties and my tenants appear to have found something better and/or cheaper. Now to get tenants in I need to drop the rent to 1996 levels.

Naturally I'm more than pleased with the capital gains, but with reports that prices have increased this year at the fastest rate since the late '80s boom, fueled by no small amount with a flight of capital out of the stock market, to record levels of finance for property investment. I have new concerns that we are sitting on the top of inflating speculative bubble.
<p>
If historically prices of property has on average increased at 2% more than CPI, then I can see that there are only two possibilities for the medium term:
<ol>
<li> Price growth will continue, investing will be replaced with speculative mania. Some unknown event in the future will burst the bubble....prices will fall drastically, many "investors/speculators" will be sitting on negative equity.
<li> Price growth will slow, giving way to caution, prices will stagnate as the natural growth curve (2% plus CPI) plays catchup with escalated property prices. If prices have doubled in the last 5 years, then we will be waiting many years to see any capital growth again.
</ol>
<p>
How will the world end: With a bang or a whimper?
<p>
Dont worry about the medium term! just think long term (20 years)?
<hr width="50%" color="pink">
<ul>

<li> Unless you change how you are, you'll always have what you've got.
<li> To have more than you've got, become more than you are.

</ul>

p><p>Shares can damage your wealth. The converse also
applies. Unfortunately, there is a spectre hanging over your share portfolio,
the spectre that negative share "wealth effects" could harm the US and other
major economies and prevent share price recoveries.
<p>A stocktake about what we know about "wealth effects" and the impact they may have over the year ahead thus follows. Its message is: don't just keep an eye on share prices - the biggest worry is what might happen to housing prices.The first problem with such a stocktake is that we don't know enough about the composition of wealth in modern economies, let alone how households react to changes in the value of the different forms of wealth they hold.Wealth is not only hard to measure, its value changes dramatically, as a glance back through BRW's Rich 100 lists would quickly confirm. And when it comes to trying to predict wealth effects across different countries, one is left in a statistician's hornet's nest.For example, most Europeans have less of their wealth in shares than do Americans. Australians are between these two groups, but have higher home ownership and wealth held in the family home than most Europeans. However, OECD, IMF and other economists have been doing some interesting research on these important topics. (See for example, the IMF April World Economic Outlook, April 2002).The first thing this research shows is that across most Western economies in the 1990s, an important change occurred. While household wealth rose sharply, in most economies, household savings fell sharply. Particularly dramatic was what happened in the US (see top graph).A similar story occurred in many other Western economies, thus raising the wealth effect spectre. Households can increase their wealth in two ways: directly, through saving, or indirectly as the result of valuation changes in assets they already hold.During the 1990s, changes in wealth were heavily influenced by changes in share prices. In the US, net household wealth as a percentage of household disposable income rose about 40 per cent, but equity holdings as a percentage of the same income rose by almost 150 per cent, making the US economy vulnerable to sharemarket corrections.In contrast, most European households have less of their total wealth in shares and are thus less likely cut their consumption when share prices fall.
Australia is essentially between the US and the European economies, despite our
growth in share ownership.
030_clarke1_sep.gif

Add to this a key further feature of the 1990s, an increase in the correlation between major sharemarket fluctuations of the major economies, then wealth effects have increased their likely impact in most economies. House price movements have historically been less correlated across countries, although there is some evidence that such correlation appears to be increasing.Research suggests that the increasing correlation of movements in asset prices means the wealth effects in consumption across countries are becoming more synchronised. In turn, this means household consumption is becoming an increasingly important driver of the international business cycle.In other words, the twin trends of rising wealth, heavily driven by rising asset prices and falling savings, means that any sharp, sustained fall in asset prices in the US is more likely to have an international, greater and longer effect than it would have had a decade ago.
Further interesting and important questions follow:
<ul>
<li>Has the wealth effect been rising over time?</li>
</ul>

The answer is yes, particularly in economies like Australia and the US.
<ul>
<li> Does the wealth effect vary between countries with different domestic financial
structures? </li>
</ul>

To examine this question, IMF researchers split 16 countries into two groups:
market-based (Australia, Canada, Ireland, the Netherlands, Sweden, Britain, and
the US) and bank-based (Belgium, Denmark, Finland, France, Germany, Italy, Japan,
Norway, and Spain) economies.

Not surprisingly, it found that changes in equity prices have a bigger impact
in the first group.
<ul>
<li>Does the impact of wealth changes vary according to the type of wealth?
</li>
</ul>

This is a difficult question to answer.

However, comparing estimates for those countries that have data on the stock of
housing wealth showed that the marginal propensity to consume out of housing is
larger than that out of share wealth. In plainer English, consensus research results
suggest that in the US, four cents of each dollar of an increase in share wealth
are spent after the dollar is earned. But for an increase in housing wealth, the
figure is around seven cents.

Unfortunately, we don't have similar estimates for Australia, but they are likely
to be lower. Still, such estimates should remind us that the sharp rises in Australian
city house prices should provide some countervailing role in helping keep consumer
optimism and spending up.

High turnover of housing stock, as has occurred over the past 18 months, is also
good for areas of retailing and the building industry.
030_clarke2_sep.gif


In other words, while share price falls can hurt consumer spending and thus the
whole economy, including business profits and share prices, the concurrent rises
in housing prices tended to countervail the growing susceptibility of Western
economies to sharemarket corrections. The flipside, though, is it also means that
a sustained collapse in housing prices would have a much greater impact in most
countries than share price corrections of the kind we have had over the past year.

What else do we know about the effect of changes in wealth on spending?

IMF studies have concluded that:
<ul>
<li> Until recently it was easier to directly realise equity gains than house
price gains, since equities are divisible and traded in liquid markets. </li>
</ul>

However, it is increasingly easy to borrow against housing wealth through home
equity loans. Moreover, rising housing prices may affect consumption not only
through higher realised home values, but also by the household's ability to refinance
a mortgage, or take out (or expand) home equity loans based on higher property
values.

This has likely increased the sensitivity of spending to housing price movements.
<ul>
<li>Since equity prices are more volatile than house prices, households may
find it more difficult to assess whether a change in their stock of wealth
is permanent or temporary. </li>
</ul>

Therefore, they are likely to be more cautious borrowing against increases in
share wealth than housing wealth, suggesting a higher impact of increases in housing
wealth on consumption.
<ul>
<li>House purchases are generally largely financed with borrowed money, while
equity purchases are not. Consequently, a rise in house prices is likely to
confer a larger net return on investment to households than would a corresponding
increase in equity prices, again implying that changes in housing wealth are
likely to have a larger effect on consumption. </li>
</ul>

This is best explained via the following example: suppose a household invests
$100,000 in a $1,000,000 house, financing the rest with a mortgage of $900,000.
If house prices increase by 10 per cent, the gain of $100,000 represents a 100
per cent rate of return on the underlying investment.

By contrast, suppose a household invests $100,000 in shares and prices increased
by the same 10 per cent; the gain from this increase is only $10,000.

Such arguments lead to the conclusion that negative housing wealth effects are
likely to be more dangerous than stockmarket wealth effects, particularly in economies
where housing ownership is higher, and have financial institutions that encourage
housing investment. Government encouragement, such as the first home buyers grant,
can also add fuel to the possible fire.

It is one thing that Western savings levels have fallen sharply over the past
decade, but if governments give taxpayers' money to low-income households without
a savings record, then the social fallout from any sharp fall in housing prices
will be greater.

Australia's generous treatment of the capital gains on the family home has also
encouraged them to consider the family house as not a castle but their tax haven.

This makes us more vulnerable to negative housing wealth effects if a sharp, sustained
housing price occurred than countries with more rational taxation systems. The
ageing problem in most Western economies will also add to the size of wealth effects.

This is because spending in an increasing proportion of households will be significantly
dependent on asset holdings and changes in their value, although older households
tend to be more cautious with their spending and invest less in most consumer
goods.

Such issues help us understand why the Reserve Bank has been warning of the dangers
of a sharp fall in Australian property prices and has warned that it will raise
rates to prevent such, if it becomes necessary.

The wealth effect is particularly important when one remembers that household
spending plays a far more important role in recoveries than downturns (see bar
chart above).

The big worry at the moment is that US household spending has remained high, despite
the general downturn, and thus may not be able to provide the usual kick-start
for a general economic recovery and profit recovery.

The fall in US saving and rise in household debt is further grounds for concern,
if the US economy fails to get moving solidly over the next few months.

Finally, other detailed recent research on recessions shows that:
<ul>
<li>The upside of the economic cycle has become longer since World War II and
that when recessions do occur, they are shallower. </li>
<li>This trend has been particularly obvious over the past 15 years and provides
some grounds for optimism that the current US downturn, like previous ones,
over this period will be short-lived. </li>
<li>Peaks in share prices preceded peaks in output, usually by about one year,
and troughs roughly coincided. </li>
<li>In the 1990s, share prices fell by about 25 per cent on average during recessions
and usually took less than one year to regain their previous peak. Like investment
contractions, share price declines were more synchronised than recessions,
underlining the role of global asset market linkages. </li>
</ul>

Serious study of downturns suggests some grounds for hope that a recovery in share
prices is not that far away. But the past does not simply repeat itself; markets
and economies forge their own unique recovery paths.

In short, a spectre that would be far more damaging to world sharemarkets than
fear of a massive negative share wealth effect would be a sustained and dramatic
fall in housing values across the major economies. Fortunately, there is little
evidence that this is likely.

More than 50 years ago, the US business cycle expert Arthur Burns wrote: "For
well over a century, business cycles have run an unceasing round. They have persisted
through vast economic and social changes; they have withstood countless experiments
in industry, agriculture, banking, industrial relations, and public policy; they
have confounded forecasters without number, belied repeated prophecies of a 'new
era of prosperity' and outlived repeated forebodings of 'chronic depression.'"

How little the world has changed.
 
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