We had a thread about Herengracht - House prices rise at 0.2% above inflation in the long term (400 yrs)
Mortgage Meltdown ABC 4 Corners Monday night
- Thread starter twobobsworth
- Start date
Quite agree with you. I was referring to capital cities. Bill Zheng came up with an excellent comment about cash flow positive properties in rural/mining towns. Paraphrasing his comment, he basically said that many cash flows positive properties have experienced capital gains due to reduced rental yields rather than increases in the underlying economic value of the property.
I don't understand this... does anyone else?
Let me explain by example:
Propety investor 1: buys a property for $100K with rents of $15K so the yield is 15%. After say a year many investors hear about positive geared real estate in rurual areas and so start buying. Buyer competition means that new buyers are prepared to pay $200k because even at $200K the yield is 7.5%.
Thus the price of the property has 'doubled' because of yield contraction not because the actual underlying value.
Propety investor 1: buys a property for $100K with rents of $15K so the yield is 15%. After say a year many investors hear about positive geared real estate in rurual areas and so start buying. Buyer competition means that new buyers are prepared to pay $200k because even at $200K the yield is 7.5%.
Thus the price of the property has 'doubled' because of yield contraction not because the actual underlying value.
and slug unsuspecting taxpayers for half the bill !
Risk and Yields
I think what you mean is the required return to hold the asset (the yield required) has dropped so the value to buy it has increased. This makes sense. But you have to ask yourself - why has the required yield dropped? In your example it used to be 15% but then suddenly people are happy to accept 7.5% ... what has changed?
In a rational market the required return would only drop if the risk in holding the asset dropped for some reason. If a company reduced its risk (its volatility on earnings) but kept its average earnings constant then the price of its shares would go up (i.e. same return, lower risk = higher price to buy). This makes sense.
But this is what is strange about property. As far as I can tell the risk hasn't changed a bit but people are accepting lower, and lower, and lower yields. To the point now where they think property has less risk than a bank term deposit!
I think what you mean is the required return to hold the asset (the yield required) has dropped so the value to buy it has increased. This makes sense. But you have to ask yourself - why has the required yield dropped? In your example it used to be 15% but then suddenly people are happy to accept 7.5% ... what has changed?
In a rational market the required return would only drop if the risk in holding the asset dropped for some reason. If a company reduced its risk (its volatility on earnings) but kept its average earnings constant then the price of its shares would go up (i.e. same return, lower risk = higher price to buy). This makes sense.
But this is what is strange about property. As far as I can tell the risk hasn't changed a bit but people are accepting lower, and lower, and lower yields. To the point now where they think property has less risk than a bank term deposit!
There's a pervasive perception that inflation risk has reduced due to RBA interventions. This translates into reduced risk of interest rate hikes which reduces the risk of loan servicing fluctuations.
As such, the risk has reduced significantly for this asset class. Add to that heightened workforce participation and you get reduced risk of your cash flows drying up.
So, reduced risk of rate rises coupled with more gaurantee of income allows the acceptable yields on property to drop significantly.
Whether or not the actual risk of these factors is aligned with the perceived risk of these factors is what seems to be being debated. I believe that they are more stable than some of the doomsayers suggest.
Cheers,
Michael.
If the expected capital gains increases, people are willing to take lower yields. A rising market creates a virtuous cycle that means increased capital gains makes people more willing to drop yield requirements to buy, which increases prices resulting in more capital gains.
Of course, eventually this can't be sustained and you have a bust. The bust then leads people to think capital gains won't happen again (mid-late 90s) and they don't buy. People who buy for yield are then pleasantly surprised when capital gains kicks off again.
That's why I tend to expect a 'normal' level of yield (less than the interest rate, but not much) and a 'normal' level of CG.
Alex
Of course, eventually this can't be sustained and you have a bust. The bust then leads people to think capital gains won't happen again (mid-late 90s) and they don't buy. People who buy for yield are then pleasantly surprised when capital gains kicks off again.
That's why I tend to expect a 'normal' level of yield (less than the interest rate, but not much) and a 'normal' level of CG.
Alex
Yep,
Me too. In fact I posted about that some time ago and coined it my tipping point hypothesis. I conjectured that at some point the differential between the prevailing interest rate and the yields achievable on property will close to the point that investors for growth will flow back into the market, the "tipping point". From there we roll into a boom cycle until irrational exuberance makes that differential too great and it takes time for rents to catch up and the next tipping point to be achieved.
All just conjecture, and it needed to be positioned within the greater macro-economic environment, but a useful way of looking at things nonetheless.
Cheers,
Michael.
Some interesting points
The conversation may have moved on from the relevance of my post but some may still find it of interest.
At the Sydney Mortgage Brokers Forum last week Shane Lee from Citigroup spoke on the US market and the effects, I jotted down what I thought were interesting points.
- the effect of the subprime issue IS now costing banks 15 basis points ( ie 0.15% in interest rate) in costs ( ie them buying money so far this has been absorbed)
- the effect on Mortgage Managers is 40 basis points
- There is no subprime market in Australia however it represents 305 of US lending
- Of these loans 15% are currently outstanding
- The Alt -A loans market in US represents 15% of lending - this is a comparable product to our Low Doc lending which represents 6% of Australian lending
- In Australia defaults are about 1% in US 2% for all lending and 15% for subprime
His estimate waas that the major subprime meltdown will occur in 6 mths and this is when the Reserve Bank will make their move Quarter 1 2008, nothing is needed sooner as the credit market is already slowing things down. I my opionion there may be more lenders that move themselves rather than see their profit reduced sooner ( ie as per Macquaries recent move)
He then went on to discuss Aust growth, Asia/India etc and construction.
Hope you find it interesting, I did.
Jane Slack-Smith
The conversation may have moved on from the relevance of my post but some may still find it of interest.
At the Sydney Mortgage Brokers Forum last week Shane Lee from Citigroup spoke on the US market and the effects, I jotted down what I thought were interesting points.
- the effect of the subprime issue IS now costing banks 15 basis points ( ie 0.15% in interest rate) in costs ( ie them buying money so far this has been absorbed)
- the effect on Mortgage Managers is 40 basis points
- There is no subprime market in Australia however it represents 305 of US lending
- Of these loans 15% are currently outstanding
- The Alt -A loans market in US represents 15% of lending - this is a comparable product to our Low Doc lending which represents 6% of Australian lending
- In Australia defaults are about 1% in US 2% for all lending and 15% for subprime
His estimate waas that the major subprime meltdown will occur in 6 mths and this is when the Reserve Bank will make their move Quarter 1 2008, nothing is needed sooner as the credit market is already slowing things down. I my opionion there may be more lenders that move themselves rather than see their profit reduced sooner ( ie as per Macquaries recent move)
He then went on to discuss Aust growth, Asia/India etc and construction.
Hope you find it interesting, I did.
Jane Slack-Smith
The RBA is going to move rates UP even though the subprime crisis will dry up lending in the economy? Why? The only reason would be that inflation goes up, but if economic activity slows down..........
Once again these are his thoughts:-
In 6 mths time the real effect of the subprime market will be felt, he has unemployment at 4.3% and inflation pressure being the main cause. The Aus GDP he has at 4.3% 07 4.3% 08 and 4.7% 09, belief that there will be a pickup in trade due to a recovery from the drought, the terms of trade will improve due to Port expansions and improvement and continual growth in China (11%)
Hope this helps
Jane
In 6 mths time the real effect of the subprime market will be felt, he has unemployment at 4.3% and inflation pressure being the main cause. The Aus GDP he has at 4.3% 07 4.3% 08 and 4.7% 09, belief that there will be a pickup in trade due to a recovery from the drought, the terms of trade will improve due to Port expansions and improvement and continual growth in China (11%)
Hope this helps
Jane
Forgive me if my thoughts process is simplistic but....
- if the credit squeeze cost banks to move interest rates up, doesn't this just save the RBA from doing it themslves.
- if rates go up too much because of a credit squeeze, won't the RBA just reduce the cash rate to compensate.
The RBA wants inflation at 2-3% and the interest rates for end uses will reflect that.
- if the credit squeeze cost banks to move interest rates up, doesn't this just save the RBA from doing it themslves.
- if rates go up too much because of a credit squeeze, won't the RBA just reduce the cash rate to compensate.
The RBA wants inflation at 2-3% and the interest rates for end uses will reflect that.
The credit crunch will slow economic activity, which generally decreases inflation. Except that's not the only component of inflation: food prices and oil prices are a concern. Theoretically you can have oil-induced inflation even if the economy is in recession. But that's about the only scenario I can think of where the RBA would increase rates in a credit crunch.
Not that the RBA needs to. The big banks still have 0.6%, 0.7% of 'discount' they can get rid of.
Alex
Not that the RBA needs to. The big banks still have 0.6%, 0.7% of 'discount' they can get rid of.
Alex
Hi chilliaa,
I enjoyed your post above. I am inclined to agree with your thoughts above. I have read so much information this week on the credit crunch, and based on this information alone it could be tempting to go and sell everything and put my cash under a matress. (Mind you capital gains tax would eat into it!).
I remember reading in Jan's books where she gave numerous examples over the past couple of decades where the validity of investing in IP's was questioned by economists and financial commentators. A few spring to mind:
1) The introduction of the GST
2) The Asian crisis - 1997 (Or there abouts)
2) The recession in 1987
2) The oil crisis in the 70's
(And since Jan's books have been published 9/11).
Unfortunately I don't have the book in front of me, but the list was very extensive - perhaps others can add to my feeble attempt!
The jist of her point was that throughout history when times have gotten a little tough the financial gurus and commentators have all questioned property investment, and it's ability to rise in value in the future. After each of the events above property went on to perform very strongly.
I would be interested in other's ideas. My post is extremely simplistic without economic analysis. Please feel free to add!
Regards Jason.
That isn't how I understood it. What I believe he said is that growth is determined/driven by scarcity, and regional and mining towns experience capital growth due to the scarcity of 'high yield', rather than scarcity of the properties fundamentals (style/land/location/access to infrastructure).
"many cash flows positive properties have experienced capital gains due to reduced rental yields" - this doesn't make sense IMO.
This 'kinda' reminds me of Steve Navra's rental reality. Hired Goon, I reckon you should check that out. I think you'll like it and I'd be really interested to see what you think of it. http://www.invested.com.au/75/rental-reality-3104/
