RBA just put rates up again to 4.25%

[alexlee]

Over the long term incomes have to rise to match property prices. It doesnt have to be the medium, it can be incomes 'appropriate' to the suburb.

I disagree with this. Why? Because people who trade up don't need high LVR mortgages. They might be buying with a 50% mortgage. In which case, their incomes just have to be 'appropriate' to half of the value of the house.

The price to income ratio assumes people take out high LVR loans to buy the properties. For the majority of buyers (that is, everyone other than FHBs) this is not the case since they're selling an existing property that's most likely gone up, and they've likely paid off part of the old mortgage.

To put it another way, if I'm on 100k salary, and I sell a 500k property, then I can buy a 1m property fairly comfortably, even though the price / income ratio is 10.

 

[kum yin lau]

Hi Boz, I;m not sure that people don;t pay down their mortgages. The data may not be specific enough for that conclusion.

I know most people on this forum won't pay P&I and I'm one of them.

Anecdotal evidence suggests the opposite. Around me, people pay off hundreds of thousands. My sister paid millions, her friends all own their own homes with no mortgages, my niece paid off her home & she's young yet.

Even me, I've 4 P&I loans.

Just wondering, how conclusive is it?

KY

 

[Intrinsic_Value]

To put it another way, if I'm on 100k salary, and I sell a 500k property, then I can buy a 1m property fairly comfortably, even though the price / income ratio is 10.

How is this comfortable,
on current interest rates of say 6.5%+ Principle repayment of say 1.5%, this is 8% of $500k (assuming the $500k property is fully paid off), which is 40% of the income.
Add in council rates, repaires and maintenance etc.

Its doable, but not comfortable.

I understand that in many incomes a dual income will then be applied.

But even if this is the case, then how do we continue to get decent sustainable increases in the medium term.

 

[Intrinsic_Value]

keithj;656621]Not quite sure I understand.... can you elaborate ?

Do some flow analysis on the lifecycle of a family unit - starting as a FHB, then an upgrader, and finally downsizer. And then add in 2% population growth pa, and add the extra cheap houses they'll need. And consider that some 'expensive' houses will be removed from the statistical population (& put to a higher usage either though apartments, or zoning changed to commercial). Also that 30% of us have no mortgage, and that 30% of us are paying P&I.

Yes i understand this, i have also stated that i am less judgemental of houses with large land content because of the increasing intrinsic value of the land.

But lets extrapolate this out to the future. Today's upgrader is yesterday's FHB. Now how easy is it for today's FHB compared to say 10 years ago.
If it is harder for today's FHB then it will be harder to get ahead on repayments to pay down the loan, which will make it harder to build a decent equity stake for the future upgrade. (yes property may go up, but then their future upgrade also goes up), and whilst the % increase maybe the same, the $ difference will increase. Now this $ increase will need to be funded by income increase.
I understand that at this point incomes will have increased due to job promotion, but then what proportion of the previous FHB to upgrader was based on the salary increase from promotion.

V. early in their life bubbles as based on fundamentals, but as they progress they are based on momentum. In their later stages bubbles can never be based on fundamentals, only momentum & the fear of missing out or that there will be a greater fool.

And at what point does the transition take place from the fundamentals to the greater fool theory. Its only afterwards that this becomes clear.
You argue that later on they are based on momentum: well if its momentum, what about the current auction clearance rates that are consistently around 80% in melbourne at the moment. Is there a current fear of missing out at the moment amongst buyers????

 

[Intrinsic_Value]

Hi Boz, I;m not sure that people don;t pay down their mortgages. The data may not be specific enough for that conclusion.

I know most people on this forum won't pay P&I and I'm one of them.

Anecdotal evidence suggests the opposite. Around me, people pay off hundreds of thousands. My sister paid millions, her friends all own their own homes with no mortgages, my niece paid off her home & she's young yet.

Even me, I've 4 P&I loans.

Just wondering, how conclusive is it?

KY

Out of curiosity KY, when your sister and friends paid off their homes, what period did it take, and what % income was being used to service the loans.

Do you think they could do it as easily on the current prices?

 

[Intrinsic_Value]

And here we also come to an interesting point in this 'debate'.

Any negative comments i make, at least in the short term, are going to be proved WRONG, by the increase in prices.

Sensing a potential bubble, and knowing when it will end are two very different things. It is almost impossible to forecast the bursting of any bubble.

 

[BayView]

There are simply just too many buyers out there, ALL of them wanting in and having the means to get in.... but many unable to actually find a property before it gets sold.

More and more i am hearing of properties selling even before being listed on the internet, people selling privately, selling well above asking price, buyers outbidding each other just to seal the deal... etc.

This is never widespread across all markets.

This sort of dramatising in the media - it's almost always select suburbs that they use for their articles where there is always good demand no matter what the state of play.

And of course, the lower end will always be the first area to go mad when people can get access to finance.

Here in Dromana where I live, anything below $300k (not much to be found at this level) is gone in seconds unless it is a total dog. Then it sits there for a bit longer.

This is happening a bit more now since the depths of the GFC.

It's not rocket science either; make money harder to borrow and people won't spend because they can't.

But now the Banks are lending a bit more freely, so out of the woodwork will come those who were frustrated at being denied some spondoola.

 

[keithj]

But lets extrapolate this out to the future. Today's upgrader is yesterday's FHB. Now how easy is it for today's FHB compared to say 10 years ago.
If it is harder for today's FHB then it will be harder to get ahead on repayments to pay down the loan, which will make it harder to build a decent equity stake for the future upgrade. (yes property may go up, but then their future upgrade also goes up), and whilst the % increase maybe the same, the $ difference will increase. Now this $ increase will need to be funded by income increase.

I understand that at this point incomes will have increased due to job promotion, but then what proportion of the previous FHB to upgrader was based on the salary increase from promotion.

I posted previously about how a FHB buying an affordable house can upgrade to a significantly better house after 10 yrs and reproduce the relevant part below.....(Original post is here)

It clearly shows how the $ difference is funded by a 50+% deposit from previous PPOR sale and increased servicability due to increased wages.

Here's a picture of a spreadsheet, showing what happens when a FHB buys a PPOR they can afford. Assume wages grow at 4%, houses increase at 7.2%, and they pay down principle over 25 yrs at 7.5% average IR. Also assume they put down 20% deposit on a house worth 5x their salary, ie borrow 4x their $50K salary.

Column G shows the most expensive house they could afford to buy, based on the same constant borrowing 4x salary and putting down a deposit of their existing equity. In Yr 1 it's still 4x salary, plus $50K deposit, after a year of paying principle & price appreciation, their house is worth $268K, their wages are up $2K, so they could afford a slightly more expensive house at $278K, only $10K in real terms better than their current house.

Extrapolate 10 yrs..... and after house price appreciation, & paying down principle their house is worth $500K, they have a equity of $342K, and their wages have increased to $74K... so using the same borrow 4x salary, and put down equity as a deposit as a deposit formula, they can afford to buy a $638K house. Their existing house is worth $500K, they can afford to buy a house 27% 'better' at $638K. This 'better' house would have cost them $317K ($250K x 127%) back when they started, so was well out of their price range.

But the most interesting column is Column I. This $638K house costs a whopping 8.6x their salary. They can easily afford to buy because we're still using the borrow 4x salary formula.

All these assumptions are the most conservative... 4% wage increase, paying off mortgage over 25 yrs (& not 7), only borrowing 4x salary (not 5 or more)., never promoted, so no wage increase above inflation.

Similar scenarios have been happening for decades.... why should it be different this time ? Ask any upgrader if buying their first home was hard ? Or if they had trouble affording a 'better' PPOR ?

And at what point does the transition take place from the fundamentals to the greater fool theory.

When yields get seriously out of whack with long term averages (takings IRs into account), or whatever your preferred metric is. It's a little premature to suggest that we're in a bubble, just because auction clearance rates are high, I think there needs to be a few more indicators than that.

Its only afterwards that this becomes clear.
You argue that later on they are based on momentum: well if its momentum, what about the current auction clearance rates that are consistently around 80% in melbourne at the moment. Is there a current fear of missing out at the moment amongst buyers????

I don't know if poor fundamentals applies to Melbourne ATM - I don't follow the market there. SSers I respect seem to think that the good buying is over, some OOs are catching onto the rising market, but there is undoubtedly a lot of pent up demand.

Sydney has had 7 yrs of 0% growth (that's ~-20% in real terms) except for the +12% last year..... that's not bubble territory in my book. Brisbane likewise. There may be some fear of missing out, but in Sydney the fundamentals are still good IMO. We've been in the early stages of an upturn for a while, definitely NOT anywhere near bubble territory.

 

[keithj]

Sensing a potential bubble, and knowing when it will end are two very different things. It is almost impossible to forecast the bursting of any bubble.

Potential is the key word. Upturns don't always turn into bubbles. The RBA appears to be keeping their eye on the ball - they are likely to ensure we don't have excessive growth.

And I agree that forecasting the timing of anything that is sentiment based is impossible. Most D&Gers will be right eventually, however their abysmal timing makes successful investing a v. low probability outcome.

 

[boz]

Hi Boz, I;m not sure that people don;t pay down their mortgages. The data may not be specific enough for that conclusion.

I know most people on this forum won't pay P&I and I'm one of them.

Anecdotal evidence suggests the opposite. Around me, people pay off hundreds of thousands. My sister paid millions, her friends all own their own homes with no mortgages, my niece paid off her home & she's young yet.

Even me, I've 4 P&I loans.

Just wondering, how conclusive is it?

KY

the data is there and mathematic is not an opinion and i think it is quite conclusive:
in 2009 loans to housing went up 9% (from 1007 bil$ to 1096 bil$), average interest on loans 5-6%, new dwelling build around 1%, inflation 2.1%. So at best we got a zero outcome, but I am pretty confident we got negative...

 

[Intrinsic_Value]

Thats a great spreadsheet keith, and i think it just proves the point about property being a great investment over the long term (which i have never disputed).

My concern is the medium term, especially with the risk of high gearing in whats still a low interest rate environment, coupled with the negative gearing and the utilisation of property revaluations to cover that negative gearing. Together with market prices that have increased rapidly (at least in melbourne) over the last 15 years.

Warren Buffet once said why bother trying to analyse 10 foot hurdles, just look for the one foot hurdle, they are much easier to step over.

And i guess thats my philosophy as well.

 

[HandyAndy888]

This is the pattern one sees in bigger cities than ours, like London or Tokyo or New York.

And Detroit.

We all know which way urbanisation went in that city...

 

[alexlee]

And Detroit.

We all know which way urbanisation went in that city...

Yes, Detroit is one example of what can happen if 1) you lose population and 2) your economy goes into decline. Obviously they go hand in hand. Japan is another, where the population of the whole country is declining.

If I thought Australia is going to lose population and our economy is going to go backwards long term, I'm certainly not going to buy. Are you of this opinion?

What's your point? I'm not saying price growth is inevitable. I AM saying it's possible if the population continues to grow and we continue to have economic growth.

 

[alexlee]

How is this comfortable,
on current interest rates of say 6.5%+ Principle repayment of say 1.5%, this is 8% of $500k (assuming the $500k property is fully paid off), which is 40% of the income.
Add in council rates, repaires and maintenance etc.

Its doable, but not comfortable.

I understand that in many incomes a dual income will then be applied.

But even if this is the case, then how do we continue to get decent sustainable increases in the medium term.

I'm pulling figures out of thin air here. My point is to illustrate how someone on 100k income might be able to 'afford' a 1m property. In any case, as you said it's doable, but looking just at the value / income ratio of 10, it would seem to be impossible.

Long term, increases will still be driven by population and wage growth. Say someone on 50k 15 years ago bought a place with a 200k mortgage. 15 years later, the property is 600k, and the person might be on 100k. Add another 400k mortgage, and they can afford a 1m property. Now, the 1m property would have been 330k 15 years ago, which they couldn't afford back then. Both times, the person borrows 4 times their salary.

If the population declines, and wage growth stalls, of course, this doesn't work: this is the situation that Japan is in.

 

[Intrinsic_Value]

I'm pulling figures out of thin air here. My point is to illustrate how someone on 100k income might be able to 'afford' a 1m property. In any case, as you said it's doable, but looking just at the value / income ratio of 10, it would seem to be impossible.

Long term, increases will still be driven by population and wage growth. Say someone on 50k 15 years ago bought a place with a 200k mortgage. 15 years later, the property is 600k, and the person might be on 100k. Add another 400k mortgage, and they can afford a 1m property. Now, the 1m property would have been 330k 15 years ago, which they couldn't afford back then. Both times, the person borrows 4 times their salary.

If the population declines, and wage growth stalls, of course, this doesn't work: this is the situation that Japan is in.

Yes your logic here follows Keith's schedule and it makes sense over the long term. I fully support this view so long as:
1) a long term view can be taken;
2) a person is financially able to hold for the long term.

My concern is with the medium term and with a view specific to the Melbourne market. I am the first to recognise that i have very limited knowledge outside of melbourne.

Residential property investing works over the long term because it is 'boring'. The effects are only shown over long periods of time. This reduces the investment appeal of property as many people are looking to 'turbo charge' their returns.

However when the investment climate is such that property investment produces 'turbo charged' results in the short term, i become very worried, because it then becomes the investment vehicle of choice for the masses. And where the masses trod, market value has a high probability of being above intrinsic value.

 

[HandyAndy888]

Yes, Detroit is one example of what can happen if 1) you lose population and 2) your economy goes into decline. Obviously they go hand in hand. Japan is another, where the population of the whole country is declining.

If I thought Australia is going to lose population and our economy is going to go backwards long term, I'm certainly not going to buy. Are you of this opinion?

What's your point? I'm not saying price growth is inevitable. I AM saying it's possible if the population continues to grow and we continue to have economic growth.

The point was in reference to 2050....when housing becomes very very expensive in Australia....

 

[alexlee]

The point was in reference to 2050....when housing becomes very very expensive in Australia....

Detroit's problem wasn't that housing became too expensive. It was because it lost the one industry it built itself around, and the population halved in a generation. What is the point of mentioning Detroit in reference to 2050? Do you think the Australian population will halve after we lose our biggest industry? What is that, anyway?

Manhattan's median is 800k+, and that's for apartments. Is that very expensive? Yes. Is it going to fall to a more 'logical' level? Not necessarily. By 2050, the house that's 300k now will be completely out of reach of the ordinary person. So what? There'll be fringe suburbs that are affordable, but they'll be 100kms or whatever further out than the outermost suburbs are now.

 

[Intrinsic_Value]

. By 2050, the house that's 300k now will be completely out of reach of the ordinary person. So what? There'll be fringe suburbs that are affordable, but they'll be 100kms or whatever further out than the outermost suburbs are now.

So what about 2150 then, will 'affordable' be 200kms further out???

I agree with you on most points, but on this i disagree.

What about 2250, will it be 300kms further out???

If this is so, what about those countries that have been around for a donky's age: what about greece, what about Italy, what about the UK??

This argument to me is a bit like LTCM, they were economic wizards, they applied the theory, it should have worked, but it didnt.

At the end of the day you MIGHT be correct. But from my perspective why take the risk.

To me the risk/reward is being skewed towards the risk, at least over the medium term.

A very wise investor emphasised to me, always look at the upside vs downside potential when investing. When you see the upside risk increasing, and the potential for downside risk increasing, start placing protective strategies in place.

At this point in time i still have 80% exposure to property compared to last year (ie i still have 4 properties compared to 5 last year).
If bullish conditions continue i will reduce this to 60% (ie 3 properties).

No matter how far prices increase (within reason) i will keep at least 2 properties, but these will be held with ZERO debt.

At the end of the day this forum is a means of communication with like minded individuals. We all have our views, and there is zero accountability.
People reading must make up their own views.

For me personally there is no way that i will be putting myself in a position at this stage in the market cycle, whereby i have any risk of being a forced seller due to unforseen economic circumstances.

 

[alexlee]

So what about 2150 then, will 'affordable' be 200kms further out???

I agree with you on most points, but on this i disagree.

What about 2250, will it be 300kms further out???

Actually, that's not so far fetched. Some 'bedroom communities' in the US and UK can be 2 hours travel from the city centre. People who work in manhattan live in upstate New York and commute. I know people making very good money in the UK who, because they want to live in a house, take a 90 minute train ride every morning (after driving to the train station) to get to work.

In Hong Kong, new estates are being built in China proper for people to commute back to Hong Kong, though in that case they're also building public transport.

If this is so, what about those countries that have been around for a donky's age: what about greece, what about Italy, what about the UK??

In the UK, being an hour or more by train is nothing. Also, you're likely to see homes shrink in size. No one except the very rich, expects to live in a house in London or Hong Kong or Tokyo. If you turn houses into 6-pack units, the number of people you can fit in jumps. People who want houses may well have to travel 200kms out.

I don't know Greek demographics, but I know that Italy and Japan are the fastest aging countries in the world. Their demographic suck for property, basically. It's not purely a matter of length of history. It's a matter of population growth rates. Australia, while aging, still has a increasing population. Clearly, just because Athens has 2,500 years of history doesn't mean it's population has grown steadily for 2,500 years.

This argument to me is a bit like LTCM, they were economic wizards, they applied the theory, it should have worked, but it didnt.

LTCM ignored the human factor. Black-Scholes is predicated on the assumption that market participants act like emotionless automatons. The basic ideas behind why property will go up is, in fact, based on irrational human behaviour and is closer to how the world really works.

At the end of the day you MIGHT be correct. But from my perspective why take the risk.

Fair enough. Your choice. My observation, though, is that Australia isn't breaking new ground here. We're still decades behind many cities that have already been through what we're going through now, in that there are cities that are much bigger, and more expensive. So I'm not just talking theoretically, I'm saying 'here are examples where property CAN keep going up'. Of course, there are those that have crashed, so one has to study the circumstances behind those and decide whether Australia has the same risk.

If Australia starts to lose population or enters long term economic decline, property will fall.

No matter how far prices increase (within reason) i will keep at least 2 properties, but these will be held with ZERO debt.

For me personally there is no way that i will be putting myself in a position at this stage in the market cycle, whereby i have any risk of being a forced seller due to unforseen economic circumstances.

I find this quite extreme. Sure, zero debt is very safe, but there are strategies that are 'riskier' than zero debt that I would still consider safe. A combination of low-ish LVR, offset balances and high-yield shares, say.

Obviously this is a personal choice, depending on your age and circumstances. If you already have enough assets to live off, I agree you wouldn't need to take much more risk.

We also have to be aware of the fact that new entrants into the market don't have the same 'historical view' that you do. I look at prices now and compare them to 10 years ago and think how expensive it is now. A young person who didn't experience prices 10 years ago will just assume today's price as normal.

 

[WinstonWolfe]

IV, I think you are right to try and understand the down and upside.

A wise investor told me to look at the big picture first, over the long term, then work your way down to the micro level and smaller time frames.

Applying this to property, I said earlier to compare gross national income growth to the growth of Australia's total property value.

The data for Australia's GNI is available from 1980 onwards.
But I don't have a means to work out the total value of dwellings in 1980.

So how about a comparison of GNI growth with repeat sales of a couple of homes I am familiar with since 1980.

GNI = 6.3% pa
repeat property sales = 8.9% pa

For repeat sales of unrenovated property to grow at a faster rate than gni, indeed 35% faster, requires the nation spend a higher % of their income on houses. This can only impoverish the nation by reducing capital spent in more productive ventures or on essential services like health care and education.


Finally, a point many are overlooking in arguing housing is affordable, is whether housing is affordable to fed, state, and local govt. We must keep in mind that the provision of housing is paid for, not only by a house's sale price, but also the taxes that fund the provision of new infrastructure (utilities, roads, transport, water etc) and upgrade of old. As houses are built further out from a cbd, the relative cost of infrastructure per dwelling climbs. The fact that Australia is unable to keep up infrastructure such as public transport to outer suburbs, is a sign Australia's population growth is not increasing tax revenue sufficiently to preserve elements of std of living like commute time, comfort, and security.