Saul Eslake & Arek Drozda

[truong]

This most recent chart by Saul Eslake is interesting. What it shows is that for the last 35 years house prices in Aus have increased twice faster than income, but only as fast as the combined effect of income and interest rates, meaning that current prices may be "fair value" after all.

The 90's was a time of undervaluation, the noughties a time of overvaluation, and since 2011 we're back into undervalued territory albeit only slightly now.

His finding is not new (many other commentators have already pointed out the drop in IRs as a major cause for prices being as they are) but his way of presenting it is striking. Also, coming from Eslake it's a bit of a surprise.

 

[truong]

An article from Drozda argues the same thing.

http://www.propertyobserver.com.au/...rty-prices-explained-independent-analyst.html

His measure of "buy cost" (i.e interest payments on a 100% loan for a median priced house) is found to be roughly in line with income and rent while house prices shoot up much faster (see attachment)

The message is clear - based on the income capacity of working Australians, residential property in this country is not overpriced and prices are far from bubble territory. We can afford current prices - and we can afford them more than in 1986. The only hurdle is that it requires accepting a level of debt that many may not feel comfortable with.

I see however another hurdle, and a major one: it's now much harder to save the required deposit. To come up with a deposit that generally increases with prices, a buyer is only aided by his rising income but gets no benefit from reduced IRs. In other words, while it's true present buyers have at least the same serviceability as before, the deposit hurdle becomes a show stopper for a lot of them.

Looking ahead, and in pure theory of course, if IRs have hit the bottom then prices can only be expected to grow in line with income from now on. This, subject to the usual fluctuations.

 

[datto]

Great stuff Truong. More $ in IPs....this can only mean one thing.....yeehah!

 

[hobo-jo]

I wrote a response to some of Arek Drozda's views on PO: http://www.propertyobserver.com.au/...ty-and-housing-statistics-boullion-baron.html

Drozda says that principal is omitted because it equates to savings...

"Paying off the loan principal is omitted in the analysis since it equates to savings and is therefore deemed irrelevant (i.e. every dollar that is paid off becomes owner?s equity that can be drawn upon in the future)."

It's true that these "savings" may be drawn upon in the future (assuming the property retains or increases in nominal value), but they have to be borrowed back for access (with interest payable) or only retrieved in full by selling the property. I wouldn?t equate this to savings.

Drozda writes about a metric referred to as the "cost of buying", which measures only the cost of interest on the loan and then uses that as his basis of "housing affordability". As I've recently written on this topic, I'll quote from my last piece (Why Serviceability ≠ Affordability):

"...Even if interest rates had remained elevated the entire period of the loan, it still ends up more affordable over the long run to have double the interest rate, but lower price to income ratio. Not only that but it would be faster to save the deposit given that it's a lower amount (relative to income) and I haven't taken into account the higher interest rate on saving for the deposit which would have benefited the 1992 scenario. Costs such as stamp duty which are tied to the price paid would be lower too. Finally, higher interest rates tend to come with a higher rate of inflation, so the real value of the debt would be reduced faster as wages increased, meaning the buyer in 1992 would have found it easier to ramp up the level of repayment.

...When considering affordability we need to take a holistic approach and not use a simple snapshot of a single repayment as the basis to make judgement calls on whether house prices or a mortgage used to purchase them is affordable. A mortgage is a long term commitment and shouldn't be treated so trivially by market commentators."

Drozda's argument in this article does show how buyers have been able to comfortably service mortgages at these higher prices (as he puts it "rediscovered their true financial capacity"), mostly a result of lower interest rates, but as I've shown that doesn't make them affordable unless you're of the opinion that serviceability is the same as affordability. I think it's deceptive to speak to the affordability of 'buying' a home, but only taking into consideration the cost of servicing the interest portion of a mortgage.

 

[Tano]

This most recent chart by Saul Eslake is interesting. What it shows is that for the last 35 years house prices in Aus have increased twice faster than income, but only as fast as the combined effect of income and interest rates, meaning that current prices may be "fair value" after all.

The 90's was a time of undervaluation, the noughties a time of overvaluation, and since 2011 we're back into undervalued territory albeit only slightly now.

His finding is not new (many other commentators have already pointed out the drop in IRs as a major cause for prices being as they are) but his way of presenting it is striking. Also, coming from Eslake it's a bit of a surprise.

Where did you get this chart from? Can i have the link to the story?

Thanks

 

[Redom]

This most recent chart by Saul Eslake is interesting. What it shows is that for the last 35 years house prices in Aus have increased twice faster than income, but only as fast as the combined effect of income and interest rates, meaning that current prices may be "fair value" after all.

The 90's was a time of undervaluation, the noughties a time of overvaluation, and since 2011 we're back into undervalued territory albeit only slightly now.

His finding is not new (many other commentators have already pointed out the drop in IRs as a major cause for prices being as they are) but his way of presenting it is striking. Also, coming from Eslake it's a bit of a surprise.

Haha thanks for posting truong. Very surprising to see Eslake not jumping up and down about house prices being elevated!

Cheers,
Redom

 

[truong]

I wrote a response to some of Arek Drozda's views on PO: http://www.propertyobserver.com.au/...ty-and-housing-statistics-boullion-baron.html

Drozda says that principal is omitted because it equates to savings...

"Paying off the loan principal is omitted in the analysis since it equates to savings and is therefore deemed irrelevant (i.e. every dollar that is paid off becomes owner?s equity that can be drawn upon in the future)."

It's true that these "savings" may be drawn upon in the future (assuming the property retains or increases in nominal value), but they have to be borrowed back for access (with interest payable) or only retrieved in full by selling the property. I wouldn?t equate this to savings.

Drozda writes about a metric referred to as the "cost of buying", which measures only the cost of interest on the loan and then uses that as his basis of "housing affordability". As I've recently written on this topic, I'll quote from my last piece (Why Serviceability ≠ Affordability):

"...Even if interest rates had remained elevated the entire period of the loan, it still ends up more affordable over the long run to have double the interest rate, but lower price to income ratio. Not only that but it would be faster to save the deposit given that it's a lower amount (relative to income) and I haven't taken into account the higher interest rate on saving for the deposit which would have benefited the 1992 scenario. Costs such as stamp duty which are tied to the price paid would be lower too. Finally, higher interest rates tend to come with a higher rate of inflation, so the real value of the debt would be reduced faster as wages increased, meaning the buyer in 1992 would have found it easier to ramp up the level of repayment.

...When considering affordability we need to take a holistic approach and not use a simple snapshot of a single repayment as the basis to make judgement calls on whether house prices or a mortgage used to purchase them is affordable. A mortgage is a long term commitment and shouldn't be treated so trivially by market commentators."

Drozda's argument in this article does show how buyers have been able to comfortably service mortgages at these higher prices (as he puts it "rediscovered their true financial capacity"), mostly a result of lower interest rates, but as I've shown that doesn't make them affordable unless you're of the opinion that serviceability is the same as affordability. I think it's deceptive to speak to the affordability of 'buying' a home, but only taking into consideration the cost of servicing the interest portion of a mortgage.

So what's the problem hobo-jo? The central point in both Eslake and Drozda is that while current prices don't make sense in relation to income, they perfectly do in relation to income + IRs. Whether you call it affordability or capacity to pay is beside the point.

And yes, there are other scenarios where lower prices would be better for the economy overall. I've posted somewhere else that lower prices would increase Australia's productivity, which in current circumstances is something we sorely miss. However there is a reality we have to live with and while it's not ideal it's nothing like abnormal.

 

[truong]

Where did you get this chart from? Can i have the link to the story?

Thanks

From here
http://www.businessinsider.com.au/merrill-lynch-housing-price-growth-will-weaken-in-2015-2014-11

In the article Eslake's gist was to warn us of a price slow down or even decline, however the graph he produced had the unwanted effect of contradicting some of his long held views.

 

[hobo-jo]

So what's the problem hobo-jo? The central point in both Eslake and Drozda is that while current prices don't make sense in relation to income, they perfectly do in relation to income + IRs. Whether you call it affordability or capacity to pay is beside the point.

There's a difference between explaining the factors which allowed house prices to rise and using those factors to change the way you measure whether an asset is overvalued or not.

Drozda's argument that Australians have the capacity to pay these prices, so they are not overpriced is just silly. It's like me saying that because people had the capacity to pay bubble prices at the peak in the NASDAQ bubble that it was never overvalued.

 

[truong]

And yet Eslake calls it "fair value". His graph and comments imply that there's a consistent and remarkable pattern to house prices over the last 35 years and that he expects it to continue in the future.

In contrast your comment about the NASDAQ bubble indicates that you expect this pattern to be broken i.e prices are going to crash while incomes continue to rise and IRs stay low.

If I have to bet my money on the more likely scenario I'd go for the former.