Why does property go up in value?

[Tom]

Hi,

I'm a long term advocate of property investment but when challenged yesterday to the reasons why property goes up at a long term average of 7-10% I was left stumped. I realise there is a inflationary component, say 2-4% and that supply and demand plays a part but why consistently 7-10% over the longer term.

Can anyone articulate why aside from the fact that it just does?

cheers,
Tom

 

[RumpledElf]

*puts GHPC hat on*

Actually, they haven't been going up at 7-10 longterm - they've only been beating inflation in the last couple of decades, and the really high gains have only been since the 90s. Something about a 'bubble' you might have heard of.

Very very longterm they lock quite well to inflation, household wages etc. You can wave lots of maths at the situation and say house prices can't outstrip wage growth forever, they have to come down to the old trendlines at some point, but I'll skip the math since prices are already coming down all over the world and it's pretty common knowledge now. There were far more heated debates on if this would happen early last year.

Most of the debate now is whether or not house prices will come right down to the old trend, or if they'll stay stagnant for a while as wages catch up. Or if Australia is totally different to the US so it can't happen here

 

[boomtown]

Demand (population + wages) and supply (replacement cost).

If replacement cost goes up, the value of existing dwellings goes up so long as there are more people that want to want to live in dwellings in that area than there is supply. This supported by population growth.

All these DGers don't look input costs (steel, lumber and builder's wages) when they are doing their analyses.

 

[ianvestor]

Let's just say that the average price of a 'home' stays the same over the long run. But average block sizes get smaller.

So if you hold for the long run, relative to everyone else, your land holdings are increasing just by holding the same 800sqm for example.

So 'home' prices might stay the same, but 'home' prices for exactly 800sqm won't.

 

[Shadow]

Nominal house prices are always increasing as inflation devalues the currency, and in recent times the money supply has been increasing at a much higher rate than CPI. If the money supply is increasing at a faster rate than the increase in prices of consumable goods (as measured by CPI) then this excess money has to go somewhere, and it tends to go into asset prices.


Why property prices in desirable locations such as major cities can continue to outstrip average incomes...

1) Shortage of supply in desirable locations means that sought after properties tend to flow towards those with most wealth.
2) Existing stock is passed down to children, which captures past property wealth for future generations to build upon.
3) Natural population increase and immigration, without adequate supply-side response, increases demand for existing stock.
4) Disposable household income is rising faster than average income, and there is a tendency to direct this disposable income toward housing.


Why property prices will not revert to past historical price vs income trends...

1) More women in the workforce means dual incomes going toward housing is now the norm.
2) Financial deregulation, product innovation and competition make finance available to a wider range of borrowers.
3) Lower interest rates and reduced financial institution's margins on housing loans improve debt serviceability.
4) New incentives such as negative gearing, capital gains tax benefits, SMSF can now invest directly in property etc.

(Obviously with recent credit tightening, points 2 and 3 have been temporarily rolled back to some degree, but certainly not back to the levels of thirty tears ago.)

Shadow.

 

[RumpledElf]

Supply/demand, diminishing block size, cost of new build ... none of these arguments hold in the country though ...

Declining population
Virtually no new houses
Vacancy rate increasing
Number of established houses reducing via fire/neglect/vandalism
No significant renos to existing houses
Number of businesses/jobs declining
Rents have hardly risen for years
Dole/pension only goes up by CPI each year (primary local wages)
No subdivisions - houses are sometimes sold with extra vacant lots so land size slowly increases

But house prices have boomed recently! Up 200-500% on 2000 prices! Is it the mining boom? No mines or miners here, although we're closer to Olympic Dam than Adelaide ...

I do agree that house quality (modern houses are larger, more bedrooms, higher quality finish), demand as the population increases, increasing size cities adding value to the inner areas as the definition of 'outer' gets ever further away, and higher household incomes have added to house prices overall, but there's a pretty big component of price rises lately that have nothing to do with any of those. And out here, we *only* get that component.

 

[DadOfSam]

Hi,

I'm a long term advocate of property investment but when challenged yesterday to the reasons why property goes up at a long term average of 7-10% I was left stumped. I realise there is a inflationary component, say 2-4% and that supply and demand plays a part but why consistently 7-10% over the longer term.

Can anyone articulate why aside from the fact that it just does?

cheers,
Tom

Are you just referring to Macro reasons, otherwise there are a LOT of micro reasons property prices rise (see Boomtown's response). Shadow's on the money with Inflation & money supply - because prices rise asa a result of buyers' willingness & ability to pay higher prices. Those 2 things are basically your answer, but probably not what you're after so sorry for that.

Otherwise, you're right on the money with inflation. Back in the days when inflation was thru the roof then of course that was a big component of the 7-10%p.a. cap growth. That's why without inflation "nominal" cap growth has been not so flash over the long term (ie decades) at a macro level.

 

[vincenzo]

I think the population growth of the world is the main driving factor, and the close secondary reasons are greed/competiton/desire of the nicest places to live, and people will fight like dogs and/or pay through the nose if that's what it takes to get what they really want.

Then there's also wage increases, which is one of the big things that can give people the power to spend more on property. There are so many contributing factors to inflation, most if not all just feed off one another... i'd hate to know what it would cost to buy even a cookie in 50 years time

At the end of the day tho, the first & main driving force for inflation in the prices of housing is population growth i think.

Block sizes are definitely getting smaller ianvestor, you can easily pay $500k for a ~75 square meter block of conrete in the middle of a building these days, and that much concrete in a building in a fancy place can cost millions

 

[natedog]

Hey Rumpledelf,
Who have been the predominant buyers in your area over the last 8 years, investors or owner occupiers?

and what was the $ value of a typical 3bed 1 bath house back in 2000?

Cheers,

 

[ianvestor]

i'd hate to know what it would cost to buy even a cookie in 50 years time

Hmmm, at 3% average CPI today's $1 cookie would cost $4.38.

Actually where can one find average CPI figures for the past 100 years?

 

[RumpledElf]

Investors and people from out-of-town or overseas. Lots of locals selling out and moving to where there are better prospects. The high vacancy rate (its about 50% in my town) is partly explained by people buying weekenders.

Most houses were in the $20-50k range back in 2000 (or lower, were still houses for sale for $10k in 2004 and a 1 bed 0 bath sold for $20k last year) and now most are in the $70-200k range. Rents are still averaging $50pw here, a little higher in the other declining towns.

There is a town near here that *does* have jobs, industry (and is where the locals sell out and move to) that has also had crazy price rises but at least that town has had the median income, population rise, phenomenal rent rise, building/subdivision etc to back it up, so it could just be a case of playing copycat.

Edit: aww, I'm going to miss the rest of this argument. I have a kitchen floor to strip and other havoc to wreak on the IP and its 40km away from my computer

 

[lizzie]

Investors and people from out-of-town or overseas. Lots of locals selling out and moving to where there are better prospects. The high vacancy rate (its about 50% in my town) is partly explained by people buying weekenders.

just looking at this component ... if the large majority of buyers are external investors, and a high vacancy rate, then there may be a level of speculation.

some inexperienced investor, or those that don't do their dd, would be looking at the past increase in valeue, current value and potential future gain (based on the past and speculation about nearby industry), without taking into effect the vacancy rate.

because it is heralded in the media about low vacancy "everywhere" (read: everywhere desirable), the run of the mill, inexperienced investors may be caught up in the hype - and only come back down to earth once they try and rent the place out.

also, you mentioned "weekenders". is your town a good location for those in the nearby industries to visit? i was suprised at the large caravan parks in whyalla that are apparently overflowing in summer - who would want to come to whyalla for a holiday? - those from places like broken hill and further out as whyalla does have a nice beach ...

you're looking at a micro area ... rules change.

 

[boomtown]

I am extremely suspicious of property investing outside major centres unless there is a clear driver for increased population growth in the area.

 

[Dazz]

Hmmm, at 3% average CPI today's $1 cookie would cost $4.38.

...you're in Australia mate....no such thing as a "cookie" - it's called a biscuit.

 

[ianvestor]

Yeah right, and I suppose you think a sub is called a 'sanga'

 

[keithj]

I'm a long term advocate of property investment but when challenged yesterday to the reasons why property goes up at a long term average of 7-10% I was left stumped. I realise there is a inflationary component, say 2-4% and that supply and demand plays a part but why consistently 7-10% over the longer term.

I always wondered why houses could grow faster than either CPI or wages for long periods of time.

Think about an average wage earner....
Assume they took home $500pw back in 1980 and thier living expenses were exactly $500pw.... that leaves $0 for disposable income... they are barely subsisting.

Then assume that inflation has averaged 3% since then and wages have grown at 4%.

So in 1981 that $500pw of wages have grown by 4% to $520, but CPI has increased their living expenses by only 3%, so their grocery/rent bill is $515. They have $5 left over, doesn't sound like much but, it's infinitely more than the $0 they had last year.

Then in 1982 same happens, wages grow a little faster than the outgoings, so they have a little over $10 to spend on doodads. That disposable income is DOUBLE what they had last year.

Anyway after 20 yrs of this, the increase in disposable income tends towards 7-8% as can be seen with the figures below.

Year		Expenses	Wages		Disposable 	Disposable increase
1980		$500		$500		$0.00		
1981		$515		$520		$5.00		Infinity
1982		$530		$541		$10.35		107.00%
1983		$546		$562		$16.07		55.25%
1984		$563		$585		$22.17		38.00%
1985		$580		$608		$28.69		29.38%
1986		$597		$633		$35.63		24.20%
1987		$615		$658		$43.03		20.75%
1988		$633		$684		$50.90		18.29%
1989		$652		$712		$59.27		16.44%
1990		$672		$740		$68.16		15.01%
1991		$692		$770		$77.61		13.86%
1992		$713		$801		$87.64		12.92%
1993		$734		$833		$98.27		12.13%
1994		$756		$866		$109.54		11.47%
1995		$779		$900		$121.49		10.90%
1996		$802		$936		$134.14		10.41%
1997		$826		$974		$147.53		9.98%
1998		$851		$1,013		$161.69		9.60%
1999		$877		$1,053		$176.67		9.26%
2000		$903		$1,096		$192.51		8.96%
2001		$930		$1,139		$209.24		8.69%
2002		$958		$1,185		$226.91		8.45%
2003		$987		$1,232		$245.56		8.22%
2004		$1,016		$1,282		$265.26		8.02%
2005		$1,047		$1,333		$286.03		7.83%
2006		$1,078		$1,386		$307.94		7.66%
2007		$1,111		$1,442		$331.04		7.50%
2008		$1,144		$1,499		$355.39		7.36%

And we all know what most people spend disposable income on.... stuff that makes them happy - like plasmas, cars and of course houses that are slightly better than the Jones.

 

[vincenzo]

I paid $2.50 for a cookie yesterday... i probably spoil myself once every week or so with a $2.50 cookie.... where are you guys finding these $1 cookies? I haven't seen cookies that cheap in years... and i don't mean a little crappy arnotts biscuit, i'm talking about nice chunky cookies!

 

[Kingbrown]

In real terms, Australian property (as a median price), has not doubled in the last 7-10 years. Even though we have had a huge boom, you would need to have had purchased your current property more than 20 years ago (1988), to see 100% real return.

If you take into account the "rubbery" figures that are reported as inflation, real return was likely to be somewhat lower.

I would really like to see a long-term chart showing real house price returns in Australia. Anyone have one?

 

[ianvestor]

Projecting that to 2508:


2507.......$2,911,973,537.......$473,739,737,197.......$470,827,763,660.......?
2508.......$2,999,332,743.......$492,689,326,685.......$489,689,993,942.......1.04% increase

On that theory, eventually it'll seem like there's no increase in disposable income. That'll be about 1000 years away though

-Ian

 

[DadOfSam]

I always wondered why houses could grow faster than either CPI or wages for long periods of time.

Think about an average wage earner....
Assume they took home $500pw back in 1980 and thier living expenses were exactly $500pw.... that leaves $0 for disposable income... they are barely subsisting.

Then assume that inflation has averaged 3% since then and wages have grown at 4%.

So in 1981 that $500pw of wages have grown by 4% to $520, but CPI has increased their living expenses by only 3%, so their grocery/rent bill is $515. They have $5 left over, doesn't sound like much but, it's infinitely more than the $0 they had last year.

Then in 1982 same happens, wages grow a little faster than the outgoings, so they have a little over $10 to spend on doodads. That disposable income is DOUBLE what they had last year.

Anyway after 20 yrs of this, the increase in disposable income tends towards 7-8% as can be seen with the figures below.

Year		Expenses	Wages		Disposable 	Disposable increase
1980		$500		$500		$0.00		
1981		$515		$520		$5.00		Infinity
1982		$530		$541		$10.35		107.00%
1983		$546		$562		$16.07		55.25%
1984		$563		$585		$22.17		38.00%
1985		$580		$608		$28.69		29.38%
1986		$597		$633		$35.63		24.20%
1987		$615		$658		$43.03		20.75%
1988		$633		$684		$50.90		18.29%
1989		$652		$712		$59.27		16.44%
1990		$672		$740		$68.16		15.01%
1991		$692		$770		$77.61		13.86%
1992		$713		$801		$87.64		12.92%
1993		$734		$833		$98.27		12.13%
1994		$756		$866		$109.54		11.47%
1995		$779		$900		$121.49		10.90%
1996		$802		$936		$134.14		10.41%
1997		$826		$974		$147.53		9.98%
1998		$851		$1,013		$161.69		9.60%
1999		$877		$1,053		$176.67		9.26%
2000		$903		$1,096		$192.51		8.96%
2001		$930		$1,139		$209.24		8.69%
2002		$958		$1,185		$226.91		8.45%
2003		$987		$1,232		$245.56		8.22%
2004		$1,016		$1,282		$265.26		8.02%
2005		$1,047		$1,333		$286.03		7.83%
2006		$1,078		$1,386		$307.94		7.66%
2007		$1,111		$1,442		$331.04		7.50%
2008		$1,144		$1,499		$355.39		7.36%

And we all know what most people spend disposable income on.... stuff that makes them happy - like plasmas, cars and of course houses that are slightly better than the Jones.

Plus, the great thing about disposable income is you can borrow against it:

So the growth in HDI is a good reason for the growth in house prices. Nicely spotted KeithJ Especially that bit on what most people spend DI on - looks like housing is a preferred method of keeping ahead of those damn Joneses