There sure has been a lot of ‘hoo-hah’ about the property market of late! Is it a bubble…will it crash…will it maintain its record breaking run…millennials can't get into the property market...who is to blame…what are the politicians going to do about it…on and on (and on) throughout the perpetual media cycle it has continued.
Aussies love their property. If I had a thousand dollars for every time a new investor came into my office wanting to commence their investment future by buying an investment property…well, I may be able to retire myself! The truth is, investing in property feels quite natural for Australians, and over the past several decades, it has treated them well. This article is to ‘pop the bonnet’ to look at what happened, why it happened, and if it is possible for it to to continue happening.
I could fill this article with economic content, discussions around the historic link between property prices and GDP growth etc etc etc, however I actually want people to read this, so I will ‘keep it real’ using a real life example as a case study, a family home of a relative.
This family home in question was bought in 1969 and sold in 2009, so the period of time of 40 years will be the time-frame. Let’s look at what happened over the forty years from purchase to sale, and then project it forward for the next 40 years, to see how things stack up!
The house in question was purchased for $15,000 in 1969, and sold for $630,000 in 2009. For those who are curious, this is an average annual growth rate of 9.79%. This home was nothing remarkable, just a typical family home in low-to-middle class Brisbane, and whilst there were some renovations done on the property (as you would need over a 40 year period!), it was within the 'feel' of the house and area, so nothing too excessive.
Now, the interesting part….what if we assumed the same rate or return for this property for the next 40 years? Well the property would be worth an eye watering $26,460,000 (yep, $26 million for a standard family home!). Sounds like a lot right?! Sounds a little impossible too, you are no doubt asking. That well-depends on what a person is earning in 40 years’ time, so let us have a quick look at that.
As this is the average family home, let us assume that the average household income in Brisbane is currently $100,000 (admittedly, it could be a lot less). Wage increases are measured by a change in AWOTE…I will not bore you with what it stands for, but just think that an increase in AWOTE is akin to inflation for the income of the community.
The most recent AWOTE was 2.2% according to the ABS 1 (ie. wages grew by 2.2%). However, let us be a little generous, and assume a 4% annual growth in income. Based on this annual increase, this $100,000 average household income would be $480,102 in 40 years time.
Now let me ask you a very frank question…would someone earning $480,102 be able to finance a loan of $26 million?? Typically, the prudent lending level of gross income that people are to use to finance their housing is 33%, with anything above this being considered as mortgage stress. A third of this income is $160,034.
If we assumed that the prevailing borrowing interest rate at that time is 6% (this is pretty generous…we are at 4% now, and in the late eighties it was in the high ‘teens’!), then $160,034 could only finance $2,667,233 and that is interest only, we have not paid off any principal. We are $23,792,767 short…If we assume a 6% interest rate, a purchase price of the above-mentioned $26 million, and a 30 year term, if we are paying off Principal and Interest we would need to pay $1,922,290 per annum in mortgage repayments alone. We are just a tad short!
There is clearly a disconnect…something is quite amiss. It does not take Einstein to note that either property prices will NOT continue at rates experienced over the past 40 years, or if it does, then our wages WILL go through the roof (not that we would necessarily have more to show for it, as it would need to go to financing our home).
Do not be like my son, who reacted badly after hearing the News saying that he will never be able to afford a home when he grows up (this picture is actually after we took his 'massive' Easter Egg off him so he did not get a stomach ache, but I had to work an angle to include it in the article!). Markets do have a way of working these things out. It is called supply and demand. Regardless of what property prices do long term, I believe it is a fair assumption that wages will allow the purchase of a family home. There will be times of 'spikes' (2000-2007) that make it difficult to enter the market for a period of time, however as sure as night follows day, there will be periods of correction/flat-lining which make it easier for those to enter the market (1987-1999).
While I was going through this analysis, and I was showing my wife the findings and how the figures were suggesting it is highly improbable property will grow at this rate for the next four decades, she said “but it did happen…why?”. To be honest, that question did stump me, so I began contemplating. The main thing that has changed from the late sixties to the late ‘noughties’ has been the increase in dual income households, creating more surplus income. Add to this the introduction of favourable tax treatment of investment loans (ie. negative gearing), and I think we are part of the way to explaining why this dramatic increase has occurred. Short of sending our children out to work, I do not think this is repeatable. Yes, of course there is an increase of foreign buyers of recent years, and whilst this certainly adds to the demand, it is not at the magnitude to materially 'move' the market nationally. Be that as it may, the Federal Government do sound as though they are looking to restrict this even further.
As a Financial Planner, who tries to look at things factually, it does concern me significantly that many have the mindset (more often than not fueled by Real Estate spruikers) that property will continue to smash new records, and all you need to do is just 'get in' and you are guaranteed to make a fortune!
Personally, I hope the real estate spruikers prove to be correct, as a strong real estate construction market is good for the economy. As much as I wish it were true…the numbers just do not stack up on my reckoning.
About the Author
Glenn Baker is a Certified Financial Planner, and the Senior Financial Planner and Principal of Adept Financial Planning Pty Ltd, a Corporate Authorised Representative of Capstone Financial Planning Pty Ltd (as of 02/08/2019), AFSL 223135, ABN 24 093 733 969.
This article has been created for communication and discussion purposes only, is intended as a 'light-hearted' discussion around a topical issue, and is not to be construed as Personal Financial Advice. It is topical in nature, and does not pertain to include all relevant factors or considerations. Therefore, no action should be entered into based on information from this article.