My Monday Rant

Last week I copped a bit of criticism following my Safe As Houses post. Here’s the first:

2 major flaws in your chart, which would suggest your post is indeed ‘enticing narrative’; – If you factored in the income from each of these assets, including the fully franked dividend from the CBA, you would find the CBA has delivered somewhere around 200% of the income return of property – What is the impact if you took said income and reinvested it? Massive… I’d love to see your chart then. Capital Growth is only one component of your return and in the case of the CBA, represents around half your return.

This reader raises a valid point – dividends and the impact and power of compounding returns. I decided to ‘tidy up’ my analysis. So I included CBA’s dividend, reinvested it (although not everyone reinvests dividends), and compared the return to Melbourne and Sydney house prices in nominal terms. I chose Melbourne and Sydney given the share of CBA’s loan book these two cities.

And voilà, here’s what we have. Although I didn’t have time to incorporate rental income from the two cities, the outcome is no different. I also note the chart is not a common base chart, i.e. all investments start at the same point, which means Melbourne’s end price would be higher given the lower start price.

You can see the correlation and behaviour is very similar. Another reader writes:

With two sides of the story being capital growth and income received I don’t think you have provided great understanding of the correlations and drivers of both property & shares and underrepresented both.

My original article was providing evidence of the correlation between residential property and CBA’s share price, and was being done so not based on the two being mutually exclusive.

The reader continues…

Families need to understand whether they want to have a part time job, maintaining a property portfolio, chasing rent, keeping tenants, fixing broken water pipes, paying real estate agents, paying lawyers. Or whether they would like a set and forget strategy of investing in the great companies of this world, where they pay a financial adviser, a platform and investment fee and they can enjoy what’s most important to them.

Although the reader seems to have misunderstood the intent of my original article, they raise a valid point. Investing in direct property can be both time consuming and costly. For this reason, most investors hire a real estate agent. They take care of the maintenance of the property, they both find and keep tenants, they arrange for the broker water pipes to be fixed, and yes, we pay them a fee. Just like our clients pay us for the services we provide. I would have also thought that property can be a ‘set and forget’ investment too, can it not?

The alternative the reader provides us with is to hire a financial adviser, pay them, hire a platform, and pay them, then pay the investment fees, and forget all about it.

I admit, my comments are tongue in cheek, but what these comments proved to me, yet again, is that those with vested interest will continue to peddle the narrative that best suits them. Walk into a Holden dealership, you won’t be sold a Toyota.

Investors deserve the truth. Investors deserve to be educated. Investors deserve the right to know what we as advisers can help them with and cannot help them with, not what we will and will not help them with – there is a difference.

My original article was not to spark debate between property or shares. Both asset classes not only behave very differently, they both serve different objectives. History tells us that both Australian shares and Australian residential property have performed broadly in line with each other over the long-term. Australian shares have provided a slightly higher rate of return, however Australian residential property has provided investors with a smoother ride along the way.

Source: AMP

I kindly remind you, as investors, look beneath the investment and ask yourself the following questions:

  1. Where am I allocating my money?
  2. What is the underlying investment?
  3. What is the investment influenced by?
  4. What am I really investing in?

Most importantly, ask yourself this question:

What is the objective/purpose of my investment?

Here’s the blueprint for how to think about investing in it’s simplest form – a snippet from our Intergenerational Wealth Transfer forum in 2018.

God speed.

Safe As Houses

I recently attended an investment forum lined up with a bunch of bond and equity managers pitching their great ideas. It was held in Crown’s Palladium, and the room was full. I can’t imagine what it cost these folk to get a guernsey for the day – but I know who’s ultimately paying for it (and I’m sure you do too).

Our industry is full of smart people and not so smart people. It’s dominated by cool charts, engaging narratives, long disclaimers, Italian neckties and hand bags, and fancy lunches and dinner. Whatever can be controlled will be controlled, all in the pursuit of influence – one way or another.

There was one presentation by a stock market fund manager that confused me slightly. Yet it provided me with such clarity.

The confusion

The gentlemen was speaking about the ‘over-inflated’ property market, at the same time presenting the audience with a number of convincing PowerPoint slides. He then went on to explain why Australian shares, specifically the Australian banks, provided investors with far better value. This was difficult for me to follow. As an investor and avid market follower, I am fully aware that the Australian banks have their fair share of exposure to the property market. I mean, this is how they make their money, right? So I decided to run the below chart. It shows Australia’s real house prices (blue), and CBA’s share price (orange). Can you spot the trend?

On one hand we’re being told not to invest in Australian property, yet on the other, we’re being told to invest in ‘blue chip’ Australian banks. Can you see the reason for confusion?

The clarity

What was made very clear to me was that the stock market guy or stock market gal is going to plug their asset class by torching others. It’s sad, but true. I guess you’re not going to be sold a Holden when you walk into a Toyota showroom, right?

What’s worse is that investors are being fooled into a narrative that lacks evidence and substance. The pitch also got me wondering about the extent to which investors undertake analysis about their own investments. Where am I allocating my money? What is the underlying investment? What is the investment influenced by? What am I really investing in? Investors really need to be peeling back the onion.

Secure debt is another example. Investors hear the words and shake their heads, that’s too risky. Yet they’re very comfortable to take an equity position in a business that does this very thing. Where am I allocating my money? What is the underlying investment? What is the investment influenced by? What am I really investing in?

If you haven’t seen this before, it’s a simple table that shows you the lowest risk (senior secured debt) investment to the highest risk (equity) investment.

Next time you are reviewing an investment opportunity, ask yourself these questions. Take the time to truly understand what and where you are investing. Filter the noise and start to make informed and educated decisions about where you allocate your capital.

Those investments, make sure they’re safe as…houses?

The Greatest Property Bubble or A New Beginning?

Melbourne’s population is booming, and it has not only become one of the wealthiest cities in the world, but has also developed an international reputation as one of the greatest cities in the world.

Melbourne is in the midst of a land and property boom. Rather than building high-density apartment blocks like the European cities, Melbourne expanded wide and far. Real estate is ‘The Land of Promise’, as proclaimed by this sales poster for Moreland Road, Brunswick.

Investors are buying up farms and subdivided them. They are luring buyers with free railway passes out to the new estates, feeding them and serving champagne before bidding gets underway. In fact, the value of land in parts of Melbourne is as high as London.

The Argus newspaper wrote, ‘[The hunger] that has seized hold of so many people is the result not of an hallucination, but of an awakening to the value of land as a safe, a sound, and a profitable investment.’

I’m talking about Melbourne in the 1880’s – it was dubbed ‘Marvellous Melbourne’. Here we are in 2019, and the tune hasn’t changed in 140 years.

In April of 1893 the bubble had popped, and the boom was over. Melbourne’s unemployment rate jumped to 20%. Property prices dropped almost 40% (Melbourne) within years, which compares to a drop of 20% during the 1930’s depression. It would take Melbourne 60 years to recover.

Every bubble is different. Their formation varies from duration, magnitude, and cause. It was higher interest rates that would eventually pop the bubble of the 1890’s, and the banks’ failure to take security for loans written during this frenzy would lead to the collapse of a number of them.

With bank lending having soared since 2012, prices having doubled during this time, and interest rates at an all time low, could we be facing another crisis like the one that has been buried in history books for decades? Or is it different this time?

According to the media, Australia’s property bubble is akin to that of the US.

When people refer to the US property bubble, I ask them which city they’re referring to. Sure, the US had a property meltdown, however not all cities we’re wiped out. New York fell 24.45%, Dallas down 7.53%, and Boston fell 16.38%. In fact, it wasn’t even the cities that had the largest growth pre-GFC that fell the most (refer LA and San Francisco). On average, prices in major cities fell around by one third of their value.

Similarly, when people talk to me about the Australian property bubble, I ask them which city/ies they’re referring to. In Australia, it’s largely been a story of Sydney and Melbourne.

I decided to run a few charts to analyse the current state of play:

Australian Real House Prices

Here’s a long-term view on real house prices:

Major City House Prices

Since the RBA started cutting rates in 2012, house prices doubled in major cities. Since peaking in 2017, Sydney is down 14% and Melbourne 11%. Hobart continues to climb, and prices rises in Sydney and Melbourne guide investors to cheaper cities.

Residential Building Approvals

The story of Australia’s construction boom has been one of apartment construction. Detached housing has been moving sideways for sometime now. Economics 101 tells us that when the supply increases, price decreases, and when supply decreases, price increases. This is the story of apartments and detached housing.

Price to Income Ratios

This ratio tells us how much of the median income (as a multiple) does it take to buy the median house. For example, in Melbourne, it takes 10 times the median income to buy the median house. In Sydney it’s 13 times. In Hong Kong it’s 20 times. It seems as though global ratios are converging following a massive divergence pre GFC.

Housing Finance Commitments & House Prices

There’s a strong correlation between the amount of debt the banks lend out and house prices. In fact, house prices lag lending by about 6 months. The data tell us that lending is still falling.

Auction Clearance Rates

This is one of my favourite charts because they are timely and have a good cyclical relationship with property prices in Sydney and Melbourne. Clearance rates have been declining for some time now, although you can see a little kick post election – something to keep an eye on.

House Prices & Household Debt

This chart shows us the strong relationship between debt and property prices. Overvaluation in prices really started in 1996 –  it’s popular to blame negative gearing, the capital gains tax discount and foreign buying for high home prices and debt. However, the basic drivers are a combination of the shift from high to low interest rates over the last 20-30 years boosting borrowing power, along with a surge in population growth.

Dwelling Construction & Population Growth

For many years we have had a supply issue in this country (thanks to tight development controls and lagging infrastructure). It’s expected that Victoria will be home to about 8 million people by 2050.

And these people will want somewhere to live, surely. Based on these numbers, it may come as a surprise to most people, but we’re just now starting to build enough property to help support our growing population.

Sure, we’re going to see periods of oversupply and periods of under-supply, which in turn will result in periods of price growth and periods of price declines. This is not unusual, the free market has been valuing assets this way for centuries.

Bank Non-Performing Housing Loans

Although non-performing loans are down from their GFC peak, they have kicked up since late 2017. A switch from Interest Only loans to Principle and Interest loans have been driving servicing costs.

They say investors have a three year time horizon.

As human beings we’re wired in such a way that makes it difficult for us to be able to see so far into the future. Take the city of Melbourne for example.

Here’s the evolution of Melbourne city over 130 years, in images, taken from the top end of town – Spring Street:

Here’s Melbourne today:

Between 1% and 3% of a city is demolished and rebuilt each year, such that over almost a lifetime, a city is completely transformed and almost recognizable. Incremental change is so difficult for us to recognize, however over long-periods of time, it’s clear as day.

If for one moment you think our city can no longer be built out, here’s the City of Melbourne’s Development Activity Model. Here’s the city as we know it today:

Let’s add the buildings under construction (yellow):

And those that have been approved (green):

And those that are in application phase (blue):

As investors we need to fight the minute by minute news headlines that try and grab our attention each and every day. Although we are not wired to, we know deep down that true, significant, and sustainable wealth is created over long periods of time – yet we want it all now.

We’re clearly in for another interesting year in property, one with moderate price growth in some locations and virtually no growth in others and falling prices in others.

Australia’s property markets are very fragmented, driven by local factors including jobs growth, population growth, consumer confidence and supply and demand.

Investors need to have a sound strategy and game plan. So when the opportunity presents you know exactly what you need to do, and how to do it. It also ensures you maximise returns and avoid unnecessary market and asset risk. Shooting off the hip is not a strategy.

Our property markets are behaving as they always do – boom, downturn, bust, boom, downturn, bust…

The biggest profits are made during the downturn and bust stage of the cycle – that’s because downturns are only temporary, while the long term increase in the value of good property is permanent.

Take the long-view.

A Text From a Real Estate Agent – Here’s What it Said

Each Saturday afternoon between 2:30 and 3:30 pm, I receive a text message from a real estate agent who provides his distribution list with an update of how the day went. Last Saturday, his tune completely changed, which intrigued me. Here’s the text:

I commend him for his honesty – well done. And it’s true. Clearance rates have been falling sharply since mid 2017 (see below chart).

Source: AMP

Clearance rates have dropped from a solid 80% to about ~46% (final) in Sydney, and ~49% (final) in Melbourne. The last time we saw these levels were back during the GFC and 2012 (when interest rates were first cut).

Here’s what the auction market looked like last week:

Source: Core Logic

Allow me to give you insight as to the implications (at least historically) of falling clearance rates. They’re a leading indicator for house prices by about 5 months (see chart below). As auction clearance rates fall, we see property prices fall in the following months.

Source: JP Morgan

Not only are clearance rates a leading indicator, so too are housing finance commitments (loans). These have also been falling (see chart below). Loan commitments are a leading indicator by about the same time as clearance rates – 6 months.

Source: JP Morgan

As the regulators and banks tighten lending standards, as we continue to see a rise in the supply of dwellings, as affordability is still an issue given low wage growth, and with the constant drumming of political and policy uncertainty (negative gearing and CGT discount), we can expect further weakness ahead.

As I began to write this note, I found out that 60 Minutes was airing ‘Bricks and Slaughter’ at 8:30 pm (click here for the ‘Part One’ episode).

The episode was basically calling for a housing crash. Martin North of Digital Finance Analytics predicts a housing crash of 40%-45% within the next 12 months, and we hear Louis Christopher of SQM Research echoing Mr North’s call.

Follow these gentlemen on Twitter and you will see a slightly different point of view:


Well done 60 Minutes in fear-mongering the Australian public.

To this day, we continue to hear comparisons being made to the US property bubble. What most people don’t understand is that the “housing market” is made up many other smaller ‘markets’. To illustrate this point, take a look at the table below. It shows the top 10 US cities’ boom from 1996-2006, crash from 2006-2011, and so on.

Take a look at New York, up 173% during the boom, and down 24.45% during the bust. Dallas was down 7.53%, and Boston down 16.38%. The interesting thing about all of this is that the city with this largest gain (LA) was not the city with the largest fall – it was Phoenix, down almost 55%! On average, the US housing market fell 33%.

One fact that I don’t believe gets enough showtime is the oversupply of dwellings in the US pre GFC. Leading up to the GFC, the US had overbuild close to 6,000,000 units of housing. As of the beginning of 2018, the US is sitting close to 2,000,000 units short (see below chart).

In Australia, we have a very different story (see below chart). For many years, we have never truly caught up to the demand for dwellings. Having said this though, we are getting to a point where we are now seeing good supply hit the market.

Source: NAB

The Australian, specifically Melbourne and Sydney property market has been running hot for a number of years now. We will see a collapse in prices – timing and magnitude, no one truly knows. However all indicators are pointing to a slow down and natural correction.

The fundamentals for property in this country remain strong, yet the sentiment remains weak. The market will present buying opportunities for those that are patient, disciplined, have a game plan and are cashed up. As foolish as one may feel for holding funds in low returning cash and term deposits, the tide will turn, and you too will have your opportunity.

Property Prices Doubling Every 10 Years is a Myth, Here’s Why

There’s an old saying in Australia, property prices double every 10 years.

How true is this old saying? I was recently presenting financial analysis we had undertaken for a property portfolio. As we presented our findings, our assumed rates of return were questioned – why would you use such a low rate of return – historically property prices have double every 10 years?

Let’s jump down this rabbit hole.

We Aussie’s have an obsession over property. I get it, I love my property too and have also been lucky enough to be a beneficiary of this market. I will however be the first person to admit that it was through no skill whatsoever, nor did I anticipate to what extent this market would rise when I initially invested in property. My decisions are driven with specific objectives – a roof over my family’s head, investment properties in specific locations for income and future development potential to help my kids in the future, a beach house to get away from the hustle and bustle and spend time with my family. What I do with any of my properties are unlikely to be be influenced by what the market is doing, nor by what the market believes my property is worth. In fact I couldn’t care less.

Yet so many people have the equation so wrong – speculating on the price of land on the basis that property doubles every 10 years. Allow me to let you in on a little secret – the concept of property values doubling every 10 years is completely misleading. Don’t believe me? I’ve crunched the numbers, and here’s what I think.

I’ve summarised the return of the Melbourne property market for every decade beginning 1980 in the table below (median price). For example, for ten years ending 1990, the growth in the median price of Melbourne property was 237.93% – ridiculous, right!?

Table 1: Nominal 10 Year Return

Source: REIA, Core Logic

Based on the above table, I can understand why you may have been told (and believed) that property prices double every ten years – both the average and median percentage return for price rises have been over 100% since 1980.

Let’s take a look at what happens when you take into account inflation. The table below is the same as above, and I have calculated the Real Rate of Return in the third column. Take a look at the example we looked at earlier. The nominal (before inflation) return from 1980 to 1990 was 237%. When you take into account inflation, or the real return for the same period, was 55.06%. Although this is still a solid return, its certainly a far cry from 237%.

Table 2: Nominal & Real 10 Year Return

Source: REIA, Core Logic

Once you take inflation into account, the average and median ten year real return is 50.24% and 44.14% respectively.

Even though in Table 1 the average and median price rises are in excess of 100%, prices only increased more than 100%, 55% of the time – 45% of the time, prices did not double. Once you take inflation into account, since 1980, Melbourne median property prices have not double. Ever. During the decade ending 2005 they came close, returning 92.58%.

Now that we have established that real property prices don’t double every ten years (although my guess is that there will still be those who don’t believe me, and if this is you, reach out to me – we can chat further), I decided to analyse Melbourne’s rolling ten year real returns per annum. In other words, what was the real rate of return each year for every decade since 1940. For example, let’s say you purchased a Melbourne property in 1940 and held it for ten years, your actual real rate of return was about 9% pa. If you held property for ten years ending 1960, your annual return was a bit over 10% pa. If you held property for ten years ending 1987, your annual real return was 0% – yes, property can not grow in real terms.

The average annual real (after inflation) return for those holding property for ten years was about 4% pa since 1940 (ending 1950).

Here’s the chart. The blue line represents the return, the green dotted line is that average annual return, and the red dotted lines represent +/-1 and +/-2 standard deviation from the average.

Table 3 – Real Melbourne 10 year Rolling Growth (pa)

Source: Stapledon, ABS

What we can also see from the above chart, is that property goes through cycles – who would have thought!? Periods of high growth are followed by periods of low growth, and periods of low growth are followed by periods of high growth.

Where does this leave housing as an investment?

This is probably one of my favourite charts. It’s put together by Shane Oliver of AMP Capital and compares the long-term return of Australian residential property, Australian shares, Australian bonds, and Australian cash.

Source: AMP Capital

Since 1926 residential property has provided investors with a similar return to Australian shares – 11.1% pa to 11.5% pa.

As you can see from the above chart is that although Australian shares have performed slightly better, they have come with higher volatility. They are more liquid and easier to diversify, whereas property has been less volatile (partly because it’s not valued every single second of the day – unlike the share market), it is less liquid and harder to diversify.

Both shares and property have rewarded long term investors. In fact, shares and property tend to have low correlations with each other, meaning they typically don’t go up and down at the same time and at the same magnitude. Therefore, from a diversification point of view, there is a very strong case to hold both in your portfolio for the long-term.

I guess anyone can fudge the numbers to support whatever narrative they’re peddling. At the end of the day, the facts are the facts. You deserve to know the truth, it helps you manage your own expectations and make better investment decisions. Just because property prices haven’t doubled every ten years, doesn’t mean they won’t.

Godspeed.

The Changing Face of Melbourne

Once upon a time in 1667, the Dutch East India Company, the most valuable company in the world at the time, wanted a monopoly on nutmeg – a spice that was worth considerably more than gold. During this time, Run island, a tropical island closer to Darwin than Jakarta, was prized as the home of nutmeg.

In July of 1667, the Dutch acquired Run island via a swap with the British. They agreed to trade New Amsterdam for Run island. The Dutch now had a global monopoly on nutmeg. It has been described as “the real estate deal of the millennium”.

Unfortunately for the Dutch, the price of nutmeg eventually collapsed. The British stole seedlings and dramatically increased supply by growing them in other parts of the world. Furthermore, the arrival of other stimulants such as coffee, tea, and tobacco didn’t aid the Dutch’s situation.

Today, Run island has a population of around 2,050, and still grows nutmeg. New Amsterdam was renamed New York, and the rest is history. All of this within a very short period of time – 351 years to be exact.

They say investors have a three year time horizon, last year, this year, and next year. As human beings we’re wired in such a way that makes it difficult for us to be able to see so far into the future. Take the city of Melbourne for example.

Here’s the evolution of Melbourne city over 130 years, in images, taken from the top end of town – Spring Street:

And here’s Melbourne today – a very different picture to that of the first.

 

Between 1% and 3% of a city is demolished and rebuilt each year, such that over almost a lifetime, a city is completely transformed and almost recognizable.. Incremental change is so difficult for us to recognize, however over long-periods of time, it’s clear as day.

Here’s a different perspective, one that most of us can recall. Southbank, in the blink of an eye is completely transformed.

Today is no different. With not only the unprecedented level of construction within the city of Melbourne, but also the density of construction, the public are outraged that we are killing our cities. Our cities have never stopped growing, have never stopped evolving, and have never stopped progressing.

This is what progress looks like. Just because it’s new, just because this wasn’t how it used to be, just because this isn’t how we grew up, doesn’t mean we should fear what the future holds.

Melbourne was founded on the 30th of August 1835. A lot has changed since then. A city which is 183 years young, houses a population of around 4.725 million. Contrast this to the city the Dutch swapped for their nutmeg monopoly in 1667. New York City, founded in 1624 is now around 394 years young, housing a population of around 8.625 million.

By the year 2046, Melbourne’s population is expected to increase by 2.8 million people. Here’s what Melbourne’s skyline looks like looking up from the south:

Here’s what the same skyline starts to look like when Melbourne houses 10 million people:

And if you were to take all the buildings on Manhattan Island and placed them into the city of Melbourne, this is what it would look like:

Although quite staggering, it can be done.

As investors we need to fight the minute by minute news headlines that try and grab our attention each and every day. Although we are not wired to, we know deep down that true, significant, and sustainable wealth is created over long periods of time – yet we want it all now. We need to change the way we think about, and invest not only our money but in ourselves. We seem to be attracted to complexity and complication when in fact simplicity yields a more favourable outcome. We seem to prefer to make significant and material changes less frequently, when in fact small, incremental changes made more frequently, which may seem insignificant to us today, compound to and have a far greater impact than we could have ever imagined. It’s like a freight train that gains momentum – it becomes unstoppable.

Try and add 5+5+5+5+5+5+5+5+5+5 in your head. It’s pretty easy, you can do it right? The answer is 50. What if I asked you to multiply instead of add in your head, 5x5x5x5x5x5x5x5x5x5? There’s no way you’ll be able to do it, in fact, I don’t even think you’ll be able to wrap your head around it (by the way, the answer is 9,765,625).

As investors we underestimate the long-term. We underappreciate the power of compounding. Because it isn’t intuitive, we ignore it, and try to solve problems through other means. Next time you’re planning ahead, stop and think about the long-term. Stop and think about the potential of compounding.

Thanks to Tony Crabb of Cushman & Wakefield for the inspiration.

The Great Melbourne Land Boom

Melbourne’s population had boomed, and it had not only become one of the wealthiest cities in the world, but had also developed an international reputation as one of the greatest cities in the world.

Melbourne was in the midst of a land and property boom. Cable trams ferried crowds through the streets and the young and fashionable ‘did the Block’, promenading the footpaths and arcades of Collins Street. Telephone and electric light were novelties and Melbourne’s first skyscrapers appeared. Theatres and opera houses drew large audiences through the weekend evenings.

Melbourne showed itself off to the world by hosting major international exhibitions of industrial, scientific and artistic progress from all corners of the globe.

I’m talking about Melbourne in the 1880’s – it was dubbed ‘Marvelous Melbourne’ by British journalist George Augustus Sala when he visited in 1885. Here we are in 2018, and the tune hasn’t changed in 133 years.

Between then and now however, Melbourne witnessed some of the most severe economic collapses which are now simply buried in history books.

Bubbles, in any market, have a tendency to burst. Not long after, in fact within a decade, Melbourne’s Land Boom crashed in the early 1890’s – it caused a depression that rippled through all the Australian colonies.

Rather than building high-density apartment blocks like the European cities, Melbourne expanded wide and far. Real estate during the 1880’s was ‘The Land of Promise’, as proclaimed by this sales poster for Moreland Road, Brunswick (click for larger image):

Source: Moreland Road, The Land of Promise, West Brunswick, close to Essendon, 1888 (Dyer collection of auctioneers’ plans, Melbourne and suburbs State Library of Victoria)

Investors would buy up farms and subdivide them. They would then lure buyers with free railway passes out to the new estates, feed them and serve champagne before bidding got underway.

By 1889, the value of land in parts of Melbourne was as high as London. The Argus, a daily Melbourne newspaper wrote, ‘[The hunger] that has seized hold of so many people is the result not of an hallucination, but of an awakening to the value of land as a safe, a sound, and a profitable investment.’

In April of 1893 the Commercial Bank of Australia, who had lent substantial money to those involved in property speculation, closed it’s doors. The bubble had popped, and the boom was over. It’s estimated that Melbourne’s unemployment rate jumped to 20% during the 1890’s. Property prices dropped almost 40% (Melbourne) within years. This compares to a drop of 20% during the 1930’s depression.

Following the collapse of the 1890’s, it wasn’t until the boom of the 1950’s that would see prices return to levels reached during the 1890’s. It would take Melbourne 60 years to recover in price.

Here’s an aerial shot of a new housing estate in 1948, known at the time as ‘Heidelberg’.

Source: Charles Daniel Pratt 1892-1968 Photographer/State Library of Victoria/H91.160/376

Every bubble is different. Their formation varies from duration, magnitude, and cause. It was higher interest rates that would eventually pop the bubble of the 1890’s, and the banks’ failure to take security for loans written during this frenzy would lead to the collapse of a number of them. With bank lending having soared since 2012, prices having doubled during this time, and interest rates at an all time low, could we be facing another crisis like the one that has been buried in history books for decades? Of course not, it’s different this time. Right?

Australia’s Property Market is a Speculative Bubble

Last week I attended an investment management conference in Melbourne. The day was lined up with asset managers providing the attendees with their point of view on markets – including the stock market, bond market, and of course, the property market. Most, if not all of the firms presenting were either equity or bond managers. I don’t believe there was a property manager presenting on the day. Yet, most managers spent a bit of time discussing the property market, and the gloomy outlook for this sector. The large debts, the level of construction, foreign buyers, I could go on.

That evening I also attended a property development forum, presented by two specialist groups, who talked about the current situation in the property market, providing a different point of view from the asset managers earlier on in the day. I guess this is what makes the market, right? One persons view compared to another.

Here’s where I think the property market is at.

We’ve been hearing the same call for years – the Australian property market is a speculative bubble…blah blah blah.

Sure, property prices aren’t cheap. In fact, they’re sitting a little above their long-term trend according to AMP.

All the reasons the equity and bond guys were giving at my presentation are well known. Ballooning debt levels, prices to income and rent ratios are high, and there are far too many cranes in Melbourne’s skyline (and yes, there is an index for this).

Unfortunately, in both my experience and readings, things are little more complex than this.

1. Ballooning debt

Household debt has been skyrocketing since the GFC, and after the RBA began cutting rates in 2012 (I guess you could argue debt has been skyrocketing since 1991). Yet the amount of interest paid by households is back down to levels not seen since 2004. Notwithstanding, this is a problem. How will this debt be reduced? Inflation? Wage growth?

2. It’s a bubble

When people refer to the US property bubble, I ask them which city they’re referring to. Yes, the US had a property meltdown, however not all cities we’re wiped out. New York fell 24.45%, Dallas down 7.53%, and Boston fell 16.38%. In fact, it wasn’t even the cities that had the largest growth pre-GFC that fell the most (refer LA and San Francisco). On average, prices in major cities fell around by one third of their value.

Similarly, when people talk to me about the Australian property bubble, I ask them which city/ies they’re referring to. In Australia, it’s largely been a story of Sydney and Melbourne.

Source: CoreLogic

This hasn’t always been the case (see chart below). Perth property prices we’re going bananas during the mining boom, yet they’ve been lagging ever since. Most cities circle around the national average, some over-performing, and some under-performing. Lack of affordability eventually encourages investment into other cities, as we’ve seen recently into Queensland and Tasmania.

3. We’re building too many dwellings stupid

It’s everyone’s greatest fear (or possibly greatest desire – a claim to fame perhaps?). The miraculous oversupply of property, more specifically in apartments. It’s expected that Victoria will be home to about 8 million people by 2050. And these people will want somewhere to live, surely. Based on these numbers, it may come as a surprise to most people, but we’re just now starting to build enough property to help support our growing population. Sure, we’re going to see periods of oversupply and periods of under-supply, which in turn will result in periods of price growth and periods of price declines. This is not unusual, the free market has been valuing assets this way for centuries.

Over the last 7 years, Victoria’s population has been growing well above the national average.

This is supporting vacancy rates remaining low. In Melbourne and Sydney, we’re seeing below average vacancy rates:

You think it’s bad now? Over the next 20 years, population growth is expected to surge. Here’s where they’ll grow the fastest:

These people are going to want somewhere to live. Here is where we’re going to see the largest growth in dwellings:

If you think there is a lot of development activity in the City of Melbourne, you haven’t seen anything yet. The city you and I know today, will not be around in the next 10-20 years. Here’s a great interactive site the City of Melbourne have up, and you can see what is constructed, what has commenced, and what has been applied for.

4. The banks are a proxy for the residential property market

Then why are you investing in the stock mister equity guy?

At the end of the day, it’s going to take one of two factors to bust (temporarily) this housing market – a rapid rise in rates, or a rise in unemployment. The consensus goes something like this…rates are rising, which will lead to higher unemployment, which will lead to loan defaults, which will lead to property price declines, which will lead to a banking collapse. Sounds reasonable. Luckily for us, this actually happened, so we can see what impact is actually had. Western Australia – mining boom collapse. Trade fell 25%, unemployment up to 6.50%, property prices fell 12%. Do you know what impact this had on Westpac’s lending losses – they doubled…from 0.02% to 0.04%.  If this scenario we’re replicated across the nation, bank profits would be cut by 0.60% (farrelly’s). Not really the Armageddon scenario that’s being painted.

5. Tighter lending standards will stop the price rises

It’s no secret, lending is tightening. This has created an opportunity for private/non-bank lenders to enter the market. The banks shouldn’t be expected to cater for every transaction that occurs. I was recently told by someone that Westpac (if WBC can do it, I’m sure most of not all lenders can) are now able to tell how much exposure they have to a single building even each purchaser took out their loan from a different Westpac branch/office. This enables the bank to limit their lending to one particular building/construction.

My expectation is that we’ll see in Australia what we’ve been seeing in the UK and US. That is, non-bank lenders growing as a proportion of all lending.

Currently you could lend senior money out and receive 10-12% pa. I do wonder though, what impact this will have on bank profits.

In summary:

We have an under-supply problem. Our population is growing at a rapid pace. We’re seeing them from all around the world, and they want somewhere to live. Here is the state of Victoria’s population and household projections to 2051. This report is used by decision makers in government to plan for our future. I suggest it’s something worth reviewing if you’re looking to invest in property. You should also check out the government’s online planning maps. Again, this may be useful if you’re looking to invest in property for the long-term.

Sure, the market isn’t cheap – this isn’t something new. The property market grows at above average rates, and is then followed by growth at below average rates. When rates eventually rise, my expectation is that we’ll see a decline in prices. Those that have over leveraged themselves will be forced to put the for sale sign out the front. The fact that most people have, and will continue to want to buy, live, and invest in property, will naturally create a safety net. Property prices can float sideways for long periods of time. They don’t always need to boom or bust, the outcome is not always binary.

As long as the music keeps playing (demand), we’ll all keep dancing. Australia does not have a property bubble.

How to Invest Your Money

Over the last week, I’ve been speaking with a number of clients and investors about their investment portfolios and how to best allocate capital.

It’s a tough one. With so much content being publish dictating how we should invest our money, it’s no surprise investors are being left a little confused. I feel as though many investors are allocating capital based on how someone else thinks they should live their life, rather than allocating capital based on their own life goals and priorities. I mean, who better to tell us what we want than ourselves, right?

So, I decided to create a blueprint to help you decide how to allocate your capital, with the following caveat: There are many other investment options that are available to investors than what has been captured in this design, although, I reckon you could probably place most of them in each of the buckets I have included. My point is, it’s not perfect, but a good enough guide.

If you have any questions, need clarification, or would like to discuss further, please feel free to get in touch.

Enjoy (click for larger image).

Like any destination, before you decide how you’re going to get there, it makes sense to decide on where you’re going first.

Australia Doesn’t Have a Property Bubble. Here’s Why.

Australian Property Bubble

I missed ABC’s ‘Betting on the House’ investigation which aired on Monday night. Luckily for me however, the ABC upload their episodes online, so I was able to catch it last night. If you didn’t catch it, click here.

It’s the Great Australian Dream – buying and owning you own home. It’s been an Aussie dream for almost 150 years. Research suggests 44% of Melbournians owned their own home in 1881, with similar rates in Sydney and Adelaide. These figures were unmatched in the developed world at the time. Not much has changed. The great dream however, seems to be slipping away for many Australians – it’s become the Great Australian Nightmare. So we’re being told.

Firstly, I must say kudos to the music director – so very dramatic. I almost lost sleep last night.

The investigation focused on two key areas. 1) speculation and fear-mongering of a permanent property collapse, and 2) speculative and poor decision making by investors.

1. Speculation and fear-mongering

“…the dream run is about to end.”

Markets go through cycles. Periods of high growth are followed by periods of low growth. This is fact, yet we carry on as if we’ve never seen this before.

The investigation reports “…a correction is now inevitable”. Of course, a correction is inevitable, markets don’t rise in a liner fashion. The more you pay for something, the lower the future expected return. The less you pay for something, the higher the future expected return.

Are we going to see future rates of return in the property market like we have seen most recently? Highly unlikely. Are we going to see a free-fall and permanent collapse like the experts are predicting? Maybe. I believe it’s unlikely.

References are made and parallels are drawn to the US property market collapse of 2008. The US property market! Where are you referring to mister property expert? Las Vegas? Chicago? New York? Because if you are in fact referring to New York, property prices fell 13% during the GFC, and are now worth more than they were at the peak of the market in 2007 (almost reminds me of the Melbourne property market actually). The “market” is such a big place, throwing it all into one big bucket doesn’t provide much insight.

2. Poor decision making

The prevailing motivation behind the stories that were shared during the investigation were fueled by greed, and a ‘quick win’.

In two years, Roy Pallesen and Rowena Ebona, who were interviewed during the investigation, bought 7 properties. They did it by leveraging more debt against the rising value of their investments. “Everybody can do it, that’s the thing, and if we can do it and I feel a little bit like Beavis and Butthead, then anybody can do it.” Wow. How do you think this will end for Beavis and Butthead when rates rise and valuations drops? Rates will rise and those who are over leveraged (such as Beavis and Butthead) are certain to face problems. It’s a downward spiral. We don’t have a property bubble, we have a greed and poor decision making bubble.

All the principles that we preach when it comes to investing were thrown out the window during this investigation. Think long-term. Don’t over leverage. Diversify your investments. Invest in line with your goals. Don’t buy property from property developers and mortgage brokers who cold-call you in the evening selling you a “risk free” investment. If it sounds too good to be true, it probably is.

We recently held an exclusive property forum for a small group of clients and investors titled, ‘The Great Property Bubble?’. Speaking at our forum, was one of the country’s most well-respected property experts, Scott Keck. Do yourself a favour. Set 25 minutes aside sometime this weekend, and listen to Scott Keck’s point of view on the situation and make up your own mind (click on the image below).

I don’t believe the market will continue rising in the short-term at the same pace we’ve seen recently. I’m not saying the property market is going to collapse either – although I do believe we’ll see certain areas in the market correcting, precisely like we’ve seen in Perth. Where? I have no idea. When? I have no idea. For how long? I have no idea. How much? I have no idea. And nobody else does either.

Investing should be done not on speculation, but on sound, thorough, and well thought through analysis. And they should be made with specific objectives that align with your life goals. For the everyday investor, if you’re making decisions purely in the pursuit of money, you’re going to lose. It’s as simple as that.

We’ve gathered a few other highlights from our investor forum, which you can watch by clicking here.