The residential property market in Australia is easily the most favored asset class by Australian Investors. Residential property is a tangible asset that people can see and experience. Most Australian property investors experience from the past 10 years has given the investor the inner belief that by holding the asset they will reap incredible rewards well into the future. They believe they understand the asset class and will benefit similarly into the future by holding the asset. Most of the last 10 years have been an extraordinary time for property investors with property returning well into the double digits. Rents have also risen at astonishing rates making negatively geared properties cash flow positive after only a few short years. What were the main factors driving property prices so high and in my view highly overvalued by historical standards?
“The average house price would now be $248,000 based on historical multiples”
As can be seen from the above graph, property on average now sells for over 6 times income where in the 80’s and 90’s property was selling for a more modest 3 to 4 times income.
How has our property market become overvalued?
Accessibility to the property market
Part of the reason why the Australian property market is overvalued when looking at ratios such as the house prices/wage ratio is due to the lax credit criteria banks were using to build their loan books. With 107% loans (loans for property that allowed the borrowers the ability to borrow not only for 100% of the property but also fees and charges) the accessibility gap was effectively gone. No longer did people need to save a deposit to enter the property market. Banks had effectively built a bridge for accessibility to the property market by reducing the need for a deposit.
Low doc loans increased in popularity and credit criteria was continually diminished. This allowed many borrowers the ability to borrow without proving that they could service the loan. They were not only introduced for self employed borrowers but also for PAYG borrowers. There has always been a genuine need for the product in that some self employed borrowers could service but were unable to evidence financials due to various reasons. But more and more it served as a disservice to the Australian public in that it to added to the various list of people entering the property market, increasing demand and prices for property. On a second note it encouraged a black market and was an incentive to some extent and allowed the cash economy to flourish. Had Lo doc loans never been introduced I believe many business owners would be doing less cash transactions in an effort to improve their ability to borrow.
A Lower interest rate environment
Interest rates have fallen from around 17 percent in 1989 to only 5% earlier this year and has improved affordability significantly. As per below as interest rates fell affordability improved to the same extent. This has allowed borrowers the ability to borrow more to buy their dream home and in-turn force up property prices.
There is a direct correlation between the first home owner’s grant and property prices. The First home owners grant was first introduced to negate the GST on new homes and improve the outlook for the property market. Government policy to introduce the FHOG in July 2000 certainly achieved its outcomes. As can be seen from the graph above the introduction on the FHOG turned the property market and the continual maintenance of the grant bought forward the purchasing decision of thousands of buyers creating greater demand on the housing stock and pushing up property prices.
Housing has generally grown at a rate higher than wage growth and increasingly reduced affordability. In Australia, society’s response to this has been to increase the household income above that of average wage growth and they have done this by increasing the number of breadwinners. Property is now at a point however where we cannot continue to grow the household income above that of average wage growth without increasing the requirement to work longer hours. At what point will Australians say enough is enough and restrict their spending on property to maintain a balance within the household.
Property Market 2010 onwards
Australians are deep in debt, property as a percentage of our income is the highest it has been in recent history (30 years), accessibility to the property market is reducing as banks increase deposit requirements and serviceability is tightening with banks using far higher living expense schedules than they were using a year ago. On the plus side supply for housing is falling short of requirements and interest rates are still at very historical low levels.
Deep in Debt:
As can be seen from the graph below our debt levels over the past 30 years have more than tripled. This has not however led to a tripling of our interest payments due largely to a huge reduction in interest rates. As interest rates rise however so do our interest obligations so going forward Australian will be far more sensitive to interest rate rises than previously.
Accessibility to the housing market is reducing:
As banks are now demanding far greater deposits to allow people to enter the mortgage market real demand for property will reduce. Many First home buyers and investors will have to delay their purchases to some time into the future. As the deposit gap is now far higher than previously (due to the significant increase in real property prices as a percentage of wages) saving for a deposit will take far longer than before. Buying an average property of $400,000 will require with many lenders $40,000 deposit (10%) plus enough to cover fees. With the average wage at 62,000, a deposit of $40,000 is a huge hurdle.
Property buyers and investors alike will also need to prove serviceability. While affordability has improved markedly due to lower interest rates affordability is still quite poor and will worsen considerably as interest rates increase as can be shown from projections below. Banks have also tightened their own criteria so many borrowers are now unable to borrow anywhere near what they were able to only 14 months ago when interest rates were 9%.
Lack of housing stock
A lot of people consider that due to an influx of migration and lack of housing stock that there is naturally an increased demand for property and therefore upward pressure on house prices. Demand for housing cannot be simply regarded as those people who wish to purchase a property but those people who wish to purchase but also have the capacity to purchase a property. I have no doubt that with increased migration levels and lack of housing stock have placed a shortage of available housing and in-turn pressure on rents but due to the already high price of housing many potential buyers and now renters are now being priced out of the market.
Many Australian families look to property as a surefire way to build wealth. We can no longer look at the previous 10 years when annual returns were easily in excess of 10% and expect the same going forward. We need to expect that capital growth will be in the low single digit returns similar to the 1990s when the average seven-year return was only around 1% per annum. To successfully invest in property you will now need to thoroughly research your investment to give you any chance of a good investment experience. Rental return (yield) will need to be the new focus, as growth is something that cannot be controlled or guaranteed. Although there is a shortage of property there are now a dozen reasons against property growing significantly over the next 10 years. There will however be a divergence in property growth from the top end of the market and the middle and lower end of the market. The top end of the market is unlikely to be restricted by affordability and as the economy improves so to will property prices. The middle and lower end of the market will be significantly affected by affordability and will be the biggest drag on growth going forward. Property will however continue to be a favored asset class for most investors and there is always value out there even in an overvalued market. If you want a good investment experience Mango Wealth Creation will help provide the tools to ensure your investment is a good one.
Written by Alex Warren, Mango Wealth Creation