Is residential property over, under or fair value?

Graphs, graphs and damn statistics!

There is no shortage of articles quoting one “expert” or another about whether or not Australian residential property is currently in a bubble, ripe to boom again or just fair value. Every article seems to be accompanied by a barrage of graphs and statistical quotations to justify the author’s point of view.

If your eyes glaze over at the detailed graphs don’t worry, you’re not alone, often mine do too. I sometimes wonder (suspect) if the detailed graphs are purposeful anaesthesia to make the reader compliant to the author’s conclusions. (Hmm, I think that sentence may have done the same…)

Overvalued or fair value or…?

Who cares?

Really in the scheme of things if property is over or under-valued matters most if you are taking a short term trader’s view – trying to make money within a short time frame from a volatile asset.

What matters more is that new residential property investors are increasingly reliant on a continuing price boom in order to make a reasonable total return on investment (ROI).

With property prices and rents at current levels residential property investors make significant annual net income losses (even after tax returns). That creates a situation where a high capital growth is required to repay the debt, offset income losses and retain a reasonable return on equity.

Yes, my generation and those with an investing memory of about 15 years may say that residential property does generate really high capital growth. But the fact is that all you can say is that over that period it has done.

Can residential property continue to deliver high annualised capital growth over coming decades?

My helicopter view

Value is in the eye of the beholder. People seem to be willing to pay whatever they can to get something they really want. And Australians really want their own home – and a comfortable one at that.

In the last decade the amount of people bidding for property and their ability to pay has rapidly increased for reasons such as:

  • Ability and willingness to borrow higher percentages of income.
  • Ability to borrow higher percentages of the property value, meaning you needed to have saved less before you could compete in the market.
  • Grants to property purchasers.
  • Commencement of lending to a lot of the population previously shunned (e.g. employed yet unmarried females of baby-making age; and those with limited or mixed financial history.).

Consequently in many of our memories we have seen stellar above-average capital growth.

Can that ability and willingness to pay increase as rapidly over the next 40 years and thereby support continuing stellar capital growth?

It would require 40 years of:

  • Above average wages growth
  • Increased percentage disposable income through reduced lifestyle expenses (less kids and more frugal living – yeah right!)
  • Low interest rates
  • Increased willingness to lend by the banks
  • More crazy Government subsidies

I’m not an economist so I don’t even pretend to have a crystal ball. But my rational mind says that in the long term gravity will kick in and force a return to normal long-term growth rates.

Therefore I expect that at some time there may be a sustained period of sideways or even negative growth (i.e. price declines.)

Predicting when that will occur matters most if you are taking a short term trader’s view.

I welcome your thoughts, reaction and responses to my view which you can in the comments section below.

Author: Matt Hern

Certified Financial Planner professional, Matt Hern has three times been awarded as one of Australia's Top 50 Financial Planners by The Australian Financial Review Smart Investor. He is passionate about guiding you on the right financial choices to achieve what you really want. Matt Hern is an Authorised Representative of Charter Financial Planning Limited AFSL 234665. All information is general advice only.

5 thoughts on “Is residential property over, under or fair value?”

  1. Good, solid article, Matt. I agree that the current flat or negative trend might simply be a correction following the anomalous fast growth of the past decade. I also agree that we shouldn’t expect to see the recent “stellar capital growth” again soon – and certainly shouldn’t be relying on it.

    It’s interesting that your list of requirements is all about the financial side of things. I’m no economist either, but I think an economist would take a more supply/demand approach, and also add factors like: Growing population, population moving to cities, mining and resources boom, China’s demand for Australian exports. All of these things could increase demand on housing, and (in my humble opinion) will DRIVE some of the factors you’ve mentioned.

    1. Thanks Gihan for your thoughts. Yes I agree that traditionally economists would look at supply/demand. And that leads to the graph and statistic laden articles I mentioned.

      My focus was mostly on the ability and willingness for people to pay the price. Rightly, the factors you mentioned can be underlying drivers of people’s ability and willingness to pay. Those stats I’ll leave to the economists and instead I wanted to zoom up for another perspective.

  2. I think there is another reason for the growth over the last 20 years, most families now have two income earners so banks can lend against two incomes and the combined household income can finance larger mortgages. The demand will continue to outstrip supply so I think banks may to look to extend loan terms over 30 years (generational mortgages).

    1. Good point Steven about the dual incomes funding a single property. That certainly would be another contributor to an increased ability and willingness to pay the price.

      Increased loan terms to the point of generational mortgages…my mind boggles thinking about the social implications of that.

      • Funding your parent’s mortgage in their retirement whilst also funding your own?
      • Or young families living with their parents whilst the (joint?) mortgage is repaid? That would be a cultural shift for us.
      • Parents banking on sustained capital growth to ensure they can repay their mortgage principal in full on retirement. This implies they sell their home on retirement and downgrade – another cultural shift.
  3. Good article Matt. I agree with your suggestion that prices will ‘revert to the mean’ at some stage. Either prices will fail to rise, or wages will increase or both. Any argument that prices could become more stretched than they already are is highly suspect. Let’s not forget what’s happend in Ireland, Spain, Great Britain, USA and elsewhere. They also thought prices could only go up.

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