Market Update March 2017

Property Update

Property price do not always go up… You will always hear us emphasise the key drivers of house prices: demand and supply. They must never be forgotten. Here’s why… The end of Australia’s mining boom (roughly 2002-2012) presents an object lesson in how property prices are set. In many places, prices rose extraordinarily during the height of the boom. Consider the Queensland town of Moranbah. In 2011, this town was the most expensive place to live in Queensland (Source: ABC online, 27 May 2011). This high cost of living was driven by the town’s proximity to various large scale coal mines. Indeed, Australia’s largest coal deposits are on its doorstep. Well, Moranbah ain’t the most expensive place to live anymore! Far from it. In December 2016, a 3bedroom house in Renier St sold for $150,000 – having been listed for sale at $130,000. According to the register of previous sales, whoever sold the house in 2016 had bought it ten years earlier –  for $355,000. That is, the house fell in value by almost 60% across the ten-year period. The same thing has happened all over town. Another property in Flinders Drive has sold three times in the past 11 years. In 2006, it sold for $310,000. Two years later it sold for $345,000. This is a ten percent rise –not huge when you factor in associated costs such as stamp duty and agent’s fees. The sellers in 2008 probably got their money back. But the buyers in 2008 did very well: in 2012 they sold the property for $787,000 – doubling their money in just four years. But what about the buyers in 2012? Well, according to the price guide estimator on domain.com.au, the property would be likely to sell for $400,000 were it to be on the market today. This means the value has almost halved in just five years. (And we suspect this is a generous estimate). So, what do we make of all this? Why did prices double in one four-year period and halve in the next five years? How is it that prices fell by 60% across a ten-year period – during which house prices in Brisbane, that state’s capital, rose by 42% according to the Queensland statistician’s office. To put that into perspective, had a purchaser paid $355,000 for a house in Brisbane in 2006, by now it would be expected to fetch a little over $500,000. The same property in Moranbah just sold for $150,000. It is all to do with supply and demand. And, in particular, what happens when demand suffers some sort of shock (either a positive shock or a negative shock). Mining booms can create two sets of positive shocks for a property market. The first occurs as the higher prices for mine output leads those mines to expand. This increases the number of people employed by the mines, which brings people to live in towns near those mines. This introduces a general and, shall we say, genuine rise in demand for housing. It takes a long time to build houses, which means that it is hard for new houses to be quickly built to meet this increased demand. Thus, the supply of housing is unchanged. Demand grows relative to supply – and prices increase. In the mid 2000s, not everyone who moved to Moranbah wanted to buy a place, though. Some just wanted to rent. This meant that demand for rentals increased as well. Again, supply did not rise. So, rents rose in accordance with the renewed demand. This is a basic market at work. The ratio of rent to a property’s value is known as the yield. When the yield exceeds the interest paid on money borrowed to buy a property, a property becomes ‘cash flow positive.’ Obviously, cash flow positivity is easier to achieve when rents are high, so this encourages people to buy houses that are entirely debt-financed. People start buying homes using ‘other people’s money.’ Unfortunately, lots of people spruik the benefits of positive cash flow residential property. It all sounds so enticing. Even if you do not have any of your own savings, you can simply borrow at (say) 7% and buy a house which you then rent out at (say) 9%. You make money immediately. It is all so good that many people think – why not buy two properties, or three? This is all part of the second ‘shock’ to demand in towns like Moranbah. Speculators looking to make money by owning investment property drive the prices of those properties up. The problem, of course, is that these investors don’t understand what caused the first shock to their market. Everything was predicated on people moving to the town to work in the local mines. But mining booms end. Prices fall. What happens when the work at the mine starts to dry up? The obvious response: people leave town again as they pursue work elsewhere. This lowers demand for housing, which lowers prices. This is the first ‘reverse shock’ – a natural adjustment to the market. But the first reverse shock also leads to a second reverse shock. As we say, people leaving town reduces demand. This reduces both the price of property being bought and sold and the rents being paid to landlords. Either way, investment returns start to fall. But interest rates remain unchanged. As a result, a positive cash flow property can quickly become a negative cash flow property – meaning that the landlord has to put extra money in to maintain the investment. This leads people who are relying on cash flow being positive to want to ‘get out’ of their investment, by selling up. This increases the supply of housing for sale, which combined with low demand pushes prices even further down. Falling prices are a real problem for people who have borrowed money to buy an investment property – lenders hate it when values drop below the amount of the loan. When this happens, it becomes a situation of ‘negative equity.’ And the landlords have to put their own money in to make sure that they meet the interest payments. This is really hard… especially if the landlord does not have any spare money. And remember what we said about people not having any savings to fund their investment, and needing to borrow the whole lot. Making the extra repayments is even harder if the landlord owns three or four of this kind of property. Before too long, landlords miss payments and lenders start to foreclose on properties> This is what has happened in Moranbah, where one real estate agent has stated that 95% of current listings are properties being sold because the owner has defaulted on their mortgage. Towns like Moranbah are a helpful way for us to demonstrate the absolute importance of supply and demand on house prices. Populations in places like Moranbah are small enough to be absolutely shocked by something like a mining boom. In 1986, the population of Moranbah was 6,883. By 2001, it had fallen to 6,133. But by 2011 the population had jumped to 8.965 – a rise of more than 46%. The 2016 census results have not been published yet. It is harder to see the effect of this type of shock on larger property markets. But it can happen. Perth, for example, saw its median price rise from below $200,000 in 2002 to more than $450,000 in 2007 (source: REIWA). This was largely driven by the mining boom, which had a particular impact on the Western Australian economy. Similarly, the drop off in mining activity since around 2011 has seen prices either stagnate or even drop in six of the past ten years – although the 2016 median remained well above $500,000 – still a 150% increase since 2002. This last point is essentially the point of this whole article. While a city the size of Perth can still be affected by things such as economic cycles, the fact that the economy of Perth is much more diversified than the economy of a small country town like Moranbah provides a level of insulation for prices. That means that taking a long-term view on a property (other than a high rise apartment or anything sold off the plan) in any well-populated area (the major city in each state and many of the larger cities in the more populous states) is likely to turn out well. Just remember: long-term means 20 years plus! Property is not a good place to make a quick buck. Just ask the heartbroken landlords of Moranbah. And one other point: if a property is being advertised as cash flow positive, that is because no one else wants to buy it and the price is low relative to its rent. Think about that: if no one wants to buy it now, why would that change in the future? If no one wants to buy it now, you probably shouldn’t either.

Share Market Update

The ASX 200 started February on 5,620 points. It ended February on 5,712. In between those dates it peaked at 5,816 (Feb 16). So it is not quite right to say that nothing happened during February. But it was a fairly bland month for the market. Not much happened. By the way: bland is good when it comes to share market investment. The long-term trend for the Australian economy is a positive one. This is true of all developed economies, but has been especially true for Australia. Remember, the city of Ballarat was the wealthiest city in the world in the 1880s. In 2016, Credit Suisse announced that its research indicated that per capita wealth in Australia was the second highest of any country in the world, even after our per capita wealth had fallen slightly in that year. (Switzerland is the wealthiest per capita economy). Australia has kept up a pretty good standard of living for the past 140 years or so. That is why a month of business as usual in the stock market is welcome news for anyone who knows what they are doing by investing into that market. Which is… to buy and hold shares in solid companies that are expected to perform well whenever the economy performs well. Remember, you are buying a very small part of the overall economy – which is why we think it pays to buy a diversified part of the economy.

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