CashFlow Capital's blog is focused on the trends in the Australian property market. Spiro Kladis talks about changes in the interest rate, property boom and bust cycles, as well as how changes in the government affect investments. You can also use the site to help you find cash flow positive properties.
A lot of people are worried about where this property correction is headed. The thing I would say is ‘don’t sweat the short game’.
Don’t get too caught up on month-to-month movements. It’s the longer cycles that really create wealth.
And that means that if we want to understand where property prices are going, then we need to focus on the long run drivers. And like most things, this all comes back to supply and demand.
Now, you hear this idea of a “housing shortage” get bandied about a lot – often by people who don’t really know what they’re talking about. But one man who does know what he’s talking about is Glenn Stevens – the former Governor of the Reserve Bank of Australia.
And last year he did a Housing Affordability Report for the NSW government.
He painted a very interesting picture of supply and demand. He was talking about Sydney, but the same applies pretty broadly across the country.
The first point he makes is that for almost 20 years, we’ve done a pretty ordinary job of bringing enough homes to market:
“Most observers agree that the supply side of the market in general has struggled to keep up with demand, probably for most of the past decade. To be sure, construction rates (a flow) are presently at record highs. But there is a stock issue: the previous period of underbuilding beginning around the mid 2000s leaves a cumulative shortfall in the number of dwellings, estimated by the Department of Planning and Environment (DPE) to be as large as 100,000 dwellings.”
So we currently have a shortage of 100,000 houses. That’s just in Sydney. That’s huge.
There’s assumptions here about household size and what have you, but the general point is true. Our population has been growing quickly, our housing stock, less so.
BUT!!! This is the thing, it’s about to get a whole lot worse. The housing stock is going to fall even further behind demand:
“The Sydney growth targets envisage, roughly speaking, about 700,000 new dwellings in the Sydney region for an additional 1 ¾ million residents, over twenty years.
There are about 1.7 million dwellings in the Sydney region now as a result of accumulated investment over the period since 1788.
The plan is to add, in 20 years, 40 per cent in net terms to that stock.
Such an outcome would require current rates of commencements, which are at a high, to be maintained, or exceeded, on average, over two decades, in a notoriously cyclical industry – and without costs escalating significantly.
This is, to say the least, an ambitious goal.”
When he says “ambitious goal” we can probably read that as “total pipe dream”. It is very hard to see any realistic scenario where Sydney keeps pace with housing demand, particularly in a context where land is in shorter and shorter supply, planning restrictions seem to be getting tighter, and costs are rising.
And remember, this is already accounting for our supposed “glut” in high-rise apartments. It is true that high-rise supply has skipped ahead of demand for the moment, and that’s putting a brake on that segment. But unless we “maintain” current levels of commencements, the market will quickly swing back to shortage.
The other thing to note, is that in Glenn’s scenario, the housing shortage will likely get worse with each passing year.
Now you might factor that into the prices you’re willing to pay now (I am. That’s why places still seem cheap to me), but the market doesn’t tend to be that forward looking.
And so we’ll have a shortage next year, and prices will go up. And then we’ll have a shortage the year after, and prices will go up again. And then will have a shortage the year after that… and on and on it goes.
So while we might get a few dips here and there, the long run drivers are pushing property prices higher and higher… over the long run.
Recent prices growth in Brisbane… well, it hasn’t been dazzling.
It hasn’t been bad either, and so far it’s holding up better than Sydney and Melbourne in the current consolidation.
But there’s a bit of a puzzle.
Why isn’t Brisbane actually doing better?
You see, Brisbane has been on the favourable end of inter-state migration in recent years. People are leaving Sydney and Melbourne for sunnier climates. And so Brisbane’s population is growing strongly.
Now normally, when this happens, you see prices start to accelerate. Population growth in and of itself typically drives prices, but there’s also a compositional effect. If you sell up in Sydney or Melbourne, then you usually have quite a bit of cash to play with when you cross the border.
But, for some reason, we’re not seeing that show up in the data… yet.
When you compare population growth and house price growth, they tend to go hand in hand. But not right now:
Over the past year or so we’ve seen population growth pick up, but for some reason, house price growth hasn’t followed.
… curioser and curioser.
I’d be guessing that this has a lot to do with the credit environment.
These aren’t normal times. APRA is pushing the banks hard, and with all the scrutiny that came with the Royal Commission, the banks are running scared.
Getting finance is trickier than it used to be, that’s for sure.
And we have been hearing word that the banks are keen to improve the ‘quality’ of their loan book. It may also be possible that, in the eyes of the banks algorithms, Brisbane is a riskier prospect that her bigger sisters.
If that’s true, the credit squeeze could be biting harder in Queensland than in the southern capitals.
And that would be putting a weight on property prices.
I’ve got no hard evidence of that. It doesn’t exist. But it wouldn’t surprise me.
And it helps explain why price growth in Brisbane hasn’t been as dazzling as you might expect.
And if it’s true then it could mean that prices will rebound very quickly in Brisbane when APRA finally declares “Mission Accomplished”.
It could very well be Brisbane leading the charge when we finally come over the hill. All the fundamentals are there.
So if you’ve been focused on Sydney and Melbourne, but are looking to diversify into a major capital, Brisbane could be a very good choice.
So 60 Minutes really threw a cat in the pigeons with their sensationalist claims about “a 40% fall in house prices”.
I’ve debunked their arguments here, but the question then is, if the house price crash isn’t happening, where are prices actually going?
Now I could tell you some stories, but why don’t we check in with one of Australia’s leading property experts, Tim Lawless from CoreLogic.
The short of it is, he just can’t see a house price crash playing out:
“Overall, it’s hard to see a scenario where Australian housing values could fall off a cliff. For this to happen we would need to see a material about face in labour market conditions, a global shock or a material rise in interest rates – none of which seems to be a likely outcome at the moment.”
He admits there are headwinds, and prices are falling at the National level already, but there is nothing really unusual about this.
In fact, compared to previous slow downs, this is really middle of the range stuff.
He presents the charts here, that compare the current down-turn (in black) with all other market peaks, for both Sydney and Melbourne.
As you can see, nothing alarming there. “Unremarkable” as he puts it.
He also looks at some forecast modelling done by Moody’s Analytics, based on CoreLogic data.
What their number-crunching points to is a “relatively mild” downturn, with national house and unit prices returning to growth in mid 2019.
As Lawless says, “Their upbeat assessment of dwelling values is based on rising business investment, particularly in the non-mining sector, a rise in infrastructure spending, above trend jobs growth, and ongoing low interest rates.”
And as he says, even with the headwinds property currently faces, many powerful boosters still remain in effect.
“In balance, even with mortgage rates edging higher, we are still in the lowest mortgage rate environment since the 1960’s. Population growth remains strong and maintaining a consistent migration policy seems to have support from both sides of politics which will continue to support demand for housing. Labour markets are reasonably healthy with unemployment holding at 5.3% and likely to trend lower, underemployment at the lowest rate since May 2014 and jobs growth above the long term trend.”
On balance, I think all this is right, and is pretty much what I’m expecting. Momentum will remain to the downside through the rest of the year, but will start to pick up going into 2019.
And for me the big swing factor here is regulation. If APRA and co. are happy with the measures they’ve had in place so far, and you get the sense they are, then we should start to see them backing off reasonably quickly, and credit conditions begin to loosen, probably early in the new year.
Price growth should follow after that, probably making Moody’s growth scenarios the most likely.
And of course, there’s always the potential for upside surprises in there too.
There. Put those expert opinions in the mix with those Current Affairs talking heads.
I try not to get too caught up on politics, but there’s part of me that feels a glimmer of hope with Scott Morrison taking the big chair.
Scott gets property.
I don’t know if everyone knows it, but Scott Morrison worked at the Property Council of Australia for 6 years. I think he was Chief Economist or something like that.
Anyway, he must understand the importance of property in the Australian economy, the contribution property investors make, and I think that means we should expect solid support for the property market from Canberra in the months ahead.
Indeed, in his maiden speech, he made property a key focus:
“Menzies talked about the other things that were needed, you know, he talked about a ‘comfortable home’ and an ‘affordable home’, as important today as it was then.
One of Menzies’ greatest achievements was the increase in home ownership, and affordable home ownership.
I think it went from around 40 per cent to around 70 per cent.
We’ve slipped back a bit from there. We need to do better on that score.”
So it seems like affordability and ownership is going to be a focus. Still, we’ve heard that before and both are incredibly tough nuts to crack.
And really, both require coordinated responses. There’s not much Canberra can do if the states aren’t overhauling their planning systems.
But what can we really expect from Scott?
Well there’s a few things I reckon. As Treasurer, Morrison was the key architect behind the Home Saver Scheme, which aimed to help first home buyers save for a deposit.
This didn’t have a huge impact, but it was a step in the right direction.
Morrison also did a study tour to London to look at their HELP scheme – where the government effectively loans first home buyers money for their deposit.
So I think we could see some measures like this, aimed at helping buyers get a deposit together. We could also see some Federal shared-equity schemes, where you co-purchase with the government, and slowly pay them out over time, or when you sell.
I don’t think we’re going back to the days of the First Home Buyers Grants or anything like that. I don’t think we’ll see the government just handing out cash. It’s going to be more sophisticated than that.
But any support they give to first home buyers is obviously going to put more activity into the more-affordable end of the property spectrum.
It’s probably not such big news for our premium property markets, but that’s ok. They’ll be alright, don’t worry about them.
The other thing I’d be expecting from Morrison is a serious and sophisticated attack on Labor’s negative gearing reforms.
I don’t think this is a political question for Scott. It’s one of ideals. So I think he’ll fight it tooth and nail.
That means it’s shaping as one of the key election battle grounds.
I think Labor has welded itself to this one now, but some fierce opposition might give them pause for thought. Morrison might be able to extract some further concessions.
We might see Labor take a slightly softer approach, and that might not be a bad thing.
And anything else?
Well, we’ll have to see. There’ll probably be a surprise or too.
But the key point is that this is a positive for property. We have a PM ideologically committed to property, with enough experience to understand how the game actually works.
I’ve had a lot of people ask me what I thought about the recent 60 Minutes segment, provocatively titled “Bricks and Slaughter”.
Things like this come around pretty regularly, but 60 Minutes is an institution. People trust it.
Which is why it’s so sad that they chose to put such a sensational spin on the whole story.
If you didn’t catch it, they interviewed a bunch of industry experts and struggling home owners, and made the case that a property apocalypse is practically upon us, and prices could fall up to 40%!
Anyway, there’s three problems that I had with the whole thing that I want to highlight:
1. IRRELEVANT EXAMPLES
60 Minutes dug up three people who were struggling to make their mortgage repayments, as if they were somehow representative of the whole market. But they really weren’t.
One was having major health issues, and looked like he was on death’s door. One was unemployed, and the other had a portfolio of negatively-geared properties that he could no longer sustain.
But really? If you’re not working because you’re unemployed or you’ve got health issues going on, of course you’re going to struggle meeting your mortgage repayments. That’s got nothing to do with the market.
And if you’ve got negatively geared properties that were only affordable when you were paying interest only, well that’s a problem with your portfolio, not with the markets or the greedy banks.
Why not shine a light on all those hopeless accountants telling their clients to get into properties that deliberately lose money?!?
2. BIASED SOURCES
You have to wonder a bit about the experts they interviewed too.
One was a real estate agent – but in a slow market real estate agents will often use the “market is about to crash” line to encourage more people to sell.
One was a liquidator – who’s business actually booms when the market crashes!!!
And then there wasn’t one voice given to the opposite opinion. They could have called me up and I could have told them why I thought the market was going to remain strong. They could of called 100 people around Australia.
But they didn’t.
3. SHAMELESS SPIN
Finally, they put some shameless spin on the whole thing. For example, they interviewed Dr Martin North, who said in the worst case scenario, prices could fall by 40%.
But he then clarified that on his blog that it wasn’t his central scenario, and would actually require a GLOBAL FINANCIAL CRISIS to make it happen:
“I rate it 20%, and it is not my central scenario. My best call would be in the region of 15-20% from top, over 2-3 years, but with some risk of a worse outcome. Nine chose not to cover these alternatives, though I went through each in the recording…”
So it’s the same old story. Fear sells, and Chanel 9 and 60 Minutes sold it like a floozy.
That’s ok. The media is what it is (as long as you know that).
But if anything it does highlight that this is a very interesting market. People who have structured their deals badly, or bought too many negatively geared properties are going to struggle.
But if you’ve got the right vehicles, and you’ve got properties that are actually putting money in your pocket, then you’re going to have a major advantage.
And if things do get tight, you’ll be taking the uneducated to the cleaners.
So invest in yourself. Get the right skills and the right training for the market.
One of the things you realise when you’ve been in the game as long as I have is that there are always markets within markets.
So when the headline numbers are saying that property prices are consolidating, you learn to take it with a grain of salt. Sure, some properties somewhere might be on the slide. But there will still be suburbs experiencing strong growth.
That’s why we have such a focus on ‘investment grade’ properties at Cashflow Capital. These are quality properties in growth areas, at accessible price points, and in thick markets (markets with high turnover).
Now some people might wonder why we don’t get into ‘prestige’ properties. Isn’t that where the big money is?
And sure, you can make massive gains in markets like this. But you can also make massive losses, and they’re incredibly fickle markets.
Take this analysis from Chris Joye at the Australian Financial Review for instance. He looks at the premier Sydney beachside suburb of Palm Beach… and concludes as an investment location, it’s a total dud:
Since the end of the 2003 housing boom, Palm Beach property has delivered miserly capital growth of just 1.6 per cent annually (see first chart)… That is, mass-market Sydney houses have provided 2.5 times the upside of their dearer “Palmy” counterparts…
It is actually worse than this. And that is because high-end housing is also riskier than the cheaper stuff precisely because it is a thinner market… This manifests in higher price variability….
In the 2008 global financial crisis, Sydney homes lost 7 per cent of their value. In contrast, the Palm Beach holiday house market slumped a staggering 25 per cent…
These insights also hold when we examine the entire luxury market. Since 2003, the middle 50 per cent of homes ranked by value have outperformed the top 25 per cent by a cumulative 12.8 per cent in pure capital gain terms according to CoreLogic…
He’s right, and this time around it’s exactly the same. It’s expensive properties in ‘thin’ markets that are faring the worst.
In fact, if you look at the cheapest 25% of the market in Sydney, prices are fairly stable, though still down a touch.
So that’s why I don’t recommend to clients that they go chasing the big gains in the prestige suburbs. Not only do they tie up a heap of your capital, they expose you to bigger risks, and tend to under perform investment grade properties anyway.
Not much to love there.
But then, what if you don’t know where to find ‘investment grade’ properties?
Talk to us. We’ll point you in the right direction.
That might sound silly since for pretty much every export we have – the main buyer is China.
And most times it’s nothing but daylight back to whoever is second or third.
And China’s rapid urbanisation and massive commodity demand has lit a major fire under the Australian economy.
It pretty much saved us from the GFC, and then sent property prices booming.
And it’s all about to happen again.
The thing is, China needs us much more than we need them.
Because the Chinese government is pretty much a one-trick pony.
If the economy stalls, build more stuff.
If the financial sector wobbles, build more stuff.
If the stock market stumbles, build more stuff.
Any time and every time the Chinese economy hits a stumbling block, the Chinese government’s response is to throw money at construction. Build more stuff – more buildings, more bridges, more factories, whatever.
Just build it.
The idea is that China is still one of the most authoritarian countries on the planet. The Chinese people seem to be reasonably happy with that, but only so long as the Chinese economy is growing strongly and rapidly making people wealthier.
If that stalled, or heaven forbid, started going backwards, then the Chinese people might start looking at the rest of the world, and the freedoms we enjoy, and wonder why they’re putting up with being modern-day serfs.
It’s the kind of things revolutions are made of.
And so the Chinese government needs the economic miracle to continue.
And the central pin in that miracle, as I’ve said, is building stuff.
And luckily for Australia, we have lots of the stuff that you use to build stuff.
We are underwriting China’s economic miracle.
And so while we need China to maintain our levels of prosperity, the Chinese government needs us for their very survival.
And that puts us in a strange win-win situation.
If the Chinese economy is doing well, they buy lots of our stuff, and our economy booms.
But if the Chinese economy doesn’t do well, then they buy lots of our stuff (though more iron ore than other things), and our economy booms.
Don’t believe me?
Take a look at what’s happening right now. The Chinese economy is facing one of the biggest tests of recent times. Trump has declared a trade war (or is it a cold war?) with China, and jacked up tariffs on Chinese exports.
The Chinese economy is still massively reliant on exports so this will be a major test.
And what has happened to steel futures – the price of steel at some point a little down the track.
Like, everyone is worried about the Chinese economy stalling, but the steel markets are partying on like it’s the biggest boom in years.
But it’s win win for Australia.
And that means it’s win win for Australian property.
I tell you, this is the lucky country if ever there was one.
How long do you think it would take someone to get out of poverty?
The answer: four generations.
That’s the answer for Australia at least. If someone is born into a low-income family, it would take four generations before their direct decedent’s were earning the average income.
And that’s a miserable statistic, but we’re actually doing pretty well. We’re slightly ahead of the OECD average, and streaks ahead of countries like Brazil, South Africa and Columbia.
What it shows is that the social mobility that capitalism promised us is a bit of a joke.
This idea that anyone who works hard can get ahead and be a tech-billionaire is just BS.
Where you are born has a huge influence on the trajectory of your life.
If you’re poor and work hard, the best you can hope for is that your children do a bit better than you do, and that your great, great grand children might be one day middle income earners.
Hardly inspiring is it?
And for me, it reminds me of just why I love property.
I mean, look at me. I wasn’t born into money. Far from it. But I’ve used the incredible wealth potential of property to make myself richer than my great grandfather could ever have dreamed of.
And I see it with my students all the time. We take people with little money behind them, no fancy degrees or certificates, and all the blockages and baggage that comes with growing up poor…
.. and we turn them into millionaires.
We’ve done it time and time again.
So I ask you, what are you waiting for?
If you’re waiting for the system to help you out – if you think that if you just keep plodding away you’ll be rich one day… forget it. The system is not designed to do that.
The system is designed to keep everyone in their place.
So stop waiting. Property offers you a way out.
It helped me. It’s helped hundreds of my students.
We already know that the top-end of town is bearing the brunt of recent price declines.
Falls are pretty much isolated to the top 25% of the market. The bottom 75% is steady or even growing.
But it’s about to get worse.
APRA is introducing a new rule in the coming financial year. Going forward, banks are going to look not just at your loan to income (LTI) ratio, but also your total debt to income DTI ratio.
Banks are no longer going to be looking at your ability to service the loan you’re applying for, but all of your debts – including other mortgages, auto loans, credit cards – the whole kit and caboodle.
And they reckon they’re going to cap debt at 6 times your income.
We don’t know how ruthless APRA are going to be about it, but UBS reckons if they make it a hard limit, it’s going to crimp people’s ability to buy.
In particular, they reckon it will put the median house in Sydney out of reach of the median buyer.
That is, an average income earner won’t be able to afford an average house.
These numbers are a bit rubbery, but the general idea is right. People aren’t going to be able to spend as much as they used to.
So what’s going to happen?
Well, as that graph shows, the median house might be out of reach, but the median unit isn’t. And I’m guessing the median town house won’t be either.
So what I’m guessing we’ll see is a lot of energy that would have been reaching towards the top, being redirected towards the lower ends of the market.
The top end is in trouble.
But that also means there’ll be competition for cheaper and mid-priced stock. That means that stock will get bid up in price.
And so what I’ll expect we’ll see is a compression of prices around these limit points.
Prices above will get pulled back down, while prices below will be pushed up.
Now, which kind of property do you want to be owning in that scenario?
Yep, solid, investment grade properties at the more affordable end of the spectrum.
What’s more, cashflow has never been more important. Forget carrying negatively geared properties. That strategy is dead in the water now.
Going forward, it’s all going to be about cash flow, and carefully watching your debt to income ratios.
If you want evidence on the fact that higher house prices in our capital city are structurally locked in, take a look at this story here.
It’s about a proposed high-rise development at Waterloo, on the outskirts of the Sydney CBD.
“Seven hundred apartments will be built on a large block around a new rail station in inner-Sydney Waterloo, government documents show.
The Waterloo “Metro Quarter” proposal by the government’s UrbanGrowth Development Corporation and Sydney Metro, made available on Wednesday, includes four residential towers of 29, 25, 23 and 14 storeys.
Much of the development would occur at the same time as construction of the train station, which will form part of a new metro line connecting a new route under the central business district with the existing Bankstown Line.”
Sounds good right. But people are worried. There are concerns that the towers will be too high and too dense.
The CEO of the company behind the development was trying to defend it:
“The chief executive officer at UrbanGrowth, Barry Mann, said the three taller towers needed to be seen in the context of the area: there would be a rail station directly underground, Redfern Station a short walk away, while the block would be divided with roads and pathways.
“The scale of it is not overly dense I don’t think,” said Mr Mann.
“It’s a logical place to put more housing for the people of Sydney, and more social housing.”
You’re not kidding. It’s pretty much in the CBD, within a stone’s throw of dozens of other high-rise towers. There’s heaps of public transport (there is literally a train station underneath it!)
It’s got to be the most logical place in Australia to build higher density housing.
And yet, even then, there’s a struggle to get everyone on board with the idea.
And the developer has to spend millions of dollars managing the project’s PR and ensuring that the anti-development lobby doesn’t through any roadblocks in his way.
And we wonder why there’s a shortage of housing. We wonder why house prices are so expensive. We wonder why our kids can’t afford to buy.
But this is the crazy thing.
The development is going to create 700 apartments.
On average household sizes, that’s homes for about 1400 people.
But Sydney added over 150,000 people to its population in the past year alone.
So we’re talking about 1% of the housing that’s needed… in a single year.
Or put it another way, this project will soak up about one week’s worth of the demand that Sydney’s added last year.
There’s a bun fight over developing the most develop-able block in Australia, and all it’s going to do is soak up just one week’s worth of population growth?!?