Monday, December 27, 2010

The cult of property

When a cult is under siege, its members tend to cling to their fanatical beliefs even more strongly than ever.  This phenomenon is in full force at the end of the year as the property spruikers that dominate Australia's media come out en masse to tell us the recent softening of the market is a huge "buying opportunity" (as I noted in my last post). Now, I don't want to waste too much more time examining these claims, but sometimes an article comes along that is just too good to pass on.

The Australian Property Investor's Michael Yardney is feeling very smug and self satisfied this Christmas season, because The Economist, Steve Keen, Jeremy Grantham, and other so called experts like the IMF told us that Australian property prices were overvalued, but "awkwardly" for these know-alls, we don't have a bubble and there hasn't been a crash! "Oops!" he celebrates in the magazine's blog.

Mr Yardney concedes that prices could fall a teeny bit in some areas, but then recites the standard mantra of population growth and housing shortages -- the same one that was popular in California in the years up to the 30% crash there -- before revealing the secret weapon in his logical arsenal.
Sure, some Australians currently have issues with housing affordability and are putting off their home buying decisions. But people still need a roof over their heads. People are still getting married and people are still getting divorced, some are having babies and others have to move house for their jobs.
So there you have it. Australian house prices must continue to grow exponentially because some people are getting married, some are getting divorced, and some are having babies. Because people don't get married, divorced, or have babies in other countries like the USA, Spain, Ireland or Japan. I'm glad he's cleared that up.

In any case, he tellingly concludes the article as follows:
Our property markets have changed – don’t expect the type of capital growth in 2011 that many of us enjoyed in the past year or two. The Reserve Bank has deliberately put speed bumps on the road. They have increased interest rates to slow our booming property markets, and to an extent the general economy, on purpose. What this means is that buying any property and hoping it will make a good investment just won’t work in this new era in property. Now is the time to buy well in areas that will outperform the averages and buy properties to which you can add value.
This is the "new paradigm" talk that Delusional Economics wrote about this week, and which we are starting to see quite frequently. When faced with evidence that prices are starting to fall in certain areas, the property spruikers are trying to reassure us that "as long as you buy in the right areas, you'll be protected from any falls, and you have nothing to worry about." Go right ahead and take out that big mortgage.

Needless to say, I think this is pretty bad advice for the average punter. How do you identify areas "that will outperform the averages"? Australian Property Investor tells us in another article that it's as simple as "concentrating on suburbs with limited supply and choosing properties that will stand up in soft and hot markets".

But if you do believe that prices are going to fall, this is not likely to give you much shelter. Evidence from other housing markets around the world suggests that in areas with "limited supply", prices tend to appreciate much faster during bubbles, and crash much more violently when housing bubbles burst (this follows from basic economic theory; see here for example). Still, Australian Property Investor is apparently preaching to the converted.

For pure entertainment value, I recommend you check out the comments from some of the property bulls on API's blog posts, in particular, this one about the attractiveness of property versus shares. API tells us that it's better to buy property than shares, because you can leverage property more aggressively, and, as we all know, it only goes up. One reader who is well and truly drinking the API kool aid even claims that property prices have doubled every 7-10 years "in the past several hundred years just about everywhere in the western world."

Because I am a masochist, I just did the calculation, and worked out that a doubling every 7 years for 300 years would mean that house prices increase by a factor of 2.6 trillion times. That sounds like an excellent long-term investment, especially if you add leverage! Speak to your accountant, because you could probably negatively gear it too.

But back on a more serious note. Luckily for us, the IMF has a fascinating chart (from this article) based on the longest study ever done of housing prices. It's a house price index for the Herengracht neighborhood of Amsterdam, and it goes all the way back to 1628. Interestingly, it shows that despite huge booms and huge busts, in the 200 year period from 1628-1828, house prices basically went nowhere. And in the 380 years since the beginning of this survey, house prices in Herengracht have only risen by a factor of 3.5. This is a much smaller number than 2.6 trillion.

Source: IMF
But this is just a small suburb of Amsterdam. Surely it's different elsewhere, isn't it? Well, funnily enough, Robert Shiller (the author of "Irrational Exuberance") has compiled a house price index for the United States that shows a similar result when looking at price trends from 1890 to today. See below.

You can see that real house prices -- or house prices after taking inflation into account -- have risen only around 30% in the US since 1890, roughly in line with building costs, which have risen not much faster than inflation. This gives you an annual real return of about 0.23% over the 120 year period. Again, you can see huge booms and busts over the years, but in the long term,  the evidence suggests that house prices generally don't rise much faster than inflation.

It's important to keep this kind of long-term evidence in mind, because it puts things in perspective. If your only experience of property investing is the past two decades in Australia, you could be forgiven for believing, that, yes, prices double every 7 years. But the past two decades was an extraordinary period that we may never see again in our lifetimes. Note that in both the series above, there are also long periods of several decades where prices are stagnant or even falling, despite strong population growth.

I'm tempted to post this on the Australian Property Magazine blog, but I'd probably be excommunicated for life. Such is the nature of cults.
UPDATE: Who Crashed the Economy has some great long-term charts for Australia too.


  1. Nice piece. I am watching both Canada and Australia closely since they seem to be mimicking the US bubble in many ways but with a 3-4 year lag. I think someone once told me (I could be wrong) that Australian mortgage debt is non recourse so they could be stuck with it when there is an implosion, unlike Americans who are walking away and just taking a credit hit but saying themselves hundreds of thousands of obligations.

  2. Tradermark > Thanks for the comment. You're right -- unlike many American states we don't have non-recourse mortgages in Australia, so you can't just throw the keys back if everything blows up. This is often cited by the "Australia is different" crowd.

  3. excommunicated? You are aware that Michael Yardney has been excommunicated himself. He was a Dr once...

    "A Victorian doctor who admitted sexually abusing around 60 women has been deregistered by a medical disciplinary board.

    The Medical Practitioners' Board has been told Dr MICHAEL YARDNEY, 43, of Melbourne's
    suburban East Brighton, had sexual intercourse and various sexual contacts with female
    patients spanning 10 years.

    YARDNEY treated some of the women with massage and relaxation techniques before indecently
    assaulting them."

    Property spruiking is the obvious next career move for such a slimy character traits.

  4. Nice post.
    I thought you might be interested in this article in the Australian this morning 29/12,

    What i noticed is listed developers funding thousands of developments, increasing profits and growth.

    I could be totally wrong, as i'm not an economists but from my observations, usually the bank has control of both ends of the asset, i.e. restricting supply by controlling and maintaining credit for the purchaser and controlling credit for the developer, all to maintain the value of the asset the bank owns.

    When the developers fund developments from their balance sheet, the banks loose control of supply of residences in the market place. Worse case being an oversupply, as purchasers will be unable to obtain credit.

    Not sure how close we are to the 'oversupply' factor to have effect? it will also be one to watch.

    Banks are slowly loosing control both ends, ie obtaining cheap funds for borrowers to prevent contraction of credit growth and an increase in supply of stock.
    Prices can only go one way.Down.
    When this happens the market tells the developer to stop until excesses are absorbed.

    As i said, I'm not an economist, but this is what i can see is actually happening...not a forecast.

    Great site..All the best for the new year.

  5. Mike -- Thanks for the link and very interesting observations. There are some interesting stories coming out about a big oversupply of new apartments in Melbourne too...

    Cheers, Dave

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