Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory & buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

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Sunday, 13 January 2013

Our old friends supply and demand...and elasticity

“What that’s got to do with the price of fish?”
It’s a number of years now since I have eaten meat or fish now, but some years ago I used to enjoy going down to the fish markets at Pyrmont in Sydney for a plate of fish and chips in the sunshine. And on a hot day, I’d wash it down with a cold bottle of beer. Magic.
That’s a slightly more pleasant experience than the old Billingsgate fish markets in London (I had an audit client there back in the late 1990s, it was a rather pungent place to work), which was purely a marketplace for buyers and sellers to come together, undertake very noisily negotiated transactions, and begin the process of large-scale distribution.
And this is really what a market is: a place where buyers and sellers come together to agree a price for a transaction.
The price, of course, will be determined by how much the buyer is prepared to pay, and while the seller may start with a higher figure in mind, after a period of negotiation a final settlement with either occur or the buyer will move on to another vendor.
Price versus value
In regards to property markets when we visit new places and particularly tourist or coastal locations, we often stroll past an estate agent’s window for a ‘sticky-beak’ at what it might cost for us to make the big sea-change.
However, what we usually see in the window are asking prices. This does not mean that the advertised properties will sell for such a price. Anyone who has bought a property in times of low sentiment or market distress will know that the settlement price can be way below the original asking price, often 20% lower or more.
For this reason it is sometimes useful to draw a clear distinction between the terms price and value.
As the old saying goes: “price is what you pay; value is what you get” or sometimes “some people know the price of everything but the value of nothing.”
Intrinsic value investors
The relationship between price and value is a key concept in the practice of value investing in the share markets.
A value investor will look to buy when sentiment and Price-Earnings ratios are low and thus share prices are materially below their long-term average valuations. They will also look for instances where they believe the share market has materially mispriced a stock against its intrinsic value which will happen periodically.
And, just like at the fish markets, sometimes there is a discrepancy between what a buyer is prepared to pay and a vendor is prepared to sell for and thus no transaction takes place. The gap is known in share market lingo as the bid-ask spread.
Supply and demand in property
Markets are always easy to read in hindsight! From the early years of this century through to the money market crash of 2007, property prices in the US had been fairly surging along.
In some speculative markets, developers jumped on the bandwagon by building ever more properties until the supply easily outweighed the demand. When the crash came it was exacerbated in areas such as California for this very reason.
This is fairly typical of how many markets work. Take the example of commodity markets: surging demand for a cheap commodity causes a commodity price to rise which incentivises the big international mining companies to mine more of the commodity, until eventually the increased supply outweighs the demand and prices retrace once more.
For this reason when it comes to commodities it pays to take heed of stockpiles on hand as indication of where prices may head next.
So it is in property: analysts will often look at stock on the market as one of their key indicators of likely price movements.
This process of prices rising and falling cyclically as supply and demand interplay with each other over time is known in economics as seasonality or sometimes “market noise”. What rational investors try to do is look at the longer-term trends to understand when a market is in equilibrium.
In share investment, it is common to compare Price-Earnings ratios and the market’s average dividend yields with historical averages in order to understand whether a market is over- or undervalued.
However, markets are rarely truly in balance or equilibrium and it is sometimes difficult to identify whether changes or structural shifts in the marketplace make historical averages less relevant.
A good case in point is that stocks may be valued quite differently in periods of high inflation from when inflation is expected to be low for the foreseeable future.
The greatest problem in property is that, while many make assumptions, it can never been agreed upon what the ‘fair value’ of a property actually is. It is often said that 3-4 times a salary should be a fair price, but why? Why not 5 times? Why not 0.7 times? Why should we even have to borrow money to buy a property at all?
Supply and demand factors
Ultimately it all comes back to what happens at the fish markets. Prices will be determined by how many properties we build (the supply) and the demand for them. The demand will be influenced by all manner of unknown variables, including interest rates, appetite for taking on debt, lending restrictions and many more.
We do know that one variable in particular will definitely increase demand, that being the ongoing huge boom in Australia’s population.
Another major shift has been that, for better for worse, more households either elect or are being forced to send two members of the household out to earn incomes - and they are having fewer children, later in life. These shifts have increased disposable income massively over the last generation which contributes to rising property prices.
Of course, you might well say that this is not a good trend, but it has nevertheless happened. The invisible hand of capitalism and self-interest often sees both parties in a couple out working long hours in an attempt to forge ahead.
The price elasticity of demand…and supply
Also bear in mind the price elasticity of demand and supply.
Some products are said to be price elastic. If the producer of the product puts the price up, demand falls away quickly. Thus if Vodafone decided to charge $39 instead of $29 for its phone credit top-up cap, I’d guess that demand would drop off a cliff – the product is likely to be price elastic.
Price elastic goods include take-away coffee or lottery tickets – you can usually source them easily elsewhere so if prices are jacked up, you may elect not to buy from a particular vendor.
Prices can be inelastic when there is a need or demand for a product, such as a medicine for a particular illness, or tickets for a rare non-recurring event. If prices went up, you may still choose to buy regardless.
Supply can also be elastic or inelastic in a capitalist economy. Think back to the example of property developers aiming to profit on the boom in demand by building a glut of properties in California.
The Reserve Bank in Australia will aim to stimulate confidence levels and construction in Australia to meet the demand for housing from the booming population and is likely to use a prolonged period of low interest rates to do so. Low interest rates are welcomed by mortgage holders but do be wary of the increasing supply which will eventually come online.
The key, of course, is to only buy property in areas where demand is increasing but there is no land available to be built on. That’s why I invest in properties aligned with the demographic shift to smaller households in supply-constrained suburbs of capital cities rather than trying to outsmart the market through regional hot-spotting.