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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Wednesday, 11 September 2013

The housing bust that never was

Cold front

After a scorching week in Paris, I’m back in Britain and it has turned absolutely perishing in the past 48 hours. Thankfully only a short stint in our London office to go before I’m back to Sydney (which I hear has the opposite problem this week). Looks like cricket will be washed out this weekend too so it’s indoor activities only here.

I was flicking through the contents of my i-Pod this morning and I had to laugh, for there is almost nothing on it which is newer than about 1999. Apparently this is fairly common - we update our musical tastes until we reach a certain age and then completely stop appreciating the new stuff.

Damningly, my i-Pod tells me that my ‘most listened to’ albums are All Mod Cons (Jam, 1978), The Razor’s Edge (AC/DC, 1990) and Dookie (Green Day, 1994). In fact, thinking about it, I even still have the same bad haircut from the early 90s when I was a suspiciously young-looking clodhopper at punk gigs at the Brixton Academy, although thankfully the Doc Martens look has been shelved.

I remain convinced that three-chord thrash is better than anything One Direction will ever come up with (even that one with the riff they ripped from The Who) but the reality is that I’m stuck in a timewarp. I haven’t updated my viewpoints, opinions or tastes in two decades and thus my views are no longer relevant - I'm musically obsolete.

I guess, then, that’s why I write for Property Observer and Property Update and not the NME.

Housing bust

I’ve made a few enemies over the last half decade by suggesting that we wouldn’t see a dramatic housing bust in Australia. 

We did get a moderate cyclical downturn in 2011 and early 2012 but prices have rebounded across the country. Price gains are actually accelerating in the major metropolises of Melbourne (+6.31% q/q) and especially Sydney where prices are up by 6.6% in just 3 months according to RP Data.

Source: RP Data

Updating views

The housing debate can all get a bit silly and childish at times, for we’re all right some of the time and we’re all wrong some of the time. Anyone who pretends otherwise is delusional. All that really matters is that views are updated when new information and evidence comes to light.

Detractors of John Maynard Keynes famously complained that some opinions expressed by him subtly shifted over the years. On being accused of being inconsistent by a senior government official Keynes replied simply:

“When my information changes, I alter my conclusions. What do you do, sir?”

In any case, there are plenty of markets such as in Adelaide and regional Australia where the housing market 'rebound' (if you can even call it that) has been very weak in spite of the record low cash rate. Brisbane's market has also been soft although I believe it is improving.

Dwelling Prices graph

In my opinion, most regional markets have had their day. I’d find it very hard to look at the below chart and say with a straight face that prices in remote locations and regional centres are going to outperform household income growth in the decade ahead.

Household Finances graph

There is still a lot of talk about positive cash flow investing in Australia, though I’m not sure why given the cheap cost of credit. If yield is the prime motivation for an investor, I wouldn’t even be looking at Australian residential property at all – you can get far better yields elsewhere such as in industrial, commercial or retail properties.

Even as an overseas investor, with a 25% deposit I can source mortgage capital in Britain at ~3.50%p.a. (locals can fix at a much lower rate) leading to an enormous reverse yield gap – it’s possible to buy residential properties even close to London where the rental income is double the interest repayments and costs, and where prices are set to soar thanks to government policies aimed at causing just that outcome.

And if income is your primary goal, you’re probably trying to turn residential property into something it isn’t supposed to be. There are a range of other asset classes and investments where stronger income can be sought.

Investing out in the regions might have been a workable strategy from c. 1990-2005 as the above chart shows, but strategies and views need to be updated as conditions change. 

Australia's markets have already experienced the leveraging up phase seen in other developed countries. As the major cities grow in size and mature they are moving into the next phase, which is where residential property increasingly begins to be seen as an investment asset class, particularly in the inner suburbs.

Contrary to popular belief, Australia’s employment is not all about the mining sector - rather healthcare, construction, retail trade, manufacturing and other services are the big employment sectors.  Property investors should follow jobs growth, population growth, and particularly, follow the wave of speculative investment capital, both domestic and from overseas.

The combination of these signals and metrics are currently pointing to Sydney as the outperformer.

Outstanding returns?

For property investors to achieve outstanding returns, they could try a punt on a mining town, but the higher returns might only be achieved with a commensurate level of risk through investing in an area which is reliant upon one industry (sincerely, best of luck).

Historically, investors have done better when they hold for the longer term as this gives prices the opportunity to grow and compound, and therefore they may be better advised to seek out areas with a diversity of employment and very strong, sustained population growth such as is found in the four major capital cities.

The Aussie economy has added 123,000 jobs in the past 12 months but it’s very much a Sydney story with more than half of that amount being added in Sydney (+64,000) but Adelaide shedding jobs (-10,200) and seeing its unemployment rate rise all the way to 7.1%. No surprise, then, that Adelaide’s housing market continues to struggle while Sydney is booming.

In fact, Sydney appears increasingly likely to enter a rampant speculation phase – a property sold in Eastwood at the weekend for $1 million above its reserve price and crumbling hovels in the inner west are fetching $900,000. Auction clearance rates have been hitting way above the arbitrary 'boomtime' 80% level and the real silly season of spring is barely even upon us.

It’s not different here

There have been a thousand articles written in Australia over the last few years explaining why "it’s not different here". 

In fact, I tend to agree. We'll likely end up with two-speed markets as Australia's population grows, with very expensive prime-location capital city suburbs which remain wildly out of whack with property prices elsewhere.

Experienced property voices have pointed out that as Australian cities balloon in size, home ownership rates are likely to fall unless revised legislation is put in place to prevent the trend from  unfolding. High rates of home ownership don't, incidentally, always equate to lower prices and stability - in fact, higher rates of ownership are often synonymous with dramatic boom-bust cycles. Singapore, for example, has state policies and 40 year mortgages which encourage a home ownership rate of above 90%, but the city remains crushingly expensive.

Check out home ownership rates in cities like Tokyo, Hong Kong, London, Singapore, New York, Bangkok, Seoul, Geneva, Paris – they all hover around 50% or significantly lower, and that’s where Sydney and Melbourne are headed in the absence of legislative intervention.

The only surprising thing by the prospect of falling home ownership rates in Sydney and Melbourne is that anyone is surprised. If we pump up the Australian population relentlessly at a rate of 1.5% per annum or above as appears to be the 'grand plan' but fail to tackle supply-side reforms (and let’s face it, as a nation, broadly speaking, we are failing to do so), with a workforce changing jobs and careers more frequently than ever before, we can expect falling home ownership rates.

Notably, close to half of all mortgage financing activity in New South Wales is now for the purposes of investment, which is the highest level ever recorded for any state.

Cash rate mean reversion

With sub-trend economic growth forecast, declining mining capital expenditure, a stubborn Australian dollar at above 93 cents, steadily increasing unemployment and inflation remaining benign, in the normal course of events one would be looking for a falling cash rate, but elevated levels of real estate speculation in Sydney and Melbourne could potentially jam a stick into the spokes.

The RBA appears to have been of the opinion all along that rising dwelling prices are a necessary pre-condition in order to stimulate dwelling construction, so it should be little surprise that we have seen a housing market rebound, but the Reserve certainly won’t want asset prices to spiral uncontrollably.

Dedicated housing market crashniks have been squealing for an interest rate hike for months now, but it remains doubtful that they’ll get one until there is conclusive evidence that the unemployment rate has stopped ticking upwards.

Graph: Unemployment Rate

Source: ABS

The implied yield curve has quickly shifted in the past 24 hours to pointing at December 2014 for an effective increase in the official cash rate to a (still historically low) 2.75%, though if we’re fortunate the economy, confidence and labour markets will prove stronger than that and the next rate rise will be some time earlier in 2014.

Either way, Sydney property prices will doubtless have long since bolted by the time interest rate hikes are able to apply any sort of effective handbrake to growth.

Infamously, Professor Steven Keen called a property bust back in 2008, forecasting a 40% crash in prices. By the time this upward property cycle finally reverses, prices may well indeed have moved by 40% in Sydney, but sadly not in the direction he predicted.