Sydney's investor demographic is like one big Ponzi scheme

There goes another financial year where for all intents and purposes profits should have been up and back to pre-global financial crisis (GFC) levels.

Some a step further by posting all time record profits given their respective graduation from the GFC together with the valuable lessons learned, which were then adopted then executed.

Having said that we should closely look at the Reserve Bank’s four prevailing views on the property market as each and every point raised is not just a concern but more of a forecast which in all probability will eventuate.

The most important message from Glenn Stevens is aimed squarely at property investors: “Investors should take care in the Sydney market, which is the main area where a large increase in borrowing has been occurring. The total value of credit approvals for investor loans in New South Wales was about 130% higher than in 2008, and it is the investor segment where there has been evidence of some increased level in lending with loan to value ratios above 80%.”

Now whilst we are on this subject in many ways the investor demographic in Sydney to me is like one big Ponzi scheme.

This week we saw headlines like “Sydney property market posts new figures showing a 15.4% growth over the financial year”. Whilst to a degree this may be correct the methodology is false, misleading and entirely wrong as the method is based on the median (middle) price where real estate in Australia is the only country which uses this calculation method.

Firstly, Sydney at a guess is made up of over 700 suburbs – so by throwing in the wealthiest suburbs that recorded $30 million and $40 million sales with suburbs which record $300,000 and $400,000 sales, it’s pretty clear this methodology is flawed to such an extent it implies false conclusions.

The debt trap is what Glenn Stevens is alluding to and those unsuspecting highly geared investors thinking 15% growth are badly advised where, depending on their gearing, they could find themselves in all sorts of trouble.

Real estate is not that hard to calculate so long as you know what are the correct numbers you should be calculating when it comes to reading and understanding a demographic market. The only way this can be done correctly is to look at individual markets such as a particular suburb – I will use my specialist market, Mosman, which has approximately 4,800 houses.

Next you need to ascertain how many houses are on the market each week where this week there are 63 houses, last week 74 houses and twelve months ago there were 63 houses for sale. Next work out how many houses sell each year:

• 2011/12  – 297 houses sold for a total value of $829,747,992. Average price $2,793,764
• 2012/13 – 306 houses sold for a total value of $846,621,000. Average price $2,766,735
• 2013/14 – 365* houses sold for a total value of $1,045,514,637. Average price $2,864,424

*These figures will get higher as more properties settle and the sales data becomes available.

Before the GFC the Mosman market was running at full steam when it cracked the $1 billion mark in value sales so we are now back at near full strength based on current market conditions. Also, when the market is running at capacity it usually trades at ten per cent of the total stock 4,800 houses equals 480 sales per year. Over the period of the GFC the numbers of houses sold dropped back to between five per cent (240 houses) and seven per cent (336 houses).

The problem is that the vast majority shoot from the hip when making these investment decisions over those who actually study the relevant data, although they will all admit their decision was data driven.

Source: The Economist's Decisive Action: How businesses make decisions and how they could do it better via Forbes.

Recently, I read this interesting piece – Are you the one executive out of 10 who isn’t clueless? 

It’s interesting to compare to what happens in real estate given so few fully analyse real estate markets comprehensively. Also, one can’t rule out being persuaded by false and incorrect data given the majority of investors in real estate would be fixated on graphs like this one.

Naturally, so long as our economy keeps performing above expectations then there is nothing to worry about however, when I read this yesterday: Setting the stage lights for Europe’s second crisis. The lessons from the GFC resonate strongly – pay down debt.