A dose of reality: Populist opinions v the property stats

GUEST OBSERVATION

I don’t usually get many comments in response to my articles, so it was a real thrill to receive a full length dissection of key points from my latest story titled 'Lies, damned lies and housing statistics'.

I always welcome constructive criticism since variety of well argued opinions promote better understanding of facts. Ultimately, this is what we are all after – an informed community with well balanced opinions and not prone to fall under the spell of any particular ideology. 

In the interest of promoting that better understanding of property market in Australia, I would like to revisit a few points from Joseph's (aka Bullion Barron) commentary to reinforce the original point made in my article – data does not lie, only people interpret it incorrectly or deliberately omit inconvenient truths to advance their own agendas.

My intention is to highlight that if one is prepared to dig deeper, there is much more to official data than often realised and that too narrow an interpretation of facts can lead to completely incorrect conclusions. 

In my previous article I presented a chart showing that, in relative terms, Brisbane, Melbourne and Perth housing prices grew much stronger in the last 28 years than Sydney prices. It concluded that the recent jump in Sydney prices may be just a long overdue catch up – the recent strong growth is nothing out of ordinary.

Further evidence was that Sydney prices grew only a tad over and above the weighted average of eight capital cities and that purchase affordability is still very good, in historical terms.

My objective was to demonstrate that if Sydney property prices were indeed out of control, we would have seen the evidence no matter what statistic was used. This was clearly not the case.

To counter my arguments Joseph (Bullion Barron) referred to information published on the internet by him and other property market commentators. Let’s examine a couple of pieces of information in detail to determine if indeed this information can decisively undermine my earlier conclusion. 

Case One:  Low rental yields as a proof of high level of speculation and overvaluation

The following chart was presented as the evidence (sourced from RESIDEX August 2014 report, indicating median values and rental yields for houses).

Source: RESIDEX

In order to determine if this data really proves speculation and overvaluation we would need to know if Sydney and Melbourne yields are indeed out of ordinary. That is, we would need to find out at least “how low is low” - by comparing current yields to those from the past, as well as to other risk free options. So, let’s put this information into a broader context.

Firstly, as any avid follower of the property market will know:

• Rental yields are always higher in smaller capital cities and in the country than in larger cities. This pattern is clearly visible in the provided data but we cannot determine whether the gap between Sydney and other cities is reasonable or not;
• Yields always fall when prices grow strongly (simply because rental contracts are usually a year in duration; as well, in many states rents cannot be adjusted more than once a year and more than by a certain percentage, so it takes time for rents to adjust to rising prices) – the table does not contain historical information for comparison so we cannot determine whether rental yields were always like this or whether they are declining or rising.

Please note, the author omitted yields for apartments which are in mid to high 4% for Sydney and Melbourne and do not show such a dramatic difference in comparison to other states and capital cities.

Examining rental yields from a historical perspective reveals that the current numbers are not the exception. For example, data published by SQM Research indicates that Sydney had similar yields in July 2010 (unfortunately, the data series does not go any further than that and I don’t have access to historical information from RESIDEX).

Yields for apartments are currently at the lowest point since July 2009 but they are still well above 4%.

SQM Research charts for capital cities confirm the pattern that rental yield for houses are generally higher in smaller cities. However, the difference between the cities appears to be smaller than RESIDEX data implies (different methodologies may explain that discrepancy).

An interesting point to note is that Perth used to have yields in the low 3% in 2010, which is much lower than Sydney and Melbourne now. This is another indication that things may not be that extreme as yet.

And comparing alternatives, Sydney and Melbourne rental yields still look pretty reasonable. For example, the Reserve Bank of Australia (RBA) publishes cash deposit rates for financial institutions which in September 2014 were ranging from 1.25% per annum for a one month term deposit to 3.75% per annum for retail deposit and investment rates on savings accounts (for banks' bonus savings accounts with balances of $10,000 plus). So, even Melbourne’s 3.58% yield is not as bad in comparison as it can appear at the first glance.

I know what many are going to say: “But rental yields are gross yields, there are costs that need to be taken out; it makes more sense to keep the money in the bank…”

True, there are costs to be accounted for but commentators tend to forget that in case of property, total return consists of rental income and capital appreciation.

Keeping money in the bank returns only interest income. Property, even if not leveraged, can therefore deliver substantially more than cash in the bank.

That is why investors can accept lower yields, especially in the current low interest rate environment and when the stock market delivers so little in comparison.

Considering Sydney and Melbourne are our largest cities (so rental yields are expected to be lower than for the rest of the country), and that alternative investments appear too risky in comparison (i.e. the share market is not delivering), it would be hard to conclude that current rental yields are the undisputed proof that property market is out of control. Rather, it looks more like just a normal stage of the property cycle where prices jumped ahead and rents have not yet caught up to these higher prices. 

Case Two: Value of investor loans for Australian states (12 months rolling basis) as a proof of out of control speculation by investors 

The following chart was presented as the evidence (sourced from Pete Wargent - a regular commentator on Property Observer):

Source: Pete Wargent

This chart is full of interesting twists. There is nothing wrong with charting raw data but special care needs to be taken with interpretation of such charts, and especially with comparisons between presented data series. Otherwise it is easy to draw totally incorrect conclusions. Let’s examine this chart a bit closer.

You will notice that it compares total value (i.e. 12 months running total) of property investment loans for states which have:

• Widely varying population sizes,
• Varying rates of population change, and
• Big differences in property prices. 

Furthermore, the information is represented as nominal values (i.e. is not adjusted for the effect of inflation over time –a billion dollars nowadays is not equal to a billion 30 years ago). Not to mention there were differences in lending rules now and then…

In other words, a lot of the difference between the presented data series and the steepness of the rise in individual lines can be explained by the above listed factors. That is, in order to make a meaningful comparison between states, as well as relative change over time, we would firstly need to adjust the data to eliminate the effect of all these factors on the original data series. 

So, yet again “the proof” ends up raising more questions than providing answers.

I will leave the exercise of recalculating the data for another occasion since this is quite a time consuming task. Then and only then we will be in a position to confirm whether what is happening in Sydney with respect to property investing by individuals is indeed out of ordinary or only proportional to changes in the Australian economy and demographics.

There is one more interesting point to be noted about this chart. That is, it starts with values close to 0. Does it indicate then that in the 1980s there was hardly any investment in residential property by individuals?

Yet, as another set of data from ABS demonstrates, the proportion of rental properties in Australia remains relatively stable over time, ranging between 27-32% for many decades…

You will have to wait until another opportunity for the explanation of this apparent inconsistency. For now, I will just point out that “the rise of individual property investor” phenomenon dramatically exaggerates what is really happening in the rental end of the property market.

I have no doubt that Joseph’s (Bullion Barron) intentions are noble and that he and other commentators proclaiming that Sydney property market is out of control strongly believe this is the reality. However, as you can see, the data does not decisively support such a conclusion.

There are more inconsistencies and erroneous conclusions I could address in Joseph’s article but I think I have already made my point. I sincerely hope that you have enough insight and wisdom now to not accept any claims about the Australian property market without a dose of realism. 

Arek Drozda is an independent property market analyst.