How can we tell what is overpriced real estate? Craig Turnbull

GUEST OBSERVER

There has been a lot of noise lately about real estate prices in Australia, particularly in Sydney. The mass media, sections of the government, financial “experts”, concerned citizens – are saying that our prices are too expensive, overpriced and unaffordable. And that values are rising way too fast.

Compared to what?

Best-selling author and international marketing and branding guru Seth Godin has some amazing insights in to pricing – particularly around the increasing value of assets.

Here’s what he says:-

Things that are going up in value almost always appear to be overpriced.

Real estate, fine art and start up investments have something in common: the good ones always seem too expensive when we have a chance to buy them. (And so do the lame ones, actually).

That New York condo that's going for $8 million? You didn't buy it when it was only a tenth that, when it was on a block where no one wanted to live. Of course, if everyone saw what was about to happen, it wouldn't have been for sale at the price being offered.

And you could have bought stock in (name company here) for just a dollar or two, but back then, no one thought they had a chance... which is precisely why the stock was so cheap.

And the lousy investments also seem overpriced, because they are.

Investments don't always take cash. They often require our effort, our focus, or our commitment. And the good ones always seem like they take too much, until later, when we realize what a bargain that effort would have been.

The challenge isn't in finding an overlooked obvious bargain that people didn't notice. The challenge is in learning to tell the difference between the ones that feel overpriced and the ones that actually are.

The insight is that when dealing with the future, there's no right answer, no obvious choice—everything is overpriced. Until it's not.

So how can we tell what is overpriced real estate?

It’s not as easy as it seems. There are so many metrics you can consider, analyse and agonize over. Average prices, median prices, price to income ratios, debt to income ratios, yields, loan to value ratios – blah blah.

I asked you earlier here – overpriced compared to what?

Some interesting stats to consider:-

1.     Hong Kong’s annual price growth to March 2015 was 18.7%. Australia was ranked 14th with 6.8% - and that figure pushed up by Sydney’s double digit growth. Even New Zealand (7th) registered higher than Australia at 9.5%. Seven of the top 10 nations were in Europe.

(Source: Knight Frank Global House Price Index Q1 2015)

2.     Price vs Household Income Ratios – this is the number of year’s income required to buy a median priced home. Over the last 50 years the “accepted comfortable & reasonable ratio” has been 3.0 to 4.0 years of annual income to buy a median priced home. In selected major capital cities in Western nations, Hong Kong ranks highest at 17.0, Vancouver (2nd) at 10.6 and Sydney (3rd) at 9.8, leading San Francisco (4th) at 9.2. Melbourne ranked (6th) at 8.7 with London (7th) at 8.5. Auckland (where lending has recently been tightened to investors) rated (8th) at 8.2 while Los Angeles came in at 8.0. Perth came in (15th) with 6.1 and Brisbane (17th) at 6.0.  

(Source: Demographia 2015)

So while Australia’s prices compare favourably with many similar overseas destinations, I don’t see them as cheap. Are they overpriced? It’s hard to say. Compared with the old metric of 3-4 times income, yes, you would say that Australian real estate is overpriced. However I think that there is an argument to say that the 3-4 times income metric is out of date and no longer relevant. Total household incomes have been rising steadily with the increasingly “normal” two person income household. A position could be taken that the new “median” household income is the average of two people’s income. If you used that more relevant metric, the price to income ratio is not that outrageous.

Something else to consider – housing prices began a rapid increase as credit got easier with the coming of mortgage insurance in the later 1970’s early 1980’s. This meant the banks were happier to lend you money if they knew their loans were insured and they could not lose. They were able to offer much lower deposit requirements and more people could buy. So demand went up and prices followed along. And ratios became less important because people could comfortably afford to buy.

There will be a point in every real estate price cycle when houses are overpriced. And then when the cycle is finished, time takes over, prices flatten out or drop, incomes rise and then comes a point in the future when the homes don’t look overpriced anymore. They look affordable. And people will buy again.

Craig Turnbull is a property investor and author. He can be contacted here.