Troubled prestige prices don’t signal woes for suburbia
One of the main obstacles people have in understanding the dynamics of Australia’s $3.5 trillion housing market is what I like to refer to as an “anchoring bias”.
Since 70% of households own the homes in which they live, they tend to think they are experts on the subject. But, as I noted in my previous column, an individual home, with all of its idiosyncrasies, is actually a very poor proxy, or representation of, Australia’s overall housing market.
Perhaps the strongest anchoring bias one finds is in the luxury market. Most newspapers and real estate publications tend to focus their reporting on high-end property sales. There are good reasons for this: reading about multimillion-dollar homes is fascinating. It sells newspapers and attracts eyeballs.
But how relevant is the $1-million-plus market to the average Australian? And could it be the case that all of the financial services executives and corporate titans who live in higher-end suburbs, and who exercise so much power and influence over “consensus thinking”, are most adversely affected by anchoring bias?
I consistently find that the more well paid somebody is, the more bearish they seem to be on housing, especially during downturns. For example, during the GFC, countless top executives would relay stories about how Australian house prices plummeted in the 1991 recession, and predicted the same would likely happen again.
Yet when we went back and looked at every available house price index, we found that Australian house prices hardly budged in 1991 despite the fact that unemployment peaked at around 11%. According to the ABS house price index, home values actually rose on average over the period January 1990 through December 1992, albeit at a very slow pace. Of course, within the national index there was a great deal of cross-sectional variation.
As was the case during the GFC (when average prices only declined by 3-4% peak-to-trough), by far the worst affected suburbs back in 1991 were the luxury markets. In places like Toorak, Point Piper, Mornington Peninsula and Palm Beach, prices indeed fell by 10-20%. And while this was doubtless a painful experience for the “big end of town”, it had no bearing on the average Australian family.
In psychology, anchoring denotes the tendency of people to rely far too heavily on small pieces of non-representative information when making decisions or estimating probabilities. In 2002, Daniel Kahneman was awarded the Nobel Prize in economics for his work (with the late Amos Tversky) documenting that anchoring biases and other behavioural dysfunctions interfere with objective human decision-making.
These frailties in our judgment have, for instance, been shown to exacerbate the protracted booms and busts in share prices that we have observed over the past 30 years.
When it comes to house prices, purported experts tend to make the mistake of extrapolating from their individual circumstances and using this information as a credible proxy for the wider market. More specifically, I would contend that the luxury market is afforded far too much weight in experts’ assessments of wider conditions. So how important is it?
In the chart below I have dissected out the price distribution of all home sales in Australia over the past year. Recall that the median dwelling price across Australia is $420,000 (including both capital city and regional areas).
Unsurprisingly, about 65% of all sales in Australia are for homes worth less than $500,000. If we widen the price band to between $0 and $700,000, we capture 83% of all sales.
In contrast, only 6.4% sales were for homes worth more than $1 million. That is, the $1 million-plus market is irrelevant to over 93% of households. If we boost the granularity of our analysis and concentrate on the $2 million-plus market, we find that it accounts for only 1.1% of all sales (ie: meaningless to 98% of people).
The next question is whether the luxury segment performs differently to the broader market. In the chart below I am have illustrated the year-on-year capital growth rates realised by the bottom 20% of suburbs (ranked by price), the middle 60% of suburbs, and top 20% of suburbs in Sydney. The results are similar across Australia.
What should be clear is that the most expensive homes are significantly more volatile (or risky) than the remaining 80% of dwellings. During the good times they experience much faster house price appreciation, while in the downturns they perform by far the worst.
This probably helps explain why the talking-heads who frequently live in these areas are prone to the most pessimistic exclamations on Australian house prices. That is, they forget that their $1 million-plus home is a poor guide to overall conditions.
Christopher Joye is a leading financial economist, and works with Rismark International. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.