The centuries-old crystal ball that proves Australia's housing price growth cannot outpace inflation forever

The centuries-old crystal ball that proves Australia's housing price growth cannot outpace inflation forever
The centuries-old crystal ball that proves Australia's housing price growth cannot outpace inflation forever

In Australia, thus far, we have avoided the sharp downward cycle experienced in the USA and areas of Europe during which the “pre-crash” environment was stimulated by low interest rates, unregulated credit booms, and to put no lighter word on it – greed.

Inevitably the market has reverted to what could be termed a more balanced atmosphere. Even with the best efforts from our state and federal governments, which are set on promoting growth in the housing sector to make up for a drop in projected mining and yearly profits, our current low interest rate environment and new rounds of swiftly introduced first-home buyer incentives are failing to produce the same level of enthusiasm witnessed during the 2009 buying spree – thus far, at least.

However, we’re reaching that time of year where real estate pundits will dust off the crystal ball and make some future predictions into 2013 – not that we haven’t had a fair few already.  Out will come the property clocks, and we’ll get a lesson in how to tell the house market time in order to assess exactly when “the right time to buy or sell” is.

To do so, most will take a look at lessons from history and evaluate market cycles – and to be fair, it would be foolhardy to ignore previous trends that form repeated patterns over time.

But it’s worth remembering the words of John Toland – a great American author and historian who used a single statement to neatly sum up “historical cycles” in his Pulitzer prize-winning book, The Rising Sun”:

“There are no simple lessons in history,” he commented.” It is human nature that repeats itself, not history.”

Human behaviour dictates historical cycles, not the other way round – hence why the consumer sentiment index is so important when assessing market cycles and can often act contrary to “on-paper” economic forecasts.

The trouble with the housing market is that we have had a decade-long boom in growth, during which median prices in many areas of Australia have more than doubled in nominal terms, and tools such as negative gearing and SMSF investment have been broadly adopted by many mum and dad investors. Reliance on the capital growth of the asset above and beyond inflation to fund retirement has further fuelled the established playing field and resulted in real estate becoming a speculators’ paradise. 

The market is spruiked, tweaked, evaluated, and analysed, and splits groups down the middle as if it were a game of politics.

We have monthly and now “daily” indexes to fixate and argue over – and with $12.6 billion in revenue set to be raised by state governments through stamp duty alone this financial year, real estate investors and property speculators are not the only ones hoping for “broad-based” market recovery in 2013 – proving once again values are on the up and punters are flocking to the market in an emotional driven foray.

The wealth of our real estate market has the ability to make or break Australia’s bank account, with some estimating its overall value around $4 trillion. It is especially significant as foreign and local real estate investment funds perceive the Australian housing market a relatively “safe” terrain counting on future prospective population growth to underpin prices for many years to come.

However, despite the growing populous, the RBA recently pointed out in its November speech that “the outlook for dwelling investment” is being negatively impacted by a number of factors, principally “the sharp increase in house prices from 1999 – 2003” along with broad-based development costs, “red tape”, and lack of infrastructure in outer-suburban areas, the cost of which – no longer funded by governments – is now passed onto the developer and consequently home buyer.

As such, new housing demand has fallen short of underlying demand, leaving many scratching their heads wondering why the much-spruiked “housing shortage” and strong population growth has not translated into sales.

It could be argued that even with a slight uplift in the number of seasonal transactions as we approach the end of 2012, a larger population of buyers have determined that the cost of housing is still too high and further corrections to market prices need to be in evidence before they read the property clock as a call to dust off the cheque book and head back out into the housing market terrain.

As if to underline how unaffordable housing is deemed to be on a historical time scale, households are no longer decreasing in size, children are leaving it later to leave the nest and the increase in the number of people sharing accommodation has accelerated.

Lifestyle factors aside, few would argue that affordability and the reluctance to take on debt is not a significant contributor to slowing of growth in local dwelling investment – and this is mirrored in the UK and US, where shared buying schemes are growing in popularity, and the rental market is once again feeling the strain, with groups such as Shelter UK calling for government action to reduce the cost of accommodation for struggling individuals and families.

For investors, housing has long been viewed as a hedge against inflation.  Since the mid-1990s to the peak in 2010 Australia’s housing market has enjoyed long periods during which prices have far exceeded the rate of inflation. However, as shown by some of the oldest housing indexes in the world, house prices that consistently exceed the rate of inflation typically undergo a period of “correction” and remain the same in real terms when viewed over the longer trajectory.

 


 

One of the first economists to show this was Yale’s Robert Shiller in his UShouse price index dating back to 1890. Another index also worth mentioning is the oldest housing index in the world – the “Herengracht Index”, which dates back to the 17th century – starting in 1628.

Professor Piet Eichholtz of Real Estate Finance at Maastricht University has undertaken extensive research on the unique document, which follows the change in real estate values along a “prime strip” of the Herengracht Canal in Amsterdam – one that is lined with magnificent single- and double-fronted period terraces. The span of his study extends to the mid-1970s and is fascinating in its content.

Modern indexes are required to adjust for changes in housing stock. For example, as extensions are added or properties upgraded and replaced, keeping an accurate record of median price changes which stratify for the difference is a very real challenge.

In contrast, the Herngracht Index shows a series of repeat sales figures for a small but significant strip of real estate that is relatively stable in type and located in what has remained a premium pocket of Amsterdam.  Therefore the need to stratify is reduced – although, as Eichholtz points out in his extensive report, the original 614 lots have, over time, reduced to 487 properties as adjacent buildings merged to allow for a larger floor area. 

This aside, for the purpose of the study, Eichholtz only makes an allowance for one “hedonic” change – the use of office space, which has added a commercial element to some of the housing’s original residential purpose and obviously has an ongoing impact on price. 

The results are significant – in nominal terms the housing values increased “more than tenfold,” with a ‘bi-annual’ increase of “11.6%” for the period. This is not surprising; after all, the area of real estate under study contains the same local desire as a “golden mile” beach strip in Australia.

However, in real terms the increase in values are largely insignificant – after 345 years of “market cycles,” the inflation-adjusted cost of housing only increased 3.2% – leaving the “real” value broadly the same.

Eicholtz carried out a similar study in rent values for Amsterdam dating from 1550 to 1900.  Once again, the “real” change over the entire period remained at the same level at the end of the study as the beginning.  Despite growth in population, economy and changing vacancy rates, short-term volatility was overridden by long-term “inflation-tracking” stability.

Of course, this study covers a distinct period in history during which trade wars, “tulip mania”, occupation, depression, WW I, WW II and various waves of immigration spurred rapid volatility in boom and bust cycles.

It’s fair to say our region of the world is a tad more stable and as such, the index under study may not be all that relevant in current property investor’s eyes. Opponents to any forthcoming on the horizon Australian property crash cite our strong population growth, limits on land supply as well as good long-term credit, wage growth and somewhat disputable “well-regulated” lending practices as placing a floor beneath prices – and thus far, this has indeed been the case.

However, the post-1950s US market was also considered stable – with Richard Peak from the Federal Reserve Bank of New York confirming back in 2005 that “(house) prices are in line with economic conditions”. Two years later, and his assumptions were starting to show cracks.

Throughout every period of history, it’s been the norm to assume a rosy outlook and the exact timing of any significant or sudden fall in property prices has rarely been predicted with outstanding accuracy.

As I said above, its human behaviour that dictates cycles and on paper figures aside, it is abundantly clear from the low level of transactions throughout the year and reluctance to take on debt that our home buying psychology – at the very least – has changed.   

At the moment, most analysts are pointing towards an improvement in the housing market as we enter 2013 and thus far, this seems to be a fair proposition – however considering the current instability with job losses and some of our larger companies going into receivership, along with continued instability overseas in both Europe and the Middle East, and the RBA describing some of its  previous forecasts as no better than a ‘random walk in the park’, there are certainly no guarantees.

There is, however, plenty of solid evidence to show our housing market is unaffordable for a growing populous of young buyers, and crashes, bubbles and long-term housing indexes aside, the RBA, Treasury, and both state and federal governments should be concentrating on keeping prices stable for an extended period of time, rather than placing us back in a low interest rate, incentive driven inflationary environment.

With 2013 in sight and an expected continuation of somewhat tenuous economic conditions, the long-term health of our housing market cannot be sustained unless we seriously address the issues that have pushed house prices out of reach for a growing minority.

Catherine Cashmore is a market analyst with extensive experience in all aspects relating to property acquisition.

 

However, we’re reaching that time of year where real estate pundits will dust off the crystal ball and make some future predictions into 2013 – not that we haven’t had a fair few already.  Out will come the property clocks, and we’ll get a lesson in how to tell the house market time in order to assess exactly when “the right time to buy or sell” is.

To do so, most will take a look at lessons from history and evaluate market cycles – and to be fair, it would be foolhardy to ignore previous trends that form repeated patterns over time.

But it’s worth remembering the words of John Toland – a great American author and historian who used a single statement to neatly sum up “historical cycles” in his Pulitzer prize-winning book, The Rising Sun”:

There are no simple lessons in history,” he commented.” It is human nature that repeats itself, not history.”  

Human behaviour dictates historical cycles, not the other way round – hence why the consumer sentiment index is so important when assessing market cycles and can often act contrary to “on-paper” economic forecasts.

Catherine Cashmore

Catherine Cashmore

Catherine Cashmore is a market analyst with extensive experience in all aspects relating to property acquisition.

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