It's an affluent housing correction: Christopher Joye

It's an affluent housing correction: Christopher Joye
Christopher JoyeDecember 8, 2020

Did you know that homes located in 80% of Sydney suburbs have actually generated capital gains of around 1% over 2011? Adding in attractive rental growth, total returns have been pretty good relative to alternatives like shares. 

It is only the most expensive suburbs in Sydney that have suffered price declines. These areas have endured a 3.2% fall in value over the course of the year (see the red line in the chart below).

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We know this because we break up RP Data-Rismark’s patented hedonic indices by suburbs ranked by price. (Dr Tony Richards at the RBA was the first person to ask us to do this.) The chart above graphically highlights the divergence in performance between the cheap and middle-priced regions across Sydney and those more affluent areas, which have been comparatively hard hit. 

We see similar dynamics assert right across Australia. For example, the cheapest 20% of suburbs in Melbourne have recorded capital losses of only 2.3% in 2011. In contrast, Melbourne’s dearest markets have registered steep 7.4% price falls (see next chart).

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A portfolio of the most expensive homes across the capital cities has experienced reasonably material capital losses of 5.6% in the year-to-date. The lowest priced homes, by way of comparison, have tapered by less than half this amount, or 2.1% (refer to my third chart).

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So why do we find these differences? A bunch of reasons. The rolling global financial crises that have affected all economies in one way or another originated in the otherwise affluent financial services industry. 

Going forward, retail and investment banks are having to modify their business models, and condition shareholders to substantially lower returns. 

Since credit growth over the next cycle will track incomes, retail banking revenues will grow at appreciably lower rates. 

During the 1990s and 2000s, housing credit in Australia expanded at an average annual rate in excess of 12%. That is simply unsustainable. In the long run, credit growth is bounded by growth in incomes (holding all other variables constant), which, on average, advance at single-digit rates. 

To maintain their historical returns, retail banks are having to cut costs. And this is just the beginning. The downward pressure on business expenses will be unrelenting in a world in which major banks can only produce single-digit revenue growth. This in turn means lower salaries and bonuses, and fewer jobs, for some of the nation’s best paid executives. (If you want to watch a funny video skit about bank remuneration in Australia, check out this.) 

The same principle applies to other companies in the financial services sphere. Investment banks – and their commercial banking cousins – are generally closing down their “proprietary trading” businesses, which is where some of the biggest income earners worked. 

Another key source of investment banking profits, IPOs, has been in a secular malaise since 2007 due to the horrific performance of share markets. Once again, all the investment banks are having to revisit their cost structures with the end game being fewer employees and lower compensation. 

We now know that the financial services industry grew to become too large a part of the economy in the years preceding the crisis. In the words of the RBA governor, Glenn Stevens, it was no longer simply the “hand-maiden of industry”. Economic logic usually ends up prevailing, and the financial services sector is now undergoing a relative retrenchment that will probably continue for years to come. 

For high-end housing that basically means top-end purchasers have skinnier wallets, which is probably one reason why we are seeing expensive suburbs underperform for the time being. 

On the other hand, there will be new sectors of the economy that emerge as winners from the structural adjustment currently taking place. Anyone with an exposure to coal mines in NSW is just one example. 

As a rule, luxury property is much more illiquid and volatile than those homes located in the mass market. Contrary to popular myth, developing expensive homes does not deliver the best returns. 

Which part of the housing market do you think billionaires like Harry Triguboff make their money in? Think properties priced under $750,000 that appeal to the widest possible audience. Put another way, would you rather be the founder of IKEA, or running your local antiques store?

Christopher Joye is a leading financial economist. The above article is not investment advice.

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