Michael Bysouth – Private Wealth Management

June 2011

With all the scare-mongering in the media at the moment, it is easy to be concerned about the future of your assets. This email is to provide a balanced approached to the entire data spectrum, and look at the real fundamentals for the Brisbane market and what the future holds.

The long term trend for growth in Brisbane remains unchanged. Floods, cyclones, recessions, and interest rate changes will have a short term impact, but over time will have little long term impact on the growth of inner suburban Brisbane property values. The key factors for property price growth are:

1. population growth (through births, interstate and international migration)
2. wages growth
3. employment growth (productivity increases)
4. demographic changes (lifestyle/household changes)
5. supply (land release and construction completions)

A lot of the media reporting about price falls (of the long term prognostications) are based on single data extrapolation. The problem with focusing on one set of data; such as affordability ratios or “mortgage stress”, is that it fails to take into account the magnitude of inputs that constitute market growth. The other redundant economic forecasting tool frequently used in the media is to compare the Australian property market to overseas markets (like the US). I have produced a newsletter about the pitfalls of this comparison;  it is like making the assumption that the sports of cricket and baseball are identical.

So back to the negative media; it is very easy for Economists to predict doom and fudge economic data – interviews are easier to get and this leads to books that are quicker to sell. So why are there so many pessimistic forecasts at the moment? Firstly, the media follows news trends, for example, when a person gets bitten by a shark, shark stories suddenly abound – and the trend at the moment is for bad property stories. Secondly, the market has dropped in many cities in Australia and slowed for the first quarter of this year.

The real time data does show a decline in median property values and a slowing of sales and a drop in auction clearance rates.  However,  this doesn’t mean the market is going to ‘burst’ or fall drastically. The Australian property market, like the weather, follows cycles (rise, slow, correct, rise) and the current property cycle can be compared to the autumn/winter weather cycle. The property market is going through a normal stage of long term growth, thus the declines in “median” values are a reflection of the current market cycle, and not a reflection of the long term future of the market.

If you look closely at the data, the biggest declines are at the top of the market, and they can heavily influence the “median” prices. It is easy to have a 2% fall in the “median” house price with little or no impact on the price of houses in the “middle” of the price range – which is where our investment properties are located. Having said that, I don’t disagree with the data, I just don’t let it affect me as I have seen it three times before over the last 14 years. It is all part of the normal cycle and a signal to keep buying. As Warren Buffet says; “when the department stores have a sale, the masses rush in to buy; but when the stock market goes on sale, the masses run out to sell.” If the property market was a Harvey Norman store you would see the masses running in to buy….and interestingly, (and historically) they eventually do in Australia, because prices only need to fall by a small amount before the home buyers rush back in to get a bargain.

Commentators and Economists talking of “bubbles” and “burst” in Australian capital city property markets are akin to a weather forecaster saying, “we are never going to have summer again because it is so cold right now.” As we become more aware of weather cycles, we know it will change and get warmer again – however we aren’t so attuned to the property cycles, and therefore find it hard to sort through all the media interference, believing that this “change in the weather” is a permanent change.

Economists can use single source numbers in the short term to support their claims, but what they can’t change is long term demographic trends. Our birth rates are declining and our life expectancy is increasing, which means we are producing fewer taxpayers to support retirees (so the government has to increase the number of working tax payers to offset this change in demographics). This ultimately will increase our population and drive wages up, and property prices will climb accordingly. Although Prime Minister Julia Gillard talks of sustainable population growth, this is just political posturing as she knows (as do all sides of politics) that Australia must increase its population if it wants to remain healthy, vibrant, and stable – and politicians need that to keep their hold on the power seats.

Our housing occupancy rates are dropping – they now stand at 2.41 people per dwelling, down from 4.21 in the late 1970’s (this means that we need to build more dwellings even if the population stays stable) and this increase in demand adds to the demand burden from pure population growth. Also the mix of occupation is nearing 50% single occupied dwellings, further exacerbating this trend. Social trends also are such that couples without children will be the largest family group in Australia by 2020, representing 31% of households – meaning demand for units and small townhouses will outstrip houses, and houses will underperform them in the long term.

Thus long term population growth, fueled with wages growth and demographic changes, are all putting a huge demand on property needs. With a long term decline in building and finance approval, Australian property as a whole is grossly undersupplied. This all bears well for future growth – the only factor missing from a property boom is attitude, which is currently in “recession” mode, even though all economic data aside from property indicates an economic boom (reflected by our dollar being valued 7% higher than the mighty US greenback).  A high dollar, massive trade surpluses, unemployment below 5%, and plenty of cash in the bank are all “statistics” of a booming economy – unfortunately or luckily for the RBA, the masses don’t translate this into their current shopping habits, choosing to save rather than spend.

Understanding market cycles can explain the current price reporting, but what about that other doom and gloom story that the TV and radio jocks like to discuss with ‘economists for comment’ ad nauseam at the moment?….the topic of the growing Army of ‘Grey Nomads’. According to these commentators, they are a demographic time bomb about to go off and kill the property and financial markets (oh and they also like to again compare us to the USA on this topic too). But is it really going to be that bad as your peer group starts to slowly leave the work force they have been addicted to for the last 40 years?

Demographics show that ‘baby boomers’ are not selling up their homes en-mass on retirement, and they are not slowing up working or spending in a hurry. The economic data used to scare us about retiring baby boomers fails to take into account the large amount of wealth they (and their parents) have stored in their homes and their superannuation funds – Australia has the 4^th largest pool of superannuation in the world and the 5^th largest stock exchange by market capitalisation. In fact dollar for dollar Australia has the highest GDP in the world for all countries with a population over 4.5 million; only small oil rich nations (Saudi, UAE, Kuwait etc) or tiny finance rich nations (Lichtenstein, Hong Kong or Singapore) do better than us in the GDP per capita stakes.

These huge stores of home equity the baby boomers have will be used to fund spending in retirement; they can do this without selling through lines of credits and reverse mortgages. Also, a good 35% of baby boomer parents are still alive, and a full 87% of them own their homes outright – and guess who gets the estate proceeds when boomer parents start to die just as they are going to retire?

Demographics also show that Australia’s population will increase at least by a further 16 million people in the next 39 years (this is not new data, I have ABS stats from 1998 predicting this). With the change in housing formations we will need a further 6,640,000 new houses to be built to support the increase in population, in comparison with the first 16 million people in Australia whom only required 3,900,000 houses. So even if the population stays the same, the change in demographics dictates an increased supply of housing. Australia has been building about 150,000 dwellings a year for the past 15 years. We have needed supply to be in the amount of 180,000 per year since 2004. This is where the banks and governments recognize a net housing shortage of around 200,000 dwellings currently, which will blow out to 500,000 dwellings in the next 10 to 15 years, unless something changes dramatically to the supply. With finance and dwelling approvals falling further this year, you can bet this will have a marked impact in another 12 -18 months in supply constraints.

Australia derives 80% of its GDP from the services industry, 10% from resources and 10% from manufacturing and agriculture combined. As boomers retire we will eventually lose around 33% of the current work force. As they leave work and ‘spend the kids inheritance’, who is going to take over their jobs?  Generation X.  And when we do, we will demand higher wages. Who will take our jobs?  Generation Y.  And they will demand higher wages. And who will take Gen Y’s jobs?  There is no-one, as the upcoming generation is too small and too young – so this leaves a void that needs filling, and only immigration can fill that void fast enough.

The Howard/Costello government was well aware of the wages inflation pressures coming up, and the baby bonus was one of a few strategies they implemented to help us “self-sustain” for the future.  As our wages increase we take those higher wages and spend it on housing. Boomers will actually increase demand on services as they spend the kid’s inheritances. Yes, the government will get less income tax from them but GST revenues will increase as they spend (but not by enough). Therefore the population must increase so the government doesn’t have to commit political suicide, and put up income taxes to counteract the declining income taxes from the retiring class.

With a huge pool of superannuation, a budget that will be positive as the retirees start, and a strongly self funded population, Australia will not fall into decline as the US may when the boomers leave the work force. With a relatively small population that is supplying 60% of China and India’s resources requirements, Australia will have little to fear as boomers retire. What it will have problems with is infrastructure bottlenecks that will need massive initiatives from the Government to fix. To give you an idea of the infrastructure projects facing Australia over the next 30 years we need to double everything to stay in pace with our growth. That is double the size and number of all our airports, rail, roads, hospitals, school, police, Defence, etc. We have to build in the next 30 years what we built in the last 150 years. Sydney is a case in point, it is reeling at the effects of not keeping pace with growth – I do believe the state government promised the Norwest a rail line about 18 years ago.

Property prices in Australia are not representative of any other country in the world and only the ill-informed or biased compare other markets to ours. Australia behaves very differently to other countries, and we have a legacy of wealth that has shaped our paradigms and governments. Unfortunately the masses tend to listen to economists, but statistically economists are proven to be wrong 61% of the time in their forecasting. So in my humble opinion economists are not worth listening to for forecasts further out than a week – don’t get me wrong, they serve a useful purpose in the day to day fact-finding and reporting, they are just not that accurate at long range forecasting, just like their peers in meteorology.

So back to the housing markets in Brisbane…new building stock prices are still increasing due to rises in material and labour costs and government sub-division charges; and have started to slow down as the market gets tighter. Eventually, the new price increase gets passed down to older stock over time. What is getting predominately sold around Australia at the moment is older housing and these older houses are selling for a lot less than new houses, and as such, are driving the “median” price down.

The market hasn’t dropped dramatically as some reports would have you expect – right now people are looking at two to three months of data for 2011. This data period in Brisbane happened at a period of time when the centre of Brisbane was under water – quite understandably people weren’t really focused on buying houses as there was a bit of cleaning up to do; therefore there was a huge drop in clearance rates and sales.

With a tiny data pool it is easily to have wildly fluctuating data on the “median” house prices. Take a typical suburb where I and my clients own property; in Wavell Heights you have 1950’s apartments selling for $250K and 2011 apartments selling for $430 – $480K; you only need two months with the former selling and the latter not selling, and presto you have a price crash.

The same is also true  the other way around as people buy the shiny new properties in a boom, and the data shows price rises of the “median” that are realistically over-exaggerated.

If you look at the attached reports for every single month over the last 20 years, and take one month at a time in a single small suburb, you’ll see the growth percentage of “median” prices fluctuate noticeably.  And if you are keen to talk about that on TV, you can pull a “select” set of data to support either a boom or a gloom stance. As property is a slow moving beast, if you average the price out yearly, the fluctuations are less dramatic.

So why then is the market “depressed” when the macroeconomic numbers are looking good for Australia? The simple answer is that the Global Financial Crisis is having a latent effect –  Australians took a while to acknowledge the GFC, and then went into real fear of a recession (which never eventuated) and decided it might be a good idea to save for a rainy day; they might not need that fourth plasma TV, or second wine fridge.

The result is that local residents have gone to ground like we haven’t seen for 20 years. Savings have increased by $250 billion, and people have cut back on retail spending; with the dollar so high people are tending to holiday abroad, and shop overseas via the internet. This change in spending and savings habits has now filtered down to property, and has had an impact on how people are buying homes.

A residual effect of the GFC is that people have changed from buying ‘ready to live in properties’ (new or renovated) to the old ‘fixer-upper and use some sweat equity’ properties – obviously much older stock. So over the last year, the majority of home sales from local residents have been older properties that are at the lowest price point for individual suburbs. This trend will drag down the “median” price in the short term, and this has helped to cause a decline in prices, as reported in the news.

And how has this slow-down in buying had an effect on the construction market?

Building construction has been continually slowing since 2004 for a number of reasons, and most dramatically since the GFC in 2009, finance has become very tight. Brisbane has just emerged from a period of fairly good stock levels, however this is now starting to dwindle. New housing starts and new finance starts are at the lowest levels in years. This means in the 12-18 month period ahead, there will be very few new properties being built in comparison to previous years. This lack of new construction will have a flow-on effect in 18 months.

The population is still growing because Gen X are still having babies (average age 41 years); and we are still importing migrants at a historically high level. We have a key labour shortage, driven in some part by the minerals boom at the moment. This minerals boom is driving migration interstate to Queensland, Western Australia, and the Northern Territory. The high dollar is also driving home expatriate Australians, of which 3 million are yet to come home.

So in summary, the ‘market mentality’ is about 12-18 months behind the ‘market reality’. This is not only very interesting as it presents a great opportunity to buy now, it is also expected, as it is exactly the length of time it took Australia to be drawn into the GFC from a consumer ’spending habit’ mentality.

So how does the short term look for property in Brisbane?

Rents are starting to rise already (with a two bedroom unit recently getting $25 per week rise for one client) as the slowdown in home buyer and investor confidence has seen a tightening of supply.  In addition, the interest rate rises are doing their job, and landlords are now able to pass on the increasing cost of funds. Again this is all part of the cycle; interest rates rise to combat capital growth, capital growth slows, supply slows, and rents rise.  When rents rise, and the market starts moving up (as it will as wages are close to breaking out) people find they have the cash to plough into new properties and avoid older properties, as their jobs (chasing pay rises) take priority. Investors start to see yields climb and with the safety of a tight employment market, start buying back.

And eventually, the property market is in boom time again. The economists will start changing their tune along with the media, and everyone will start to complain that the rising cost of house prices is pricing our kids out of the market. We will even move to stop rich foreigners buying homes to give local residents a chance.

Does this sound all too familiar? Didn’t this all happen not so long ago? Yes and Yes!

Brisbane is at the start of a growth curve and therefore “at the bottom” (I can’t say the bottom was this month, last month, or the month before, but we are there – or past it) in terms of sales. And this indicates the start of a rising market.

All the factors are in place for a rising property market; the supply constraints, the rising rents, the high employment levels, high migration, high dollar, booming minerals sector and increased flow of financing. The only thing missing in the market is consumer confidence. But just like the weather, this will eventually change.

Rents are now starting to rise slowly as vacancy rates are falling and unemployment is below 5%. As rents rise there is a two-pronged move for buyers to re-enter the market;  first home owners take the plunge due to their rents start to equal a mortgage repayment, and investors dive back in because the returns look good.

The frame of mind of local residents right now is nothing like what the employment rates and wages growth reflect – that is, people are holding off buying even though we have practically full employment (it is not wise to go below an unemployment rate of 4% as you’ll get very fast wages inflation). The marketplace should be buying, as there is a real housing shortage imminent.

I can’t say exactly what will happen over the next 6 – 10 months but I can say as an investor, it is simply a matter of time before properties achieve desired goals – to double in value over an 8 -10 year period.

There is a fairly consistent format to how the Australian property market moves – see how economics affects market sentiment.

At no time do we ever say (in the current time) this is the top or this is the bottom – as governments can change monetary or fiscal policy and make quick changes that have short term influences,  but we do say that the market will follow this pattern.

As wages rise and population grows, house prices will follow. I have always advised against holding property in the Northern Hemisphere as they either have wages decline or population declines. The UK and the US have had GDP growth for 20 years but at the expense of real wages growth, as most of the growth has been funneled to fewer and fewer people (66% of the income to the top 1% of the population), wiping out a middle class – and the middle class are the majority of property buyers; if you get rid of buyers, prices will fall.

Australia has been the opposite and continues to be so, as we are expanding our wealth in real terms and across the classes – we have a middle class spread that rivals the socialist Nordic countries, and our wealthy are growing also.

You can see this cycle occurring in “median” prices for Brisbane suburbs from recorded RP Data sales between 1970 and 2008 on the attached spreadsheet. That is, if you bought in 1991 and sold in 1993 you would be ahead by 15%; if you sold in 1996 you would be ahead by 4%; but if you held to 2001, you would be 100% ahead, and 2011 over 200% ahead. So, timing the market is hard but time in the market is harder….because most people find it hard to hold for long enough to realize their wealth gain.

Interesting to note is that while Queensland and NZ have about the same size populations (though Queensland’s is growing much faster), the GDP of NZ in 2010 was US$140 billion, compared to Queensland’s GDP, which is almost double at US$267 billion.

Finally, ABS statistics show our population growth is stronger than any time since 1971, thanks to a mini baby boom and strong overseas migration.

A Matusik Property Insights report released last month indicates the annual housing demand for each state:

Queensland 45,898
New South Wales 36,268
Victoria 35,552
Western Australia 22,463
South Australia 8,146
Tasmania 1,791
Northern Territory 1,386
Australian Capital Territory is 1,898

The capital cities facing the biggest supply problems are:
1. Melbourne, which needs 15,207 houses and 13,875 attached dwellings
2. Brisbane, which needs 12,791 houses and 11,745 attached dwellings
3. Sydney, which needs 12,603 houses and 11,552 attached dwellings
4. Perth, which needs 9,068 houses and 8,108 attached dwellings

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