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The Aussie housing market remains a tale of two superficially conflicting dynamics. On the one hand, prices are continuing to slip, albeit at a relatively benign rate. On the other hand, very low rental vacancy rates are fuelling impressive growth in rental returns. Total returns are, therefore, likely to be in positive territory, which compares well with other asset classes, such as shares.
This morning we get the latest RP Data-Rismark house price index results, which are the benchmark that economists and the RBA watch most closely.
Drawing on more than 110,000 home sales nationally in 2011, the RP Data-Rismark Home Value Index for Australia’s capital cities declined by 0.3% (seasonally adjusted) in the month of May (or by -0.5% in raw terms). The flash April estimate was revised down slightly from -0.3% to -0.4%.
Capital city home values have now fallen for the last five consecutive months, with by far the worst seasonally adjusted result coming in the month of January (-1.2%), which accounts for 45% of the 2011 decline.
The softening in Australian home values is delivering a valuation dividend, with Australia’s dwelling price-to-disposable income ratio falling to 4.2 times (see chart), which is its lowest level since June 2003, according to Rismark’s analysis.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune301.jpg"><img src="/images/stories/joyejune301thumb.jpg"></a>
RP Data-Rismark’s Index shows that gross Australian yields have now touched the 5% threshold. The best rental yields can be found in <city>Darwin</city> (5.7%), <city>Canberra</city> (5.4%), <city>Brisbane</city> (5.2%) and <city><place>Sydney</place></city> (5.2%). The worst yields are in <city>Melbourne</city> (4.2%), <city>Adelaide</city> (4.6%) and <city><place>Perth</place></city> (4.9%).
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune302.jpg"><img src="/images/stories/joyejune302thumb.jpg"></a>
Over the three months to May 2011 dwelling values in Australia’s capital cities have retraced by 1.2% on a seasonally adjusted basis. In raw terms, dwelling values have fallen by 1.3%. The quarterly rate of decline has, however, moderated since the end of March when home values were off by 2.0%, care of a flood-affected January.
Over the 12 months to end May, Australian capital city dwelling values are now down 2.3% (seasonally adjusted). If we just look at the first five months of 2011, Australian home values have stepped back by 2.7% (seasonally adjusted). However, in raw terms, actual dwelling prices are only off 1.2% in 2011. The difference between these latter two estimates is a mostly a function of the fact that the first few months of the year are normally very strong, but this year we got hit by the floods. Accordingly, the seasonally adjusted numbers look especially bad.
Across the capital cities performance has been varied, and have run against the grain of what one might expect if focusing purely on Australia’s nascent capital expenditure boom. <city><place>Sydney</place></city> is the only market to have recorded a modest capital gain over the last year (up 1.0%). Homes in <city><place>Canberra</place></city> have also held ground (-0.1% over the year). All other capitals have slipped into the red, with some down by significant margins.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune303.jpg"><img src="/images/stories/joyejune303thumb.jpg"></a>
The two weakest conurbations have been Perth, where dwelling values are down 7.5% year-on-year, and Brisbane, where capital growth is -5.9% over the year.
 After extraordinary capital gains in recent years, Darwin (-3.2%) and Melbourne (-2.9%) have also both experienced small corrections. Interestingly, in the last three months the laggards have again been Perth (-4.2%), Melbourne (-1.8%), and Brisbane (-1.4%).
 
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RP Data-Rismark’s Rest of State Index captures the 40% of all homes not located in the capital cities. The Rest of State areas have had smaller peak-to-trough swings in value since 2007. Over the three months to end May, Rest of State house values were down 0.9%. Year-on-year, the Rest of State markets capital growth was -1.4%.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune304.jpg"><img src="/images/stories/joyejune304thumb.jpg"></a>
The national median dwelling price in capital cities is $470,000, based on sales over the three months to May. Sydney is the most expensive market, with a median dwelling price of $522,000, followed by Melbourne ($500,000). The cheapest cities remain Hobart ($315,000) and Adelaide ($382,500). In the Rest of State markets, the national median dwelling price is a far lower $325,000. Across all Australian regions, the median dwelling price is currently a very reasonable $420,000.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune305.jpg"><img src="/images/stories/joyejune305thumb.jpg"></a>
The trend of premium markets taking the brunt of the correction has continued, with the top 20% of capital city suburbs ranked by price recording a fall of 3.9% over the 12 months to end May compared with a fall of 0.9% across the cheapest 20% of suburbs and a fall of 2.3% within the broad “middle” 60% of the market.
Demand for luxury homes has likely been sapped by a combination of Australia’s abysmal share market performance and a surging currency. The former has dampened the ability of financial services professionals to bid for high-priced homes, notwithstanding Jonathan Chancellor’s revelation yesterday that an ANZ banker bought an $8.4 million holiday <a href="https://www.propertyobserver.com.au/residential/a-rising-tide-lifts-all-luxury-yachts/2011062950650">home</a>.
The Aussie dollar’s ascendancy has made local housing much more expensive for expats located in Europe, North America and Asian countries (with US dollar currency pegs) to buy.
Financial markets are currently pricing in a decent chance of an interest rate cut over the next six to nine months. If the RBA does indeed reduce rates, this would provide substantial support to the market. However, our central case remains that rates are heading up, not down, and thus we are not looking for any capital gains in 2011 with the risk to the downside if rates do rise. That said, total returns will be boosted by very solid growth in rents.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune306.jpg"><img src="/images/stories/joyejune306thumb.jpg"></a>
Note: Some of the information above derives from today’s RP Data-Rismark media release, which is available on request.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. 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. You can follow Christopher on twitter at <a href="https://twitter.com/#!/cjoye" title="Follow Christopher Joye" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">@cjoye</a> or read his <a href="https://christopherjoye.blogspot.com" title="Christopher Joye's blog" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">blog</a>.
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chrisjoye-JYhJsTrNRC

Rents robust, but house prices slide slightly

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In late 2009 Rismark repeatedly forecast that the double-digit house price growth registered over that year would fall back to single-digit levels in 2010 in line with expected disposable household income growth of 3% to 5% (see <a target="_blank" href="https://christopherjoye.blogspot.com/2011/05/benchmarking-our-historical-house-price">here </a>for the records). As it turned out, house prices rose by about 5% last year. In September 2010, a couple of months before the RBA’s de facto double rate hike, I commented, “Since 1993 there have been five instances when the RBA has lifted the cash rate sharply. On every single occasion national capital city dwelling prices have flat-lined or declined. If the RBA aggressively raises rates, there is no reason to expect 2010-11 to be any different.” Two months later, I further warned that, “Our central case is that there will be little to no nominal dwelling price growth over 2011, with a chance of small nominal declines.”  In the first two charts below, I have illustrated how Rismark’s “out-of-sample” (i.e., blind) forecasts for Australia’s two biggest cities have stacked up against actual house price movements over the last few years.
<img src="/images/stories/JoyeJune1/joye1.jpg">
<img src="/images/stories/JoyeJune1/joye2.jpg">
RP Data-Rismark’s <a target="_blank" title="RP Data April results" href="https://www.propertyobserver.com.au/news/prices-tumble-in-top-end-of-town/2011053150353">April index results</a> very much confirm our 2010 projections. In short, the RBA’s “double-tap” in November has started to bite, with the luxury end of the market leading the way.
Raw house prices have retracted by 0.7% over the first four months of 2010. To put that in perspective, that’s similar to the daily movements one sees in the Australian sharemarket index. In seasonally adjusted terms, which allows one to strip out the periodic, intra-year seasonal shifts in house prices, dwelling values are down a far more noticeable 2.5%.  The difference between these two results reflects the fact that the housing market normally realises above-trend growth at the start of each year.  As I have explained <a target="_blank" title="Chris Joye's blog" href="https://christopherjoye.blogspot.com/2011/05/silly-housing-data-debates-mk-v">here</a>, the RBA explicitly asked us to report seasonally adjusted index results in addition to the raw numbers, which is what economists and statisticians also prefer. There are two interesting insights to be drawn from RP Data-Rismark’s latest release. First, the rather unexciting overall market conditions conceal some more striking cross-sectional dynamics. The chart below shows the movements in home values over the 12 months to end April.
<img src="/images/stories/JoyeJune1/joye3.jpg">
 
Observe the circa 7% corrections in the value of housing in Perth and Brisbane, which contrasts with the rest of the nation, where house prices range from being up 1.2% to down 2.9%. This is consistent with the ramp-up in repossessions that the RBA has documented in Queensland and Western Australia since the GFC, although repos seem to be declining again (see <a href="https://christopherjoye.blogspot.com/2011/05/so-where-are-all-those-housing-repos">here</a> for the RBA's repo data). Notwithstanding the absence of capital gains, rents have been growing relatively quickly, with apartments now yielding 4.9% gross. We saw that in the first quarter of 2011 the ABS also reported that rents rose by 1.3%, significantly outpacing core inflation. The second finding of interest is the rapid deceleration in the luxury home segment.  Following a request by the RBA, RP Data and Rismark divided our capital city house price index into three sub-indices: the bottom 20% of suburbs ranked by price, the middle 60%, and the top 20%. Over the year to end April, dwellings in the most expensive capital city suburbs recorded a 5.4% loss (see next chart). In contrast, home values in the middle 60% of suburbs were down by only 0.9%. Dwellings located in the cheapest 20% of suburbs were the best performers (down just 0.5%).
<img src="/images/stories/JoyeJune1/joye4.jpg">
The uber-luxury segment is risky and highly illiquid, and has had the rug whipped from under it via a combination of the soaring Aussie dollar and the enormous destruction of wealth in Australia’s volatile sharemarket.  A final fly in the ointment is the much lower growth – and pay packets – expected in the financial services industry. Luxury homes in areas like Sydney’s eastern suburbs will continue to face valuation headwinds as banks deal with the new normal of subdued credit growth.
 
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Christopher Joye is a leading financial economist, and works with <a target="_blank" title="Rismark International" href="https://www.rismarkinternational.com">Rismark International</a>. 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. 
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Luxury home market getting slammed, as predicted

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Are <place><country-region>Australia</country-region></place>’s banks overexposed to housing vis-à-vis business lending, as so many pundits claim? Does the regulator madly tilt the odds in favour of the former? And should banks have a softer, social objective to extend more finance to businesses as opposed to residential borrowers, since, it is argued, the latter are “unproductive”? I hope to address all these questions today.
<place><country-region>Australia</country-region></place>’s banking regulator, APRA, is regarded as being a far-sighted and prudent agency in comparison to many of its overseas peers. (I’ve previously made the case that there was as much providence as prescience in <place><country-region>Australia.</country-region></place>). It is certainly true to say that over the years APRA has placed Australian banks under tremendous pressure to adjust practices it considers to be unnecessarily hazardous.
APRA works hand-in-hand with <place><country-region>Australia</country-region></place>’s central bank, the RBA, which until 1997 also had responsibility for banking supervision. Following the findings of the Wallis Inquiry, APRA was created, and the prudential supervisory responsibility previously held by the RBA transferred to it. The idea was that the RBA had too much on its plate – too many objectives once one accounted for its central role of keeping prices stable via management of economy-wide interest rates. There is much to be said for this logic, which is actually a rather unique regulatory setup in a developed world context (most of our contemporaries have their central banks, like the US Federal Reserve, do pretty much everything).
Having said that, the RBA does, in fact, continue to exercise regulatory responsibilities in the banking domain through two chief means: first, the RBA controls the so-called “liquidity facilities” that all Australian banks and building societies have access to and tap from time to time. These facilities allow them to “put” their assets to the RBA in a liquidity crisis and obtain funding from it (i.e., the RBA lends to them against this collateral).
The second way the RBA exercises influence over the banking system is through its so-called “financial stability” remit. Inside the RBA there is a team of very highly qualified economists – led by assistant governor-in-waiting Dr Luci Ellis – who spend all their time monitoring the manifold risks that have the potential to threaten the viability of Australia’s financial system.
Since most of this system is dominated by the banks, the RBA’s team does an enormous amount of analysis on different credit risks, default rates, the exposure of banks to the housing and commercial property sectors, and so on. All of this work comes to fruition bi-annually in a detailed, 100-plus page study known as the Financial Stability Review.
Neither APRA nor the RBA get rewarded for banks making big profits. They are typically only recognised when they help us avoid some catastrophe, such as during the GFC. This tends to make both institutions exceedingly conservative.
With that background in hand, we can turn to my first question: what do APRA and the RBA consider to be riskier – housing or business lending? This is actually easy to answer through the formal “risk weights” that APRA forces banks to apply against different types of loans. The risk weights in turn determine how much capital, or money, a bank needs to hold against every dollar of residential or business credit it extends. These weights are, therefore, a proxy for the probability of loss when you get into the lending game.
For all non-major banks, business loans attract a 100% risk weight, whereas residential credit gets half this amount (i.e., a 50% risk weight). APRA applies a much lower risk weight to residential credit precisely because the proven empirical risks associated with this form of finance indicate that it has lower probabilities of loss than conventional business lending. If the opposite were true, and home loans were a more hazardous credit, then the risk weights would work the other way around.
The major banks get the benefit of even lower risk weights (and, thus, a lower cost of capital) compared to their competitors because they are permitted to use an “internally determined” risk-weighting system under what is known as the “Advanced Route”. This means that APRA allows them to set their own risk-weights subject to a range of sophisticated rules.
You can see in my first chart, which was extracted from the RBA’s latest Financial Stability Review, the various risk weights the major banks apply to different credits. On average, the risk weight on home loans is about one-quarter the risk weight on business loans to large companies. Since banks can hold less capital against a home loan, this is, in theory, a relatively more profitable activity for them to undertake. That last statement ignores, however, the impact of bank margins. Margins on business loans tend to be much higher than residential loans (as seen in higher business lending rates) in recognition of the former’s risks and the relatively greater labour intensity associated with assessing business credit risk. When all is said and done (i.e., adjusted for margins), the actual returns on the two forms of finance are likely to be similar.
 
<a href="/images/stories/Joyejune28/joyejune281.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/Joyejune28/joyejune281thumb.jpg"></a>
 
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A second powerful quantification of business versus residential risk is supplied by examining bank default rates (i.e., “non-performing” loans) and associated losses (or impairments). Once again, the Financial Stability Review delivers in spades here.
The next two charts cast into sharp relief the fundamental problem bank regulators have with business lending. In the right-hand-side panel of the first chart, the RBA has broken out Australian banks’ non-performing loans by type. Non-performance (i.e., loans in arrears) is expressed as a percentage of the total loans in that category.
 
<a href="/images/stories/Joyejune28/joyejune282.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/Joyejune28/joyejune282thumb.jpg"></a>
So, we can see that more than 3.5% of all business loans (blue line) are non-performing (i.e., in default). In comparison, only about 0.7% of all residential borrowers (orange line) are materially behind on their repayments. That is, default rates on home loans are a fraction of arrears on business loans.



Yet the real clincher is in the total dollar value of these non-performing loans. Today Australian banks tend to have a rough 60:40 split in favour of residential/business lending. Before the 1991 recession, the ratio was the reverse, with the majority of bank credit going to businesses. These exposures almost caused the collapse of two of the majors, ANZ and Westpac. Since that time, the majors have acknowledged the higher risks inherent in their business portfolios, and reversed course, with the encouragement of regulators. 



Even so, look what once again happened during the GFC. Compare, in particular, the first two panels of the next chart. The far left-hand-side panel shows the dollar value of impaired housing loans (the red line). It looks like impairments are a little higher than $2 billion in total, which is trivial when you consider that there are well north of $1 trillion worth of residential mortgages out there. Now contrast this against the middle panel, which shows the banks’ impaired business loans based on the latest data. Total business impairments look to be more than $22 billion, or a remarkable 10x higher than residential impairments.

 
<a href="/images/stories/Joyejune28/joyejune283.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/Joyejune28/joyejune283thumb.jpg"></a>
Now ask yourself this question: would you have Australian banks ramp up their exposures to the middle column (i.e., business lending) in preference to the first column (i.e., residential lending), as folks like Steve Keen suggest would be a smart idea? I don’t think so. 



For what it is worth, exactly the same phenomenon asserted itself during the much more acute 1991 recession. My final chart shows the loss rates across CBA’s different credit portfolios in that downturn, when unemployment peaked at close to 11% while mortgage rates hit 17%. Notwithstanding the serious difficulties households were having at the time, the losses on home loans (bottom red line) were a tiny fraction of the losses CBA realised on all other forms of credit.

 
<a href="/images/stories/Joyejune28/joyejune284.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/Joyejune28/joyejune284thumb.jpg"></a>
I want to conclude with some words on the question of whether housing investments are “unproductive”. Notionally respected critics employ this argument to suggest that policymakers should discourage it by changing the negative gearing and/or capital gains tax rules. This logic is, however, flawed.
In standard economics theory, the two most basic necessities for a functioning economy and, more specifically, productive labour, are: food and shelter. We can interpret “shelter” as covering both residential property, which is the accommodation required by a functional labour force, and commercial property, which is the accommodation needed for productive businesses.
You can either be a “producer” of food and shelter by investing in, and owning, the underlying assets that supply these services/products by owning farms, homes, or commercial buildings; or, alternatively, you can just “consume” these services/products and not invest in the assets by simply buying food from the supermarket, renting a home, or leasing space in a building.
There is a final option where you can both consume and invest by living on a farm (and eating its produce), owning and occupying your home, or owning and occupying the building in which your business operates, as some companies do.
As an investor in agriculture, housing, or commercial property, you derive returns as you would with any other productive asset: via a mix of both growth in the capital value of the asset and income from the sale of the products/services (i.e., food, residential accommodation and commercial accommodation).
In addition to its innate productivity as a form of shelter for workers, academic researchers have shown that housing investments positively impact both labour and business productivity. That is, the higher the quality of housing, the more productive workers and businesses can be. The ABS has also demonstrated that investments in new housing have a very high, 2.9 times economic multiplier. This means that every dollar committed to building homes generates another 2.9 dollars of extra spending across the wider economy.
Finally, the housing market is increasingly fulfilling a new economic purpose: with the advancement of technology such as the NBN, housing supplies accommodation for businesses as more people work from home. The home is no longer an office for just the self-employed individual, or for secondary employment activity. It is increasingly the workplace of professional service employees in their primary jobs, who don’t wish to commute long hours to their labour market.
Christopher Joye is a leading financial economist and works with <a href="https://www.rismark.com.au/" title="Rismark International" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. 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. You can follow Christopher on twitter at <a target="_blank" title="Follow Christopher Joye" href="https://twitter.com/#!/cjoye" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">@cjoye</a> or read his <a target="_blank" title="Christopher Joye's blog" href="christopherjoye.blogspot.com" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">blog</a>.
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Businesses riskier than bricks and mortar when it comes to lending

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In a speech yesterday the governor of the RBA, Glenn Stevens, has touched on the apparent paradox of falling house prices in <city>Brisbane</city> and <place><city>Perth</city></place> juxtaposed against a once-in-a-century resources boom.
According to RP Data-Rismark’s house price index, which the RBA publishes in its quarterly Statement on Monetary Policy, dwelling values in <city>Perth</city> and <city><place>Brisbane</place></city> have fallen by 7.1% and 6.8% respectively over the last 12 months.
The chart below shows the performance of <city>Sydney</city>, <city>Melbourne</city>, <city>Brisbane</city> and <city><place>Perth</place></city> dwelling values since the end of the last east coast boom in 2003 (rebased to an index level of 100 as at December 2003).
<img src="/images/stories/joyejune151.jpg">
It demonstrates that Perth and Brisbane house prices have actually outperformed their Sydney and Melbourne counterparts for most of the past seven years. It was only in the middle of 2009 that Brisbane capital growth was overtaken by Melbourne’s surging market.

Stevens argues that the striking differences in house price movements across Australia reflect the underlying demand and supply dynamics, which is a point we have also emphasised for years.

Stevens says: “It is hard to avoid the conclusion that changes in relative housing costs between states, while certainly not the only factor at work, have played an important role. Relative costs are affected by interstate population flows, but those costs then in turn have a feedback effect on population flows. This is particularly so for Queensland.”

“Queensland has had faster population growth than the southern states, as it has seen a slightly higher natural increase, a rate of net international migration on par with other states and a very substantial net positive flow of interstate migrants. Net interstate migration to Queensland peaked around 2003 – not long after Sydney dwelling prices had reached a new high relative to other cities.

“Interstate migration at that time was contributing a full percentage point a year to Queensland's population growth. By 2008 this flow had slowed a bit, but international migration had picked up and Queensland's population growth increased, peaking at nearly 3%. Western Australia's population growth was even higher, peaking at almost 3½%” Stevens says.

In 2002, house prices in Brisbane were just over half the level of equivalent homes in Sydney and Melbourne. Many people presumably decided to move up north to capitalise on the cheaper accommodation and strong labour market.

A similar pattern asserted itself in Perth.

Since the GFC, however, population growth rates in Queensland and Western Australia have slowed while the cost of housing converged back towards Sydney and Melbourne levels.

Today the median dwelling price in Sydney is $515,000, followed by Melbourne ($485,000), Perth ($468,250) and Brisbane ($430,000).

As the next chart from the RBA shows, there has also been a spike in repossessions of homes in Western Australia and South-East Queensland following the GFC, which is presumably another part of the story explaining the resources states’ relative underperformance in house price terms.

<img src="/images/stories/joyejune16.jpg">
Another city that has clearly undergone a Perth-like structural change in housing costs is Darwin. I have added RP Data-Rismark’s Darwin dwelling value index to the first chart above, and the results are striking (see below). 

Housing costs in Darwin have grown by more than 160% over the last seven years, which is well in excess of any other major city. 

This too has been driven by a combination of soaring economic prospects, population growth, robust labour demand, and the fact that in December 2003 the median dwelling price in Darwin was just $190,000, or only 60% of the national capital city price. 

Yet by April 2011, the median price of a Darwin home had risen to $442,500 or 94.5% of the national capital city median. That is, there has been a rapid convergence in the relative cost of housing across the country.
<img src="/images/stories/joyejune162.jpg">
Christopher Joye is a leading financial economist and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="https://www.rismark.com.au/" title="Rismark International" target="_blank">Rismark International</a>. 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. You can follow Christopher on twitter at <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Follow Christopher Joye" href="https://twitter.com/#!/cjoye">@cjoye</a> or read his <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Christopher Joye's blog" href="christopherjoye.blogspot.com">blog</a>.
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Falling population growth beats Queensland

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There is mounting evidence to suggest that <country-region><place>Australia</place></country-region>’s housing market rests at a critical juncture. The first two charts below show the evolution of Australian dwelling values since 2000 and 2006, respectively. You can clearly see the latest innovation in the housing cycle, wherein overall Australian home values (blue line) have tapered by a modest 2.3%. The question on everyone’s lips is: what lies in wait?
Before I address this, it is interesting to inspect the charts more carefully. Observe, in particular, how Sydney dwelling values have massively underperformed the rest of the Australian market over the last 11 years or so (black line, first chart). It is also fascinating to note that even though the Perth and Brisbane housing markets have suffered 7.5% and 5.9% declines in the past year, they have actually been our two best-performing conurbations over the past 11 years.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune211.jpg"><img src="/images/stories/joyejune211thumb.jpg"></a>
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune212.jpg"><img src="/images/stories/joyejune212thumb.jpg"></a>
In my opinion, the near-term destiny of Australia’s housing market very much depends on next week’s second-quarter inflation numbers. If inflation is low, the RBA will likely be on the sidelines for the rest of the year. It can argue that it was vindicated for not responding to the very high first-quarter results, and will in any event be downgrading its economic growth forecasts for 2011, which were always on the high side.
Talk in the media will galvanise more firmly around rate cuts. Consumers will start to scale back their still extraordinarily hawkish interest rate views (see chart below), with 84% anticipating rate hikes. Given the average Australian thinks he will be hit by two or more rate hikes in the next 12 months, it is no surprise that underlying economic conditions have been so soft.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune213.jpg"><img src="/images/stories/joyejune213thumb.jpg"></a>
In this low-inflation scenario with no future hikes and the prospect of cuts, our forecasting models predict that Australia’s housing market has the ability to start grinding out very modest capital growth, which, of course, should be complemented by healthy rental returns (see next chart).
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune214.jpg"><img src="/images/stories/joyejune214thumb.jpg"></a>
In the less favourable alternative, where inflation next week is reported high – at, say, 0.8% for the quarter or more – it saddens me to say that our beloved central bank will be very much on the interest rate warpath. That means the likelihood of a rate hike, or hikes, before the year is out. And the half-nelson that the RBA currently has <country-region><place>Australia</place></country-region>’s housing market in will only tighten. 
These crossroads are best illustrated by the divergence of beliefs between economists and the financial markets. The following chart shows ANZ’s interest rate forecasts contrasted against the futures market’s expectations. Whereas the futures market is predicting rate cuts, ANZ thinks we will get hikes.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune215.jpg"><img src="/images/stories/joyejune215thumb.jpg"></a>
Who is right? We cannot tell at this point. It all depends on inflation. So, if you are looking to buy but have not found a place yet, you should be hoping for a high inflation outcome, which will inevitably result in persistent, interest rate-induced pressure on prices. If, on the other hand, you are looking to sell, you should be praying for a low number next week.
Christopher Joye is a leading financial economist and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. 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. You can follow Christopher on twitter at <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="https://twitter.com/#!/cjoye" title="Follow Christopher Joye" target="_blank">@cjoye</a> or read his <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="christopherjoye.blogspot.com" title="Christopher Joye's blog" target="_blank">blog</a>.
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It all comes down to inflation

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What’s the chance of losing money when you buy a home? Or, put another way, what percentage of all people who buy and sell suffer losses before accounting for costs? As simple as these questions may sound, they are not easy to answer. There are only a handful of organisations with the data and capabilities required to run this type of analysis. 
Addressing this question is also important if you want to better understand individual property level risk, which is something that I have written about for years. In <a href="https://www.propertyobserver.com.au/observers/not-as-safe-as-bricks-and-mortar/2011071150768">this column</a>, I showed that the volatility of a home is akin to that of the sharemarket, and three to five times riskier than a broad-based house price index. 
Commencing our analysis in 1990, Rismark’s team of PhDs collected 3.7 million purchase and sale pair transactions pertaining to the same home. We call these “repeat sales”. In total, there were 7.3 million transactions. Of course, there are going to be many people who bought homes during this period but who have yet to sell. They are, by definition, excluded. 
The team then calculated the buy-and-hold annual compound capital return (excluding imputed or explicit rents). These are, to be sure, gross returns and do not account for the many transaction costs associated with holding a home. They also do not control for alterations and additions (viz., renovations), which are undertaken to offset the physical depreciation of the asset, or simply to improve it. 
Several years ago we took the ABS’s alterations and additions data and tried to estimate its impact on annual capital growth. The number we arrived at was about 0.55% per annum, which has been confirmed by other analysts. 
The results of the first cut of our research are illustrated in the chart below. The median capital return to property owners since 1990 has been 7.8% per year.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejuly261.gif"><img src="/images/stories/joyejuly261thumb.gif"></a>
This is interesting for a couple of reasons.
First, it is exactly the same compound annual growth rate we get when we look at RP Data-Rismark’s hedonic house price index over the last 10 years, which is a completely different methodology.
Secondly, it just happens to accord with the return we get if we calculate the compound annual growth rate attributable to a very simple “median” house price index over the last 28 years. 
Observe in the chart above that the distribution of buy-and-hold returns looks to be right skewed: more people are realising high returns relative to very low returns. 
In particular, 9.3% of all home owners traded their property for a loss (note that these are pure capital returns, and ignore the rental income that you would have got along the way). This is also gross of all transaction costs, so you can be sure that the net number is higher. Ipso facto, about 90% of owners realise positive gross capital returns on their homes before accounting for rents and costs. 
The next diagram breaks out this analysis by capital city so that we can get a feel for relative performance over the last two decades. And the results are fascinating. Perth and Adelaide are the two best-performing cities, generating compound annual capital growth rates of 10.3% and 9.5%, respectively. The worst performer was <city><place>Sydney</place></city>, which has yielded about 1% per annum less than the national average of 7.8% per annum.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejuly262.gif"><img src="/images/stories/joyejuly262thumb.gif"></a>
Two other things to think about. 
First, these returns reflect the change in the capital value of a home over time. What they do not tell us is what the home owner’s actual equity, or geared return, would have been. We can comfortably assume that the equity returns are far higher (likewise the losses for the one in 10 folks who get unlucky). 
Second, as discussed, this analysis excluded gross rents, which are currently around 4% to 5% per annum. It also ignores all transaction costs, which sum to around 1% to 2% per annum for the average home owner who stays in a property for seven to eight years. 
In closing, what are reasonable growth expectations going forward? A simple benchmark is national disposable incomes. If we take the ABS National Disposable Income estimates, and divide by the number of households to control for population growth, we get a useful per household growth estimate.
Based on this measure, Australian disposable incomes per household have risen by 4.9% per annum since 1993, which is about 25% higher than wages growth. The differential could be attributable to the advent of multiple-income households, the tendency for marginal tax rates to decline, stimulatory government subsidies, such as middle-class welfare, and as a result of the better portfolio diversification households are getting via superannuation.  
Looking ahead, one might reason that disposable income growth will be a bit lower. This in turn implies that house price growth might be less than the circa 7% to 8% annual rate that it has compounded at over the last three decades.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. 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.
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The home buyers' losers club

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You often hear that Australian housing is more expensive than, say, <place><country-region>UK</country-region></place> or US housing, if not the dearest in the world.
Wild fluctuations in currencies make international comparisons hard, to say nothing of profound differences in house price data, household formation and population growth rates, the availability of new housing supply, the urban structure of nations, interest rates, and the legal, tax and institutional features of housing markets around the world.
By way of example, the rate of home ownership in Germany is about 40%, compared with circa 70% in Australia, the UK, Canada, and New Zealand.
In the US there is capital gains tax levied on the owner-occupied home while mortgage repayments are tax-deductible. In contrast, the owner-occupied home is CGT-exempt in Australia, the UK, Canada, and New Zealand, but this comes with a cost: mortgage repayments are not tax-deductible.
One country Australia does share strong commonalities with is, naturally, the UK. The UK also has the benefit of very good housing data that is not plagued by “sample selection biases” (i.e., when you only get a fraction of the total population of home sales, as you do with US house price indices).
So today I wanted to address two simple questions.
First, have Australian housing costs risen more rapidly than their UK equivalents during the last couple of decades?
And, second, how far did UK house prices fall during the GFC, given the near complete disintegration of its banking system, with the whole or partial nationalisation of many of its largest lenders? (UK taxpayers ended up owning 100% of Northern Rock, 83% of RBS, and 41% of Lloyds.)
I ask this question because the correspondence between the Aussie and UK banking systems, which are both dominated by a <personname>sma</personname>ll number of big institutions, and their housing markets (both have near-identical approaches to tax and similar demand and supply fundamentals) makes a study of the UK downturn a credible guide in the event that something – god forbid – catastrophic were to happen here.
That is, it gives us a reasonable indication as to how far Australian house prices might decline if our banking system imploded, the economy careened into an acute recession with soaring unemployment and default rates.
For the purposes of this analysis we have taken the broadest possible <country-region><place>UK</place></country-region> house price measure, which is produced by a group called <a target="_blank" title="Acadametrics" href="https://www.acadametrics.co.uk/">Academetrics</a>. We then compare this with our standard RP Data-Ri<personname>sma</personname>rk Hedonic Combined Capital Cities Index.
The results, which are illustrated in the two charts below (click to enlarge), are fascinating.
First, in the 15 or so years before the GFC, UK housing costs actually increased at a substantially greater rate than their Antipodean counterparts.
Of course, the cataclysmic economic and financial collapse subsequently experienced in the <country-region>UK</country-region> in 2007-08 resulted in a very significant contraction in <country-region><place>UK</place></country-region> dwelling prices.
Specifically, on a peak-to-trough basis, <country-region><place>UK</place></country-region> home values fell by 13.6%. This compares with a <personname>sma</personname>ller 3.9% peak-to-trough decline in Australian dwelling values, which did not have to contend with big increases in unemployment (or arrears).
<a href="/images/stories/joyeaugust111x.jpg" rel="shadowbox" title="Click to enlarge"><img style="border-style: initial; border-color: initial;" src="/images/stories/joyeaugust111thumb.jpg"></a>
Monetary policy also works differently in <country-region><place>Australia</place></country-region>, with almost all borrowers on “adjustable rate” loans. In the UK, the split between variable and fixed-rate loans has historically been around 50:50. This makes it harder for the <country-region><place>UK</place></country-region> central bank to deliver cash-flow relief to borrowers in the event of a crisis.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust112x.jpg"><img src="/images/stories/joyeaugust112thumb.jpg"></a>
The circa 14% drop in UK house prices is noteworthy, but perhaps not as big as some might have expected. For example, the Aussie share market (as measured by the ASX/S&amp;P200) has fallen further in the last month or so. 
And based on a far less-accurate benchmark for US housing costs, the S&amp;P Case-Shiller Index, which unfortunately excludes about 40% of all US homes, the correction on the other side of the Atlantic was twice as steep. This might be partially explained by the fact that <country-region>US</country-region> default rates were nearly three times higher than comparable <country-region><place>UK</place></country-region> arrears (and about 10 times higher than Australian defaults). 
 
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A more interesting finding speaks to relative value. Because of the much stronger run-up in UK house prices prior to the GFC, the overall change in housing costs over the last 18 years has been virtually identical to Australia’s, notwithstanding the sharp recent correction. 
This can be seen in two ways. First, the levels in the charts are similar after accounting for a couple of decades’ worth of value changes. Second, the compound annual growth rates between 1993 and 2011 are statistically indistinguishable (7.3% in the case of <country-region>Australia</country-region>, and 7.0% for the <place><country-region>UK</country-region></place>). 
If we plot the two house price benchmarks on a so-called “logarithmic scale” we can also evaluate their changes on a truly like-for-like basis. A log scale transforms the first chart such that movements in the two lines represent the same percentage change. As you can see in the second chart, the two lines look like one. 
As a final test, we can compare house price-to-income ratios. Luckily the economists at ANZ, which happens to have a British CEO, have done this for us (see the third chart below). It turns out that the <country-region>UK</country-region> house price-to-income ratio is actually higher than <place><country-region>Australia</country-region></place>’s, which suggests that Aussie housing may actually be better priced.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust113x.jpg"><img src="/images/stories/joyeaugust113thumb.jpg"></a>
Based on the analysis above, residential property in <country-region>Australia</country-region> looks to be just as good value as <country-region><place>UK</place></country-region> housing today. Indeed, with demonstrably superior economic and household income prospects, and faster household formation rates, one might reasonably project superior returns in future. 
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. 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.
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Aussie housing showing up the Brits with all their woes

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As we look to what's ahead for 2012, Property Observer is republishing some of our most noteworthy stories of 2011.
 
One of the perennial puzzles tossed around Australian dinner tables is whether our bricks and mortar is expensively priced.
Despite the steady ascent of national dwelling prices at an inflation-plus pace over the last few decades, one has never had to look far to find an “expert” declaring that the world was about to end. Predictions of catastrophic falls in house prices have always been good for garnering a few media headlines.
And, regrettably, the media is not great at holding purported experts to account. A classic example appears in the Australian Financial Review today. AMP’s Shane Oliver is reported as claiming that <city><place>Sydney</place></city> housing is overvalued because the representative dwelling price is an unacceptably high $634,000. Shane also contends that since his home’s capital gains have outstripped his personal income growth, this is likely true of all <city><place>Sydney</place></city> housing.
Unfortunately, the facts do not fit with this fiction. Shane’s estimate is actually off by $119,000 (or 23%). According to the biggest database of home sales in <country-region>Australia</country-region>, which covers all transactions, the median dwelling price in <city><place>Sydney</place></city> is currently $515,000. Furthermore, <place><city>Sydney</city></place> dwelling prices have only risen by a compound annual growth rate of 2.7% over the last eight years. That means Sydney dwelling prices have declined in “inflation-adjusted” terms (after a very strong run-up before 2003). If we look at Sydney detached houses – as opposed to all dwellings – the compound annual growth rate falls to just 2.3%.
In income-adjusted terms, the comparison is even more stark: the ABS reports that average disposable household incomes have advanced by 6.3% per annum since March 2003. This is a massive difference. It means that while disposable household incomes across Australia have risen by 63.4%, Sydney dwelling prices have expanded by only 24.6%. That is, incomes have outpaced <city><place>Sydney</place></city> dwelling prices by an extraordinary 38.8 percentage points over the period March 2003 to March 2011.
In sympathy with the boom-bust business cycle, asset prices tend to also rise and fall.
The housing market is a little different to other asset-classes insofar as you can typically obtain more debt against a property – more than 90% in some cases – and for longer terms – up to 30 years – than alternative investments. This means that there are latent risks that can build up if credit growth is unnecessarily lubricated and used to fuel house price inflation, which can stimulate more credit creation until the Ponzi pattern is undone by a shock.
The point is that policymakers need to be attuned to these interdependencies if they are to avoid the sorts of problems we saw emerge in the <country-region><place>US</place></country-region>.
Across the $3.5 trillion worth of private housing in Australia, the amount of debt secured against it is actually quite low, at circa 29%. For those home owners with a mortgage, the value of their loan as a proportion of their home is, on average, also pretty low, at 50 to 60%. That means house prices would have to fall by about 40% before the typical person suffered “negative equity”.
Clearly, there are also folks sitting in the tails of this distribution who are more vulnerable. But they are a small percentage of the total. The RBA estimates that only 2.5% of all borrowers have a loan-to-property-value ratio equal to or greater than 90% and are paying away more than 50% of their disposable income to service their repayments. 
 
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One of the reasons banks have been prepared to lend so much for so long is the fact that borrowers have historically been vigilant in paying off these loans. Today there are slightly more than 30,000 borrowers who are more than three months behind on their home loan repayments, juxtaposed against a total pool of roughly 4 million to 5 million borrowers. That is, Australia’s “mortgage default rate” is a paltry 0.7%, despite our internationally high lending rates. This is less than one-10th and one-quarter the equivalent US and UK default rates respectively.
With more than 60% of all household wealth accounted for by housing, discussions around its valuation understandably attract attention.
There are, of course, many ways to “value” an asset. One school of thought is that the best possible measure is the price at which willing buyers and sellers are prepared to transact. That is, today’s prices. This is known as the “efficient markets” view of the world.
Others like to point to the underlying demand- and supply-side fundamentals while abstracting away from prices, incomes and the cost of debt. These drivers are, among other things, the rate at which new households are formed, which is determined by population growth and the number of people willing to share their homes, and the rate of construction of new dwellings (i.e., supply).
The RBA, Treasury and the Government’s own National Housing Supply Council have all concluded that underlying housing demand in Australia looks to be running well ahead of supply.
An alternative benchmark that gets regularly referenced in the media is how house prices compare with incomes over time.
Although the calculation of a “house price-to-income ratio” is tricky, if you can lay your hands on a timely (i.e., regularly updated) proxy for dwelling prices, and contrast this with an equally frequent measure of household incomes, you can make some valuable comparisons of the change in normalised housing costs over time.
Rismark produces <country-region><place>Australia</place></country-region>’s most comprehensive and timely dwelling price-to-income ratio, which is released on a quarterly basis following the publication of the ABS’s National Accounts. It covers all homes sales across <country-region><place>Australia</place></country-region> and uses the ABS’s measure of disposable household incomes, which is the only official estimate available on a quarterly horizon.
In encouraging news for home buyers, <country-region><place>Australia</place></country-region>’s dwelling price-to-disposable income ratio is now back around its June 2003 level, based on Rismark’s latest analysis.
We found that Australia’s average dwelling price-to-average disposable household income ratio has fallen to just 4.2 times in March 2011 from its recent peak of 4.7 times in December 2009. (While one can quibble about the exact levels, the change in incomes and prices is more difficult to dispute.)
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune91.jpg"><img src="/images/stories/joyejune91humb.jpg"></a>
Assuming that the RBA hikes interest rates another 0.5 percentage points over the next six to 12 months, we believe that the gap in the growth rates attributable to incomes and prices will widen.
While it is unlikely that that Australian dwelling prices will rise much as long as the RBA wages its war against inflation, investors will continue to benefit from robust rental returns given our historically low vacancy rates. And although we will hear complaints about the multi-speed economy, solid overall wages growth of more than 4% per annum in concert with the income flowing from the capex boom should yield reasonable increases in household earnings.
The RBA will be pleased with these developments, since it is hoping that the retail and housing sectors will make room for the unprecedented volumes of private investment already baked into the capex pipeline.
Rismark’s central case is that the RBA will commence normalising interest rates at some point during 2012-13, which should drive a powerful affordability dividend. This will stimulate higher capital growth rates and the price signals necessary for builders and developers to start committing scarce capital to the production of new housing supply. Indeed, the recovery, when it eventually materialises, could give rise to significant capital gains. Through the cycle, however, we believe that the cost of housing will track disposable household earnings, as it has done in the past.
Contrary to popular myth, <country-region><place>Australia</place></country-region>’s house prices have actually grown more slowly than household incomes since the end of the last boom in 2003. According to the ABS’s National Accounts data, disposable incomes on a per household basis have realised a compound annual growth rate of 6.3% since March 2003. In contrast, RP Data-Rismark’s hedonic index suggests capital city dwelling values have risen by a more modest 5.7% per annum. On this basis, disposable incomes in <country-region><place>Australia</place></country-region> have advanced 7.5% further than capital city dwelling prices over the last eight years.
Unlike other estimates, Ri<personname>sma</personname>rk’s national dwelling price-to-disposable household income ratio includes:
<ul>
<li>Dwellings across all Australian regions (not just capital cities); </li>
<li>All property types (not just detached houses); and </li>
<li>The ABS’s quarterly National Accounts measure of average disposable household incomes (not just average weekly earnings), which captures income earned from all areas (e.g., labour and investment income) and reflects the fact that there is typically more than one income earner per household.</li>
</ul>
Our preferred ratio also compares average dwelling prices with average disposable incomes on a per household basis.
It is important to note that the income measure Rismark uses is the quarterly ABS National Accounts disposable household income proxy before interest payments and excluding unincorporated enterprises, which is then divided by the HIA’s estimate of the total number of households. It represents the total disposable wage and investment income generated by all members of the household and should not be confused with simpler estimates of average wages or median incomes.
On an annual basis, one can examine the impact of excluding the “net imputed owner-occupied rents” that the ABS includes in its National Accounts numbers. The chart below shows that this results in a small increase in the dwelling price-to-income ratio.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune92.jpg"><img src="/images/stories/joyejune92thumb.jpg"></a>
Christopher Joye is a leading financial economist and works with <a href="https://www.rismark.com.au/" title="Rismark International" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. 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. You can follow Christopher on twitter at <a target="_blank" title="Follow Christopher Joye" href="https://twitter.com/#!/cjoye">@cjoye</a> or read his <a target="_blank" title="Christopher Joye's blog" href="christopherjoye.blogspot.com">blog</a>.
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Aussie housing stock is not too expensive

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As we look to what's ahead for 2012, Property Observer is republishing some of our most noteworthy stories of 2011.
 
In my first official article for Property Observer (you can see my archives <a href="tags/christopher-joye" title="Christopher Joye archive" target="_blank">here </a>), I thought it might be helpful to go back to basics and bust a few housing “myths”. I hope this will be a useful guide for anyone who is thinking about investing in property and who has stumbled across the many sensationalist allegations that exist out there in the ether. In the weeks and months ahead, I will try and explore these issues in more detail.
The first housing myth is that it is easy to understand. Almost all people writing about housing know very little about the facts of the subject. Since 70% of households own a home, they feel like they are instant experts. This gives rise to an “anchoring bias”, which I will come back to another time. In brief, we tend to extrapolate out from our immediate housing experience and assume the rest of the asset-class behaves the same way. This is why, for instance, many successful people have a visceral certainty that house prices collapsed during the 1991 recession when they did nothing of the sort. 1
It is true that house prices in affluent areas (e.g., the Point Pipers and Tooraks of the world) suffered substantial price falls. But across the eight to nine million homes that exist nationally, house prices barely budged, as the chart below shows.
<a href="/images/stories/JoyeJune6/joye1.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joye1thumb.jpg"></a>
A similar dynamic reasserted itself during the GFC, wherein national dwelling values retraced by a modest 3 to 4% on a peak-to-trough basis. The $1 million plus market, on the other hand, fell by 10 to 20%. But, in contrast to what you might be led to believe when reading newspapers, homes worth more than $1 million actually only account for about 5% of all transactions. That is, this segment is irrelevant to 95% of home owners.
The truth is that housing is much more complex than the popular media would have us believe. The “we-are-all-property-experts” syndrome is likely one reason why there are so many misconceptions that abound about the asset-class.
A second, all-too-common myth is that Aussie housing benefits from unusually generous tax breaks. As this Reserve Bank of <country-region>Australia</country-region> study <a href="https://www.rba.gov.au/publications/rdp/2006/pdf/rdp2006-12.pdf">shows</a>, the tax arrangements in <country-region><place>Australia</place></country-region> are not remarkable by international standards. CGT exemptions, negative gearing, investor depreciation allowances, and the like are found in many other countries around the world (see table below).
<a href="/images/stories/JoyeJune6/joye2.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joye2thumb.jpg"></a>
 
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The tax-break proponents are especially fond of “cherry-picking” their claims. They will tell you that it’s a travesty the family home is exempted from capital gains tax, for instance. Or that negatively gearing is a phenomenon unique to our country (the table above illustrates otherwise).
What they neglect to mention is that, firstly, there is a substantial cost, or trade-off, associated with the CGT exemption: any mortgage debt held against the family home is emphatically not tax-deductible, in contrast to all other forms of debt (including investment property debt). This makes owner-occupied home loans very expensive, and encourages Australians to use more equity and pay back whatever debt they have quickly, which is obviously a good thing.
Indeed, the exception here is, ironically, the <country-region><place>US</place></country-region>, which does levy capital gains tax on the owner-occupied home in exchange for allowing mortgage debt to be tax-deductible. The result has been, unsurprisingly, higher levels of gearing (or debt) held against <country-region><place>US</place></country-region> housing, and vastly higher mortgage default rates (refer to the next two charts below). In the <country-region><place>US</place></country-region>, households have had every incentive to take on significantly more debt because it is tax-effective to do so. Those willing the Gillard Government to levy CGT on the family home should be wary of what they wish for: the likely outcome will be the <country-region><place>US</place></country-region> approach, and all of the risks that this entails.
<a href="/images/stories/JoyeJune6/joye3.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joye3thumb.jpg"></a>
 
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Perhaps most importantly, those arguing that Aussie housing gets atypical tax subsidies typically forget to account for the fact that it is burdened with a raft of additional levies, such as huge stamp duties, which can amount to more than 5% of the value of a property, land taxes, and local government duties, which sum to a de facto land tax equal to 1% or more per annum.
Indeed, the OECD estimates that the round-trip transaction costs associated with buying a home in Australia are the fourth highest in the developed world, and equal an extraordinary 13% of the value of home (see chart below). By way of comparison, the cost of buying and selling a home in the <country-region><place>UK</place></country-region> is less than half this princely sum.
If we look at just vendor costs, <country-region><place>Australia</place></country-region> has the highest housing expenses in the OECD. Contrast this, for example, with shares where the round-trip costs are less than 1%.
<a href="/images/stories/JoyeJune6/joye5.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joye5thumb.jpg"></a>
A third myth is the popular claim that luxury, or more expensive, properties outperform cheaper ones. This is just not supported by the empirical data. Analysis produced by Rismark proves that mid-priced homes have actually delivered stronger capital growth than their dearer counterparts. And this also comes with considerably lower risk.
The luxury end of the market is “illiquid” – that is to say, it only attracts, by definition, a small number of buyers and sellers – and is afflicted by far greater risk or volatility. This is highlighted by RP Data-Rismark’s luxury property index, which is denoted by the red line in the chart below. Observe how during 2009 and 2010 the most expensive homes outperformed the broader market. Yet during the recent soft-landing, it has been this same cohort that has tanked, relatively speaking.
<a href="/images/stories/JoyeJune6/joye6.jpg" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joye6thumb.jpg"></a>
 
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My fourth favourite myth is the “safe as houses” aphorism. As with most matters, the truth is more complicated. First, house prices do fall, as we recently witnessed. Second, the individual home is actually a risky holding.
Rismark was the first Australian group to disclose empirical research that quantified precisely how risky a home is. We found that the capital gains generated by a single family home vary markedly over time, and exhibit annual volatility of around 15 to 18%, assuming that you hold on to it for a typical six- to seven-year period. That means that your home has similar risk to the overall sharemarket. In contrast, if you could invest in an “index” of housing, which represented, say, the national housing market (or about $3.5 trillion worth of homes), your annual risk would fall to just 3 to 5%. This is about half the risk of Australian government bonds, and about a quarter the risk of Australian shares.
 The difference between the volatility of an individual home compared with a nationally diversified portfolio of housing is similar to contrasting the risk of a micro-cap listed on the ASX with the volatility of the ASX All Ordinaries Index, which includes every company listed on the exchange. As Miguel de Cervantes’ saying goes, it makes sense to try and ensure that all your eggs are not in the one basket!
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The good news is that there will shortly be new investment products available that allow you to take insurance out against the risk of house prices falling, or to invest in a nationally diversified index. More on that another time.
 
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A fifth myth is that because houses trade only irregularly, there is sparse data on the subject, and we cannot, therefore, truly know what is happening to prices. In actual fact, RP Data captures about 40,000 to 50,000 homes sales every month (or more than 1,000 per day), which means that we have a wealth of information on price movements. This allows us to create very sophisticated measures of house price changes, which directly control for the fact that we are observing different types of homes transacting over time. You can read more about RP Data-Rismark’s index methods <a href="https://www.rpdata.com/property_indices/overview_of_the_rp_data_rismark_home_value_index">here</a>.
My sixth myth is that Australian house prices are massively overvalued and set to fall by 20 to 40%. You may recall that my regular sparring partner, associate professor Steve Keen, famously predicted in 2008 that Aussie house prices were “going to fall by 40% or so in the next few years.” Well, he could not have been more wrong. Dwelling prices in <country-region><place>Australia</place></country-region>’s capital cities are currently 30% higher than their March 2008 peak, just prior to the GFC hitting our shores.
Put differently, dwelling prices are nearly 70% higher than where Dr Keen expected them to be. My other mate, the economist Rory Robertson, challenged Dr Keen to a bet on this note, which the latter lost. As a result, Dr Keen ended up walking from Canberra to Mount Kosciuszko wearing a T-shirt exclaiming “I was hopelessly wrong on house prices” (or something to that effect).
Related to this myth is the claim that national “median” prices of $500,000 to $600,000 are seven to eight times national disposable household incomes, and hence way above where they “should” be.
 Based on RP Data’s sales database, I can tell you that the national median dwelling price across all regions is today only $418,000. Median dwelling prices in the capital cities and non-capital city areas (where the latter account for about 40% of the population) are $468,000 and $325,000, respectively.
Rismark produces a quarterly average dwelling price-to-average disposable household income series. This analysis uses the ABS’s National Accounts measure of disposable incomes, which is the most timely series available. If we strip out a few non-cash items from these data, we find that <country-region><place>Australia</place></country-region>’s dwelling price-to-income ratio is 4.5 to five times. This is clearly far removed from the hysterical claims that dwelling prices are seven or eight times incomes (see chart below).
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What the doomsayers ignore is the profound structural change that took place in the Australian economy over the 1980s and 1990s. Although many may have forgotten, inflation in <country-region><place>Australia</place></country-region> used to be much higher than the 2 to 3% pace that we have gotten used to seeing. 
Inflation averaged around 6% per annum between 1980 and the middle of the 1990s. Since 1995, inflation has averaged slightly less than 3% per annum. This is in large part attributable to the good work done by the RBA. 
It has also had deep ramifications for the housing market. In particular, the stability of inflation around the RBA’s 2 to 3% per annum band has permitted a structural downward shift in mortgage rates. This is illustrated in the next chart below. Observe how between 1980 and 1995 mortgage rates averaged 12.6%. Yet since that time they have averaged only 7.3%. If the cost of debt falls through the floor on a permanent basis, how do you think households react? They gear up, which is exactly what happened, with a structural upward shift in both household debt levels, and <country-region><place>Australia</place></country-region>’s house price-to-income ratio over the late 1990s and early 2000s. The key point to note is that this was a once-off event, and will not likely occur again.
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A final myth is that housing is not a productive investment. Now this is just complete crap. 
In standard economics theory, the two most basic necessities for a functioning economy and, more precisely, productive labour, are: food and shelter. We can interpret “shelter” as covering both residential property, which is the accommodation required by a functional labour force, and commercial property, which is the accommodation needed for productive businesses.
You can either be a “producer” of food and shelter by investing in, and owning, the underlying assets that supply these services/products by owning farms, homes, or commercial buildings; or, alternatively, you can just “consume” these services/products and not invest in the assets by simply buying food from the supermarket, renting a home, or leasing space in a building.
There is a final option where you can both consume and invest by living on a farm (and eating its produce), owning and occupying your home, or owning and occupying the building in which your business operates, as some companies do.
As an investor in agriculture, housing or commercial property, you derive returns as you would with any other productive asset: via a mix of both growth in the capital value of the asset and income from the sale of the products/services (i.e., food, residential accommodation, and commercial accommodation).
The bottom line is that new or established housing is just as productive in the services that it furnishes to the wider economy as farms, factories or commercial property. More on that topic another time!
<div>Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. 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.</div>
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Busting big housing myths

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Rismark reports today that <country-region><place>Australia</place></country-region>’s average dwelling price-to-disposable household income ratio fell from its peak of 4.7 times in December 2009 to just 4.2 times in the March quarter of 2011.
In encouraging news for home buyers, <place><country-region>Australia</country-region></place>’s dwelling price-to-disposable income ratio is now back around its June 2003 level.
 With the exception of the GFC, this is the longest correction in <place><country-region>Australia</country-region></place>’s housing market valuation since Rismark’s analysis began in 1993 and confirms its projections last year. 1
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This follows news yesterday that the RBA could keep its finger off the interest rate trigger until after the second-quarter 2011 inflation results are released in late July.
The headline mortgage rate is currently 7.8%, which is slightly higher than the average rate of circa 7.3% since the RBA adopted its “inflation-targeting” regime in the early to mid 1990s.
Rismark joint managing director Ben Skilbeck says: “We expect the national dwelling price-to-income ratio to continue to trend down over the next year or so as wages and disposable household incomes outpace capital growth. We are forecasting robust rental returns during this period, which should furnish owners with better total returns.”
“Contrary to popular myth, disposable household incomes in Australia have outpaced Australian capital city dwelling prices by a 7.5% margin over the last eight years based on RP Data-Rismark’s hedonic index.”
On the topic of when the RBA will next hike rates, ICAP’s Adam Carr says: “Having kept rates steady this month at 4.75% when there was a clear cut case to hike, the natural question is: what additional information could they possibly need to see to hike?
“My initial thoughts are that if they are going to wait till July, then waiting till August is no biggie. They are already behind the curve, so it makes little difference. I’d also note that there is no urgency in this [RBA] statement to hike in July – no clear signal. So until we see the board minutes, I think July and August are fairly even bets,” Carr says.
Terry McCrann of News Ltd and Fairfax’s Alan Mitchell are, however, today insinuating that an August move is more probable conditional on the second quarter inflation numbers supplying Australia’s central bank with a case to go. This brings them in line with UBS’s chief economist, Scott Haslem, who has long forecast an August hike.
If the inflation data do turn out to be benign, the RBA may be on hold until later in the year, consistent with Goldman Sachs’s Tim Toohey’s November forecast.
McCrann, who is known as the RBA’s “Shadow Governor” in financial markets, now believes that the RBA will need to be presented with an empirical catalyst to hike rates in July before receiving the next tranche of inflation data.
Tomorrow’s unemployment figures therefore loom large as a major monetary policy event. If the unemployment rate falls significantly below its current 4.85% level, which is widely regarded as consistent with a “fully employed” labour market, the RBA may feel it has sufficient justification to undertake another rate increase.
There has been widespread speculation that the RBA’s executive is at loggerheads with its more “dovish” board, which contains five representatives of corporate Australia, including businesses that are adversely affected by higher interest rates and an elevated currency. These include a current director and former CEO of the large retailer Woolworths.
McCrann has rejected this critique, and declares today that the RBA Board is “unified” around its comparatively dovish position, which has thus far ignored Australia’s very high first quarter inflation results.
Another swing variable is the departure of the notoriously “hawkish” Professor Warwick McKibbin from the RBA Board. July will be Professor McKibbin’s last board meeting.
Australia’s central bank has missed its 2.5% per annum through-the-cycle inflation target over the last decade, with underlying or “core” inflation averaging a substantially higher 3.0 per cent.
Alongside <country-region>Norway</country-region>, <place><country-region>Australia</country-region></place> has the highest inflation target in the developed world.
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Christopher Joye

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