Is CG doubling every 7 to 10 years sustainable???

One of the key concepts of property investment is to buy, hold, wait for equity to double every ten years, use increase in equity to live, buy more IP's etc etc

Sounds great. Has worked for a lot of people here. But is this growth sustainable?

If you look at compound interest of 6% (very generous) over 10 years, 100K would go to 180K vs property going from 100K to 200K over the same period. This means property prices are increasing at faster rates that pretty much every thing else (apart from national debt), CPI, wages, education blah blah blah

So why are property prices able to have this growth? Simplistically speaking because people can afford them so there is demand. In the face of doubling in value every 7 to 10 years, can people continue to afford property that increases at a higher rate than their income?

I love property, love researching, learning and the idea of expanding my portfolio. I am worried though that a strategy that does not take into account the possible lack of sustainability of double growth is flawed.

For instance if growth is not sustainable, maybe focusing on positive csh flow would be a better strategy.

My understanding of both property and economics is limited (a kind way of saying stupid) so the thoughts or people more knowledgeable than my self would be really appreciated.

 

The reason you are confused is that the assumption that property doubles every 7 -10 years and will coninue to do some for eternity is wrong.

It may have been true in the short term the last 20 - 30 years or so but if you go back over the longer term you'll see the statement is wrong.

assuming the false statement were true, and assuming the conservative end of the spectrum that property doubles every 10 years the internal rate of return is around 7.2%.

The formula for exponential growth is (1 + interest rate)^time

given the average price of a house in sydney was $870 pounds (in nominal terms) back in 1880, the result of this formula is

(1.072/100)^128 = 7,327

Which means that the average house should be worth 7,327 times as much. Or alternatively the average house in Australia should be worth $6,374,582 now. doesn't seem right does it....

We are at the end of a massive 20 year property boom, don't believe the hype and don't believe statements such as these.

 

All focus on high grow vs. high yields. What about cash flow? From what I see almost all people investing in RE are doing well if they can increase volume of their cash flow and maintain it. They may not even realise as they do it by focusing on grow or yields. Regardless if your IP doubles in 10 years or not if you are sitting on multimillion IP portfolio cost of the consumer goods are looking very cheap. Do not confuse it with situation where people are refinancing IP to buy new car. I am talking about real cash flow what is coming in and out of the portfolio. Many people do not have strong stomach to handle big volumes of money and they get scared or start spending before they reach comfortable level. Perhaps secret is in volumes.

 

What you say here Dudek is very interesting but I dont' understand you properly. Could you please explain.

 

Principal of wealth creation. The bigger volumes of money passes through your hands the smaller 50K looks like. One of the ways to do it is to create big portfolio of assets (IP, shares etc.) . If your portfolio of assets is smaller, even if you are positively geared 50K may look like big sum lump. If you can refinance you IP to get new car, wouldn’t you better off to use this situation to get another IP?

 

But property values only increase at a higher rate than our income for the duration of each boom which lasts 3-4 years. After that prices stagnate or fall.

And it's not only property prices increasing.
Our wages are also going up at above inflation rates.
Assuming that inflation on average is around 4% then wages would be increasing by 7% so wages will also double every 10 years or so.

It's a cycle and always works like this.
When property prices and interest rates are high, demand for properties is low so property prices either stagnate or fall.
Over time, wages and rents go up while interest rates go up or down.
At some stage, wages and rents would have gone up considerably so when interest rates come down, paying a mortgage becomes very affordable and when compared to paying rent it's similar, so suddenly property becomes popular.
This sudden demand increases property prices and we have a property boom. Properties become unaffortable and demand drops.
End of cycle.

We now have to wait another 7 years for the next boom to start.

 

Thanks BV. I did not realise that wages where going up at the same rate.

Given that wages double every 10 years then the doubling of CG is sustainable because property will still be affordable and in demand.

Be interesting to see the stats on wage increases over the last 10 to 20 years and see dips and curves of that growth over time. Would also be interesting to have the growth in property prices super imposed on the same graph and see the relationship if any.

 

In the lesser skilled jobs, wages probably won't double because there is no shortage of such workers but professionals always double their salary in that period because they have the added advantage of getting pay increases as they move to new jobs.

 

What about bread and milk, every day items. It will also be interesting to see how they perform overe the 10-20 years.

Also on the topic of skilled workers, I think is more about moving up/promotion opportunities. There is more to gain in life if you are more educated. I doubt if you stay in the same job for 10 years in mercy of your boss you will double your salary. You will just catch up with inflation.

 

Unless ofcourse we go through a very low inflation period in which case wages won't increase by much.

We had one of those periods recently.
At my work for example, in the past few years we were getting between 4 and 6% increases. The latest 1 this year was 6%.

However, during that same period we also had an unusually high property growth exceeding the norm and in many cases properties tripled in value.

It's hard to analyse this particular CG because demand was largely driven by speculative lending and in particular regions eg QLD was also driven by the mining boom and interstate migration. eg by people who thought it was cool to move there for a while.

Situations change though, the easy lending and speculative investors will be gone, the mining boom ends, people move back home and market forces will bring prices to the traditional growth levels we are used to.

 

Wages growth to be tempered: economists
25/02/2009 3:41:34 PM

Wages rose last year at the fastest pace since records began 11 years ago but the rate of increase is expected to slow in coming months as a weakening economy threatens jobs.
Total hourly rates of pay without bonuses grew by 4.3 per cent, seasonally adjusted, in the year to December, data released by the Australian Bureau of Statistics (ABS) on Wednesday showed.
It was the fastest annual wages growth since the ABS data series began in late 1997.
Other government data, also released on Wednesday, showed a sharp decline in skilled vacancies in February.
The labour price index rose by 1.2 per cent in the December quarter, compared with an unrevised one per cent jump in the previous quarter.
Nomura chief economist Stephen Roberts said a worsening labour market and rising unemployment would lead to wage pressures easing in 2009.

"It's not expected to persist because we expect the weaker labour market developing to start to bring wages growth back, so it's not unduly alarming," Mr Roberts said.
Public sector employees enjoyed a 1.4 per cent pay increase in the December quarter, a big jump from the 0.9 per cent pay rise they had in the three months to September 30.
Private sector pay rose by 1.1 per cent in the December quarter.
Commonwealth Bank of Australia senior economist Michael Workman said the latest wages data was more symptomatic of the labour market a year to six months earlier than now.

The Department of Education, Employment and Workplace Relations data, also released on Wednesday, showed an 11 per cent fall in skilled vacancies in February, with declines in 17 of the 18 professions surveyed.
"It is fairly obvious given those skilled vacancies falls again today that the wages numbers are likely to move under one per cent a quarter over the next year," Mr Workman said.
ANZ economist Riki Polygenis said the latest wages result was unlikely to determine the size of a possible interest rate cut in March.
"If anything, today's high wage number could lead to concerns about labour shedding due to rising real wages," she said.
Ms Polygenis said the RBA would cut rates by 25 basis points on March 3 to a 48-year low of three per cent.
The ABS wages data showed the commodities-driven state of Western Australia enjoying the biggest annual pay increase of 5.7 per cent in December.

The labour price index in WA rose by 1.8 per cent in the final quarter of 2008.
The story was very different in NSW, where wages grew by one per cent in the December quarter, and four per cent over the year, with both measures well below the national average.

 

The answer is, it depends. But if we were living in the ideal world the answer would be no.

I think the fact you are asking the question implies that in your heart you know the answer. The answer being, of course people can't continue to afford property if their income isn't increasing at the same rate (holding everything else equal).

Despite your lack of formal education, I'd say you have what's vastly more important, smarts and intuition. The fact you ask these sorts of questions puts you well ahead of the herd which tends to accept what they are told.

So I thought I'd just touch a little on incomes and their growth rates. I think it's important that people looking to become property investors ponder a little on what actually prompts incomes to rise considering it is such a big factor in property values (unfortunately most don't). In my opinion, the two biggest driving forces behind income growth are:

- increases in output
- increases in fiat money supply

Both of them indirectly stimulate property price growth, but only one of them is REAL growth. Care to guess which one?



In simple terms a output relates to the amount a worker produces in a fixed period, ie an hour. If an individual can double their output then they have doubled the amount of produce they can sell, therefore doubling their income (just assume that capital inputs (machinery) are held constant). Obviously a person can increase their output by working more hours which also results in an increase in income.

Anyway productivity growth normally sits somewhere around 2% pa for Australia.

Now as has been mentioned on these forums many times if you look at over a LONG time frame ie 100 - 200 years housing prices are normally around 3 to 4 times income. Which would imply that a significant, but not overbearing amount of an individual's income would be put towards either a mortgage or rent.

With that said, it definitely raises the question of if our productivity growth is only at 2% pa then how on earth are incomes growing at a much faster rate? Are business owners accepting smaller and smaller profits and passing more onto workers? Pfft... obviously not. The discrepancy lies in the second major driver of income growth - fiat money supply growth. Lots of people loosely refer to this as "inflation" yet they don't have a complete grip on the principle.

The reality is when you have an ever increasing amount of money entering the system it erodes the value of the money already present - aka inflation. Now the RBA, banks and governments would love for you to believe that the money supply growth was similar to the level of inflation but the sad reality is that the M3 money supply growth has been many times the inflation figure of the last decade or so and is increasing at an ever faster rate - at least that was until the credit crunch. People need to remember that the inflation targeting system is based on a small "basket" of goods that completely ignores massive segments of high inflation in the economy, ie asset prices as a simple example.

Anyway, with an increasing amount of fiat money in the system people start paying and demanding more money for goods and services which lifts business profits, and in turn business owners looks to expand business by offering higher wages than the year before. So nominal wages increase, and by using a biased version of inflation those in charge argue that "real" wages have increased, but I'm going to argue the point that wages in comparison to true inflation have fallen, but of course this doesn't factor the income earned through the increase in an individual's "net worth" that most people are experiencing a result of asset price inflation (normally through their home values and share portfolios). Most people don't view capital growth as income, but that hasn't stopped lots of Australia using the equity in their homes as income that they can spend on consumer items.

If you are not following what I'm saying the pretty graph on this site might help a little bit:

AusChart · Growth in Money Supply for 49 Years

The post succinctly makes the point that:

Isn't it ironic that house prices tend to double at a very similar rate to which currency and M3 grow... weird...



Anyway I could talk for hours about this. But my point is simple, money supply growth has done vastly more for house price growth than any other factor. Whilst it is true that income and house prices are related, I think it is prudent to understand why stimulates income growth - and once again in recent history money supply growth has been a far bigger contributor than productivity growth. In addition to this in the last two decades Australians have continued to pile a greater percentage of their income into home ownership in order to capitalise on this trend, but I'm of the belief that this trend is about to end given the excessive levels of debt now in the market, and that it would a debt deflation cycle has begun.

I'd go as far as to call it a 40 year asset price boom, with 20 years of "irrational exuberance" in the property market.

You'd be hard pressed to find property in any Australian capital cities that is worth less today than it was 3 years ago, let alone 5 years ago. Unfortunately the rising tide has lifted all the ships - that tide being money supply.

It all depends on how you define inflation and what items you use to calculate inflation.

If only that were true, we could all become filthy rich just by following the simple steps of the cycle. No one would ever have to work again - it would be utopia.

The reality is nothing lasts forever and using words like "always works" implies that the variables never "change", and I can assure you they do, you don't have too look to far into history to see just how dramatically things can "change". Hell they elected the Obama on that word alone...

This assessment is all well and good assuming the fundamentals don't change, but at this stage, with no bottom in sight, and more and more people realising that problem may be a lot bigger than they thought, I'm very comfortable in my prediction that the fundamentals coming out of this will be very different.

Right... I'm going to assume you were just playing around when you say it will be 7 years before the next housing boom, like the system operates like clockwork.

I attrached a picture for you that relates to median income versus house prices in Australia captial cities over the last 25 years.

 

Probably true- but the Australian notion of home ownership is still high a priority of many in our country and I think it's going to take quite some time before the trend reverses and more Aussies prefer to rent rather than buy. Don't forget too that PPOR ownership not only provides security but also a tax free asset upon sale- still a good enough reason for wannabe home owners to take the plunge. In fact, I think that this period of debt consolidation by some will result in homes being paid off faster and buyers pulling out of the PI market, as they elect to pay down debt rather than accumulate more.

Not 100% sure what you meant here, Chris, but I can certainly provide you with several examples of properties that are worth less today than in the last 5 yrs. Just last week I had a valuation come back on a property that was basically 80% of it's purchase price from it's 2006 cost. Even larger drops if the properties were bought in the 03-04 boom, in some cases.
Mind you, the FHB market is bouncing back so I expect this trend to basically reverse over the next 6 mths or so.

Good point and I know that you're far from alone in your opinion that this time is "different". I suppose we only have history to rely on when it comes to forecasts and there are too many who rely on that alone to see them through. Let's just hope that the recession ride ahead isn't too rough and we develop smart strategies in the meantime for surviving and coming out the other side as unscathed as possible. For a lot of investors I know, it's all now all about focussing on reducing debt and keeping their heads above water in the job world.

 

This is what the debt deflation spiral relies upon, and everytime someone opts to pay down debt ratehr than borrow more the economy contracts that little bit further until the majority of the population reach a point where there debt is low enough that they are confident about the future.

That's why they call it a deflation spiral, because it starts feeding on itself, obviously the more debt in the system the longer and faster we spiral down... if a deflationary spiral does grip Australia it's be wise to appreciate that we are carrying more debt than at any other point in history. So it's a long way to fall.

There is a big difference between "bouncing" back and "being manipulated". I tip my hat to the government for their very shrewd maneuvering with the doubling and tripling of FHOG, but this global downturn will run for quite a bit longer yet, and time will tell if this blatant market manipulation can keep deflation at bay.

I really hope you are right, but my fear is that the system (democracy) is designed to produce sub optimal solutions to these problems we face (tragedy of commons). Until all the temporary, quick fix, band aid solutions are exhausted the masses will refuse to face reality and implement long last solutions, but these solutions will involved quite a bit of recessionary pain.

The reality is you can't borrow or print your way to prosperity, but that is largely what we, like the rest of the developed world, have done for the last three to four decades. It is time for a radical societal shift towards putting in an honest days work for an honest days pay.

 

A very good post and I really appreciate the effort and content you put into it.

I need to correct you on this point though

I said my understanding of perperty and economics was limited and that other people here are more knowledgeable than myself. That does not mean I lack formal education.

My formal education consist of a Degree in science, a graduate diploma in Hositality/Tourism, a Masters in Business and a few other things I can't remember. I've even taught economics, marketing and accounting for Monash University

BUT when it comes to property, there are many people here who are extremely educated, knowledgeable and experienced. I'm here to benefit from these people and the best way to that is to listen, read and learn.

The best way to do that is by focusing on what you don't know and learning that just to fixate on what you do know.

Anyway, keep up the great work on your posts.

 

Sorry, I meant to say "Despite a lack of formal education in economics." I wasn't meaning to imply that you weren't well educated in other areas.

Personally I don't think "formal" education is all that crash hot anyway, I personally don't put a lot of weight in it, and as I mentioned in my post I place much more value in the opinion of someone who is naturally inquisitive and resourceful. As they tend to want to discover the truth rather than swallow the most published rhetoric.