Real Estate Prices Set To Boom Again?

OK I was doing some thinking about the future of Australian real estate prices in light of the discussion that has been going on in this thread:

http://www.invested.com.au/6/housing-may-flat-but-its-future-35690

It dawned on me that even if housing prices temporarily drop, the sheer growth rate in incomes and the multiple of house prices to earnings (currently 7.5) will still be fuel for massive growth in the future.

It was mentioned that this multiple being 7.5 times average earning is probably a little high and warrants a correction/slowdown in the market, which I think we have been seeing of late. Nonetheless on the 4th page of the above thread there are a number of reasons why this multiple has increased over the last two decades and even if there is a strong argument for it being too high at 7.5 I think most here on these forums would agree that a multiple somewhere between 5 - 6 would be acceptable in light of the improvement economic and household demographic conditions over the last two decades enabling the growth of the house price to earnings multiple.

It was mentioned by the RBA in another thread that Australian's incomes are also growing at a substantial rate :

"over the past five years and real incomes had risen 30 per cent" which can be approximated to about 5.4% per year, which would then convert to a nominal growth rate of somewhere between 7% - 8% per year.

So by my thinking, even with a pessimistic outlook for the next 3 years in regards to real estate with the expectation that the house price to earnings multiple will drop back to 6 (that's a big drop), and income growth will slow to 6%pa (nominal rate), you are still looking at 36% growth rate per year, though there probably won't be a lot of growth over the 3 year period due to the decline in the house price to earnings multiple.

Nonetheless past 2010 if income growth remains high I still can't get my head around how growth in the future will be lower than 20%pa not including rental yields.

Also this is being based on pessimistic results and I see little reason why growth rates in incomes can't be similar to what they have been over the last decade once we are past this global recession nor do I see a big reason the house price to earnings multiple dropping significantly if interest remain low (less than 6.5%) past 2010.

What do other people think of my reasoning and its implications for the future?

 

Chris

The above scenario is possible but is it likely?

Probably not because property prices in many suburbs are already high so apart from the few exemptions I think we should generally be expecting moderate growth for a few years.

cheers

 

My point is exactly that, by my logic and maths it is not only a "possibility", it is "probable".

I mentioned that things will most likely be slowish until the end of 2010, but even at conservative estimates those figures point to anywhere from 20 - 40% house price growth post 2010.

I mean even at a house price to earnings multiple of 5 (which is reasonable) and 4% nominal wage growth (which is on the very low side) you are looking at nominal price growth of 20%pa and that is before rental yields are considered. That is a very tidy growth rate...

I mean for me the only thing likely to stop this outcome is a changing in government structure when it comes to the urban footprint, and the rate at which is rezones to Residential property to LMR to help abate the shortage of supply in the market, which would bring down the house price to earnings multiple.

 

Hi Chris

Two points:

1) you cannot multiply house price : household earnings ratio (5) by Income growth rates (4%) to get a conclusion of 20% growth rate in housing. For example if today house prices are 7 x income and next year income grows by 4% then house prices will only grow by 4% (assuming the price to income ratio of 7 stays the same). If the price to income ratio reduced from 7 to 5 as you suggest it might, and income increases by 4%, then house prices actually reduce by 25% !!

2) The last 5 years has been an exception rather than the norm for real income growth. If you look at the original RBA speech you will see that the average rate of salary increase has been about 3.5% real.

 

Firstly Try Anything Once, thanks for your response I appreciate the feedback as I try to wrap my head around this as well a speculate on the future.

Man my maths/thinking was way off thanks for the correction. I was wondering why I was getting astronomical growth rates.



So house price growth should on average only be equal to nominal growth in earnings, holding the House Price to Earnings Multiple (HPEM) the same.

I may be an optimist but I can't help but feel that in 2 - 3 years things will be back to close to what they were 12 - 24 months ago. I really wouldn't be surprised if real income growth rates continued to be at least 4% - 5% pa which would make nominal income growth rates between 6% - 8% assuming the RBA keeps inflation between its 2% - 3% target band most of the time.

I think the scarier thing, now that I'm thinking about it, is that housing prices probably need to correct down to a HPEM that is closer to 5, which is still higher that historical levels, considering there may be social changes that justify a higher HPEM than has been traditionally seen in past decades.

Anyway, by my maths (which isn't good, so please double check it) these are the possible scenarios for the Australian real estate market over the coming years, assuming it needs to correct back down to a HPEM of 5 without crashing (which I don't think it will do) given various levels of income growth rates and inflation:

Option 1: Income growth (3.5%) with low inflation (2%) = Nominal Income Growth = 5.5%

Option 2: Income growth (4.5%) with avg inflation (2.5%) = Nominal Income Growth = 7%

Option 3: Income growth (5.5%) with high inflation (3%) = Nominal Income Growth = 8.5%

Option 1 suggests a flat Australian Real Estate market for around 8 years.

Option 2 suggests a flat Australian Real Estate market for around 6 years.

Option 3 suggests a flat Australian Real Estate market for around 5 years.

What does everyone think about these scenarios...

What would really get me scared would be if we see another surge in property prices when in 6 months times as things start to look at little rosier from an economic sense with interest rates a lot lower than they are today!

 

Chris

My gut feeling is that there is option 4.

I've been thinking for a while that as city transport improves and decentralisation takes place we could end up with a flatter price structure.

I imagine the upper end coming down and the lower end coming up and they meet somewhere in the middle.?

This ofcourse could just be my imagination....

cheers

 

I would have thought given the way petrol prices / energy prices in general were going that cities would become smaller rather than sprawl out more. Not to mention that traffic congestion in Australia is terrible and apparently is only getting worse...

 

Chris

It's not possible for cities to become smaller.

Also, I don't believe that high petrol prices are sustainable.
Look at what happened recently, petrol prices started going up out of control and the oil companies started to lose customer base.
People were switching to LPG, smaller cars, hybrids etc.

In the near future I believe that electric vehicles will give the petrol companies good competition. As soon as China start mass producing them the game is over.

cheers

 

Obviously cities don't generally become smaller, I meant it in the sense that people will look to move closer to the city to offset some of the negatives of living a long way from the city. As in, people will begin to opt for the 2BDR appartment in the city over the 3BDR house in the burbs.

Also in regards to petrol prices, whilst I do think oil prices will drop, I don't see the AUD going back to $0.95USD. So all in all I see petrol prices coming down but not down to levels anywhere near the levels we saw earlier this decade, and I think the general long run trend will continue be upwards.
Outside of petrol, I'd say that it isn't alone when it comes to energy sources that are becoming more expensive - electricity will increase significantly in price over the coming years.

With the world's increased integration of machinery and technology into life comes the increased need for energy to power things. Yet ironically the world is cracking down on traditional forms of energy production to "save the environment" as a result I think we might be in for a tough decade or two in regards to all forms of energy prices with increasing demand and stagnant or deminishing supply.

Also one thing that is a MASSIVE issue in most Australian cities is traffic congestion which more than anything costs people time. I know I for one place a high value on my time and I think the value placed on time in the community is generally trending up and as such I'd expected if traffic congestion isn't significantly reduced then there is increased incentive to move closer into the city. From everything I have read, heard and seen, when it comes to congestion things are definitely getting worse.

So I think the signs point more towards people moving closer to the cities rather than sprawling out, thoguh if their were big reforms in public transport in major Australian cities I wouldn't be surprised if this negated trend of people moving towards the city.

 

I don't mind paying extra for electricity if the money is spent in producing clean electricity but I don't see the federal government investing in clean technology so I won't be very happy if they start charging me for THEIR inability to provides us with clean energy...

Why should we pay extra when they had billions in surplus and could have made at least one solar power generating station in every state

cheers

 

It's all about votes and ROI.

Clean energy costs more to produce, so either consumer pay or the government pays, but if the government pays it needs more money from somewhere, and the only place the government gets money is from its citizen, so we could pay more taxes, but increasing taxes doesn't normally win elections.

Instead the government can build a coal power plant that is environmentally unfriendly but cheaper which allows governments to spend money on other vote winning expenses, like raising aged pensions, dropping taxes or general job creation projects. That way governments get reelected and citizens have more money in their pockets, but the environment suffers.

Until saving the environment wins more votes than saving money and creating jobs, unfortunately prices for clean energy are going to be expensive.

You gotta love the flawed democratic system - It's the best system we got but it is still pretty mediocore.

 

And has every house taken up the $8000 subsidy on solar panels?

We have ordered one, $500 installation cost only - the $8k rebate covers a 1kw panel.
And this is not one off - we have had letter box drops offering similar.

The government has stated that the solar rebate has been over subscribed. They have been surprised by the up take.

One negative - I cant get the subsidy for solar panels on my rental properties. Which strikes me as hypercritical really.

And back to the topic. BIS indicate housing as growing 0-3% next year. Not bad compared to other investments in this climate. I'm optimistic about RE. At the end of the day new properties are subject to increasing costs - which makes RE keep pace with inflation at least. And given the leverage ability for property - 80%LVR. The cash on cash return is very good.
And I've never had a margin call on my RE.