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Property maths made easy

Property maths made easy

There’s so much confusing and conflicting property forecasting information out here, I thought I would simplify matters with a simple equation.

Maths_equation_Jan_2019

This equation uses the latest published Australian Bureau of Statistics data, and dramatically shows us that we are rapidly approaching a critical shortage of rental accommodation in the major eastern cities. Record population growth is combining with the effects of savage cuts to investor and new housing finance to reduce the available stock of rental properties.  

The maths is alerting our State and Federal governments that it’s high time to stop punishing and start encouraging property investors, because it is investors who provide virtually all rental accommodation. If our governments fail to respond, they can expect a rapid escalation in asking rents in Sydney, Melbourne and Brisbane.

This graph shows just how much rents have fallen behind price growth in our capital cities, with the gap between growth (the black line) and rent return (the red line) steadily growing since 1999. Right now, the shortfall is the worst it has ever been.

Perf_house_prices_rents

Cash flow is about to become king again

This situation occurs because rent growth tends to lag behind price growth in our big city markets, and indeed, rental yields in Sydney, Melbourne and Brisbane are now lower than at any time since the post-war housing boom. They do catch up, however, whenever prices stop rising.

When capital city housing price growth slowed down or stopped in the past (for example from 1910 to 1916, 1929 to 1941 and from 1951 to 1965), you can see from the graph what happened next. Rents rose quickly and dramatically, as indicated by the red line. This has occurred because our capital city populations have always been growing, and if new residents can’t buy, they have to rent.

The equation and the graph would indicate that rent rises are highly likely to occur again in the eastern capital cities. It also shows that this is likely to happen very soon and that cash flow will replace capital growth to become king.

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The farmer and the fox

The farmer and the fox

The current standoff in our property market is quite bizarre. On the one hand we have increasing demand for housing in our major cities created by record population growth and on the other hand, buyer demand in them has slumped. Let me share the story of the farmer the fox with you, to shed some light on what could be going on.

A farmer captured a fox that had been taking his chickens. To teach the fox a lesson, the farmer tied some dry grass to the fox’s tail and set it alight, then let the fox go.

But the fox ran straight into the farmer’s wheat field, which was ready for harvesting and as the burning grass fell off his tail, it set fire to the farmer’s crop and destroyed it. The moral of this fable is to be careful with acts of revenge as they can often backfire.

We can easily refashion the story. The government decided to punish the big banks for the way that they treated customers, so it held a Royal Commission into their bad behaviour to teach them a big lesson. But instead, the banks responded by slashing housing finance so much that the whole economy was threatened with a recession, to teach the government an even bigger lesson.

Now I don’t think that the banks want to send the economy into recession, but they obviously want to make a point about their power and importance. So, just like the fox, they are sending a strong message to the government to leave them alone.

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The half time break is about to end

The half time break is about to end

During the last year property buyer demand fell because of:

´      
The big banks self-induced housing finance squeeze
´       APRA’s controls on investor and interest only loans
´       Huge stamp duty hits for overseas property buyers

These restrictions have caused property prices to fall in some cities and fail to rise in others, but this situation is only temporary, because the demand for housing continues to rise strongly. What we are experiencing right now is like half time at the football – a temporary lull before housing demand forces prices up again. 

The demand for housing is increasing because of one inescapable fact – we have one of the highest population growth rates in the world – at 1.6% per annum, it’s easily the highest in the western world, (more than double that of the UK or USA and three times that of China, according to the latest United Nations figures). 

Change_in_population

What makes these stats even more significant is that over sixty percent of our population increase now comes from overseas arrivals, and most of them (according to the latest ABS data released 20 December 2018), prefer to live in our three biggest cities, with one third heading for Sydney, one quarter to Melbourne and another ten percent to Brisbane.

People are also moving from the west to the east

That’s not the end of the population boom story either, because many immigrants to cities such as Adelaide, Perth or other regional centres, make another move a few years later, seeking better employment prospects or more affordable housing.

This results in a net interstate migration of around 40,000 people to Brisbane, Melbourne and Tasmania each year, in addition to those directly arriving from overseas and all those arrivals from other States and countries need immediate housing, most of which will be rental accommodation.

Huge housing shortages are about to emerge

These huge numbers of new residents have obvious implications for our housing markets, especially the rise in rental demand it will generate in our eastern capitals, such as Melbourne and Brisbane. Because most of these new residents will become aspiring first home buyers when they are settled, there will also be a rise in buyer demand which will continue for years. That will occur even if the Federal government makes such a policy change.

The inevitable outcome of our rate of population growth is that we are about to face a huge housing rental stock shortage in our major eastern cities, accompanied by a surge in buyer demand when the housing finance controls are lifted and the banks seriously start lending again.

What are our governments doing about this?

We are facing major conflicts with our migration and housing policy, but our governments are doing nothing, and they will continue to do nothing, because migration is a Federal issue and housing is a State matter. High levels of overseas migration are economically good for our nation – new arrivals create work, keep labour costs competitive, keep our nation young and active.

Australia currently derives over sixty percent of its annual population growth from overseas arrivals, which is the highest relative intake of all the major nations in the world. Our Federal politicians see overseas migration as an economic benefit which has kept Australia out of recession for nearly thirty years. Even better, they don’t have to worry what happens to migrants after they have arrived, because creating and providing transport, health, education and housing services are State matters.

This is why State governments are not so enthusiastic about high levels of overseas migration, but even though most arrivals end up in the already population challenged cities of Sydney, Melbourne and Brisbane, State politicians are powerless to control this in any meaningful way.

State governments get financial benefit from property buyers

The situation is even more confused because State revenues are heavily reliant on stamp duty from property transfers and so a rise in property sales is in State government financial interests. Many of the huge transport infrastructure projects currently underway in New South Wales, Queensland and Victoria rely heavily on stamp duty revenue from property sales.

So while State politicians publicly sympathise with frustrated potential first home buyers, they are really on the side of the big developers and investors who buy properties and generate the stamp duty revenue they need.

What should property investors do about this?

This is a unique period in our history. On the one hand, demand for housing is rising strongly, and on the other, our ability to buy property has been curtailed. It’s like half time at a football match, with everyone taking a breather before the siren goes and the game continues, with an inevitable rise in both prices and rents in the eastern capital cities.

This temporary halt in buyer demand is not going to last very long, and the rising pressure of demand for housing is likely to have several different effects.

Firstly, asking rents in the big three eastern state capital cities will increase over the next year and lead to a renewed influx of property investors seeking higher rental yields.

Secondly, rising prices in these cities will encourage investors to look at the cheaper capital cities for affordable bargains.

Thirdly, opportunities for profitable renovations and developments as well as for long term buy and hold investments will grow in all capital cities as market driven growth picks up.

Market conditions now favour buyers in many suburbs of our capital cities and some suburbs also offer great cash flow potential as well as a strong medium-term price growth outlook and excellent buy and hold investment opportunities.

Where can you find these suburbs? In our just released Lindeman’s Best Buy and Hold Suburbs reports, the only predictive reports personally produced by property market expert, John Lindeman.

TO ORDER OR FOR MORE INFORMATION CLICK HERE

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Where are our housing markets heading in 2019 and beyond?

Where are our housing markets heading in 2019 and beyond?

Most experts making their housing market predictions for 2019 and beyond will rely on past performance, because they believe that the market will continue to perform in future as it always has in the past. Let’s take a look at how our markets behaved in the decade from 2000 to 2009, when the onset of the GFC caused price growth to end, using official published ABS housing price data.

The first really interesting fact is that Sydney was the worst performing housing market of all capital cities from 2000 to 2009, with the median house price rising by 57%. Melbourne nearly doubled this percentage growth, and all the other capital city property markets more than doubled in price.

The second fact is that they didn’t all go up at the same time – Sydney’s housing prices shot up first, from 2000 to 2002 and then price growth stopped. Melbourne boomed from 2001 to 2003, Brisbane’s property market boom started in 2004, then Adelaide, Hobart, Perth, Darwin and Canberra all boomed in successive years and growth slowed after a year or two of really high price rises.

The takeaway we gain from this is that the booms rippled from one market to another, and as markets became unaffordable, buyer demand moved to the next affordable city, where prices were cheaper. When prices in turn rose there, buyer demand moved to the next most affordable city and so on, until the boom ended.

Hobart’s housing market rose the most in percentage terms because it was the cheapest. In other words, Hobart’s median house rose the same in dollar terms as Sydney’s did, which maintained the relative price difference between them.  

Now let’s look at the way that our capital city housing markets have performed since then, and what we see is that the performance has been the wrong way around, with the dearest two cities going up in price the most, while the others have barely moved, except for Hobart.

Cap_city_house_price_change2010-2018

Some experts put this mirror image in performance down to causes such as the ending of the mining boom or high levels of overseas migration, but the real reason is that the price ripple effect of growth moving from one capital city to the next has been stopped dead in its tracks.

A succession of events, such as the Banking Royal Commission, APRA regulations on investor housing finance and the savage increases to stamp duty payable by foreign investors has interrupted buyer demand. My prediction is that when conditions return to normal, and these artificial controls on buyer demand are removed, demand will pick up where it left off, resulting in the following possible price growth scenario.

Cap_city_house_price_predictions

This forecast is not based on past performance, but on my analysis on the key demand trend dynamics of housing markets and their likely effects on housing prices over the next decade. 

This analysis also indicates that the next housing market to boom is likely to be Brisbane.

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The tipping point for investors

Property investment offers us many ways to create wealth such as the profits from development, renovation and passive price growth when we sell a property, and cash flow while we own it. But even though we all believe that property values grow over time, there are also many traps for the unwary in relying on the power of passive price rises to create profit.

Remember those mining towns in Western Australia and Queensland, where real estate values fell by over ninety percent from 2102 to 2017? What about capital cities such as Adelaide or Brisbane, where housing prices have stubbornly refused to rise during the last ten years, despite the confident predictions of so-called experts that they were about to boom? Even worse, in cities such as Darwin and Perth property prices have actually gone backwards over the same period of time.

This uncertainty about future price performance leads many investors to the view that while prices may rise over long periods of time, the immediate benefit of owning real estate is cash flow from rent, because it is immediate and measurable. If the rent we obtain each week is more than the costs of holding the property, we have achieved the holy grail of property investment – a property which is paying for itself and providing us with positive cash flow.

For example, if you followed my predictions and bought an investment property in Hobart’s Bridgewater for $180,000 in 2017, your current weekly rent would be $300, which is a rental yield of nine percent. Of course, you have to fork out for repairs and maintenance, property management fees, rates and insurance, which typically amount to around two percent of the property value each year. In addition, there’s the interest cost of the loan on your property, which can be around three to four percent of its total value, depending on how much of the purchase price was borrowed from a housing finance provider.

Your Bridgwater property could therefore cost you up to $200 per week to hold, depending on how much you borrowed to buy it, but the weekly rent is $300, so you end up with at least $100 per week in your hand – not only is the property paying for itself, it has generated around $10,000 net cash flow since you bought it, and the median house price in Bridgewater has risen by $40,000 over the same time – not a bad result.

Far more common are investments where the income from rent is not enough to cover the costs of holding the property and their owners are losing real money. For example, if you purchased an investment property in outer Sydney for $1,000,000 in 2017 you would be able to charge around $600 per week in rent, giving you a gross rental yield of three percent.

Just like in Bridgewater, you must pay holding costs amounting to two percent of the property value, plus the cost of the loan interest, which in total amounts to around $1,100 per week, so you are losing $500 each week. This property would have cost you around $50,000 to hold since you bought it, and median house prices in Sydney have fallen by around $70,000 over the same time – so why would you even contemplate such an investment?

The answer lies in the belief that housing prices will rise over time and in the lure of negative gearing, which allows you to offset your holding cost losses against other income, reducing your income tax liability. But while gearing reduces your tax, it does not generate income and you still have to pay the cost of holding the property.   

This is the hidden reason why buying demand from investors, especially in our mainland capital cities, has slumped. It’s not so much about prices as it is about gross rental yield, or the return on investment we receive from rent. There’s no doubt that tougher lending regulations, lighter loan limits and termination of interest only loans had their effect, but even though the restrictions have been eased, investors have not returned.

Rental yields in our mainland capital cities are too low, and the gap between income and expenses is too high to make property investment attractive. The tipping point at which investor interest currently wanes is when the gross rental yield drops below five percent, which is when the cost of holding a property starts to outweigh the benefits of owning it as in our Sydney example. Conversely, when rental yields rise above five percent investors sit up and take notice, because properties in such areas can deliver positive cash flow from day one, such as the Bridgewater example.

The reason that rental yields are so low in Sydney and Melbourne is that housing prices have nearly doubled in the last six or years, but asking rents lag behind, and have only risen by twenty percent over the same time. The gross rental yield is now at its lowest level since 2012 – at around three percent. Virtually every Sydney and Melbourne property investment made since the booms began generates much less income from rent than it costs to hold and the owners have to make up the difference out of their own pockets each week. So, while all the focus is on rising prices, the real issue for investors is low yields.

Other mainland capital cities have also suffered from falling rental yields since 2012, but these have been caused by oversupplies of new housing, particularly in Brisbane and Perth. New home surpluses have been keeping a lid on housing prices. They encourage aspiring first home buyers to move out of rental accommodation and into their own home, with the repayments often being lower than the rents they were paying.

The drop in rental demand has seen rental yields in these cities fall by over one percent in the last few years as rental vacancy rates blow out and landlords compete for tenants. With rental yields in Adelaide. Brisbane and Perth at only four percent and prices going nowhere, investors are not excited.

The proof of the “five percent tipping point” lies just across Bass Strait, in the one property market that has been booming while others have languished – Tasmania. Rental yields in Hobart were over five percent in 2017; much higher than any other State capital city and they were even higher in other parts of Tasmania. Mainland property buyers have been surging into the Tasmanian market since then, buying properties in suburbs such as Bridgewater and yet both prices and rents have continued to rise due to an underlying shortage of housing stock for rentals as well for purchase.

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The bad boys

Here’s a tale about four bad boys, which has great relevance to what’s taking place in our housing markets.

While mum and dad were out, the four boys started playing up. Searching the fridge for leftovers, they found and devoured some chocolate cake, washed down with a bottle of lemonade. They discovered and cleaned out the biscuit tin in the pantry, leaving crumbs everywhere. With no one around to stop them, they ventured into the family room and polished off a packet of after dinner mints, celebrating their good fortune by consuming the ginger beer and the other soft drinks they found in the bar fridge.

No sight of their parents yet, so on they went into the holiest of holies – mum and dad’s bedroom, to see what was on offer. There they found the block of Swiss Chocolate dad had given mum a few days before and soon it was all gone.

Then suddenly the front door opened – it was mum, who quickly realised something was amiss. She saw the foil wrappers and crumb trails, sticky drink spills on the carpet. The culprits stood quietly, their guilty faces covered in chocolate and mousse as their mum cried out, “Just you wait until your father gets home – you boys are really gonna cop it.”

As panic set in the oldest boy said “We’ve got a few hours before dad gets home – let’s fix the place up and do whatever else we can to calm him down.”

So they set to work, cleaning everything up. They even polished dad’s golf clubs, put out the rubbish, mowed the front lawn, picked some flowers for mum, did everything they could to make amends before dad got home.

I won’t tell you what happened when dad did get home, but this story illustrates what is going on in the housing industry right now. Having acted much as they wished while mum and dad were away, the big banks have been called to account by the Royal Commission and they’re anxiously waiting for the Commissioner to deliver his verdict on their bad boy behaviour over the last few years.

So what do they do while they’re waiting? Exactly what the bad boys did – not just clean up their act, but go even further to demonstrate just how loyal and trustworthy they really are before the Royal Commission delivers its findings early next year.

This is the only reason that we are experiencing a totally unnecessary squeeze on housing finance – there’s no financial crisis, no economic crash, no reason to restrict lending other than the banks trying to prove how diligent they are by applying what some would argue are excessively stringent borrowing criteria.

Once the Banking Royal Commission is behind us and the banks have been suitably chastened for their bad boy antics, things will get back to normal again. Housing lending will start to rise and housing demand along with it. This is because banks are in the business of making money from lending, and secured housing finance is the safest form of lending they can provide.

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Discretionary buyer booms are coming

Discretionary buyer booms are coming

Firstly, let me explain what I mean by “discretionary” purchases. These are property purchases made by people who don’t intend to make the dwelling their home, and neither do they plan to rent them out either. 

This may seem like an unlikely thing to do, yet there are around 600,000 such properties located around Australia.

These properties are commonly known as holiday homes or weekenders, many of which are located in popular coastal, lakeside or riverside destinations while some are also tucked away in more remote hinterland areas.

There are two different types of people who buy such properties. The first are high fliers who have earned a great deal of money in a reasonably short time. They are typically mining construction workers during mining booms or share investors during stock market booms. Some of these cashed up buyers purchase trophy type units in fashionable holiday areas such as the Gold Coast not so much to live in as for the bragging rights that go with them.

If the financial situation of these buyers deteriorates when the boom ends, their trophy type purchases are the first to go, and it’s this “discretionary” buying and selling in locations such as the Gold Coast which generates much of the unit market booms during the good times, and the busts which inevitably follow when the booms end.

There is another far more significant type of discretionary buyer in the market right now and the numbers of these buyers will grow in the next few years. The reason for this is the way that the Sydney and Melbourne housing markets have performed over recent years.

Over the last five years, housing values in Sydney and Melbourne have grown rapidly and delivered their owners a huge increase in equity. This is because the benefit of these increased property values applies to all homeowners, even if they didn’t buy or sell during the heady boom years.

The numbers involved are truly staggering – around one million fully owned homes, and well over one million homes being paid off with a mortgage plus another one million investor owned dwellings have all doubled in value during the last five years.

The total increase in property values is estimated to total more than $800 billion, but despite this huge amount of gifted capital, most of these households have been content to stay in their homes with no intention of upgrading. Many are also not inclined to risk their new-found largesse by entering the market as property investors, particularly when the growth appears to have ended.

Increasingly though, homeowners in Sydney and Melbourne are finding that they can make use of this new equity in a different way – to buy their own holiday home. They now have the means to buy a weekender in one of their favourite getaway locations and may also be tempted to turn this into an income generating opportunity by renting the property out for Airbnb or other short-term rentals.

The typical locations for such homes are in coastal towns, inland lake resorts and popular tourist destinations around Victoria and New South Wales which are easily accessible by road. With school and work finished for the week, the family packs the car and in a few hours they are a world away.

These property purchases are real “heart not head” territory and now occurring in popular holiday destinations such as Victoria’s Gippsland Lakes and Port Stephens in New South Wales, where several locations have high price growth potential.

We are already seeing increased buyer demand and price growth occurring in many such areas. As prices rise and then become unaffordable, the buyer demand shifts to other nearby locations where prices have not yet risen.

By identifying the best areas and the right types of properties, investors can get in first and then benefit from the uplift in prices. The trick is to buy before the price growth starts and then sell to a holiday home buyer before the growth is about to end.

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Hold or sell?

Why it's better to hold than to sell

Did you know that there have only ever been three times in our history as a nation when Australian property prices suffered significant falls? They are shown in these graphs:

Each of these price falls was precipitated by an economic crisis – there was the Great Depression in the thirties, the sixties Credit Squeeze and the more recent Global Financial Crisis. More significant is that each of these crises followed the same sequence of events – firstly the share market crashed, then there was rising unemployment, falling wages and salaries and a curtailing of housing finance.

It was the lack of housing finance which actually caused housing prices to fall, and as you can see from the graphs, the only really big price fall was during the Great Depression, which incidentally was followed by the biggest rise in housing price history a few year later, when house prices trebled in ten years from 1945 to 1955.

What we are witnessing right now is a cut in housing finance – there has not been an economic crisis, nor a share market crash, neither are wages and salaries falling or unemployment rising. The banks are simply responding to the tighter APRA regulations and the Royal Commission by cutting their lending to property buyers.

The only eventual outcome of this is that rents will rise, as we are not building enough dwellings to meet the demand from our growing population, and if new households can’t buy, then they have to rent.

Once rents start rising, governments will come under pressure to increase lending to owner occupiers and investors, and so prices will start to rise again. It will just as easy for the banks to increase lending as it has been for them to reduce housing finance.

In that regard, it is important to see that the growth in house prices has averaged 8.3% per annum since 1901. This equates to a doubling in house prices every ten years and that is exactly what has occurred in Sydney and Melbourne, except that virtually all the growth has taken place in the last five years. This means that we haven’t had a boom in Sydney or Melbourne at all, while prices have only been marking time in the other capital cities.

So hang in there, investors – the next boom is not far away.

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Our Accuracy

My published predictions - an unequalled record of accuracy

In the Australian Property Investor magazine’s Hot One Hundred Issue of April 2012, I was the only expert whose predictions all rose in price over the next two years.

I also picked the hottest performer of all the experts – Highgate units, where prices rose by nearly 50% in a no-growth market.

 

 

In the Australian Property Investor magazine’s Hot One Hundred Issue of May 2013, I was the first expert to publicly predict Sydney’s imminent housing market boom.

My predictions also revealed which of Sydney’s suburbs would be the first to rise in price, heralding the boom to come.

 

 

My published articles have correctly predicted booms for Hay and Berri where prices doubled in a year or less and Byron Bay, Weipa and Highgate, where prices doubled in just a few years. 

 

 

 

In Property Observer Issue of 27 May 2016, I correctly predicted that Hobart was the next property hotspot and would boom in 2017, just before the growth kicked in.

Hobart was the best performer of all capital city housing markets in both 2017 and 2018.

 

 

In Your Investment Property’s Annual Top 100 suburbs guide Issue of January 2018, I picked the top performer, which is Karuah.

Karuah is not only the top performer of the Top 100, but has been one the best performers in the whole of Australia, with the median house price increasing by nearly 50% in less than one year.

 

All of the above predictions were authored by John Lindeman and published in the sources quoted, with the results independently verified by CoreLogic published data.