Property doubles every 14 years, not every 7

[MichaelW]

Hi Guys,

Excellent little article in the SMH Domain section today:

Beware spruikers on house prices

The truth is that over the past 20 years Sydney residential property prices as reported by the Australian Bureau of Statistics have increased by a compounded rate of 5.2per cent per annum, which effectively means property prices double on average every 14 years.

That's right, folks, not seven years but 14 years.

Before everyone points it out, I know this is Sydney-centric, but even so its a good insight. Before I get onto the implications of this, here's another nice snippit if you're one of the many out there trying to time your entry and considering the Sydney property market:

As you can see, the seven-year claim (or even the 10-year claim) is ridiculous. It is just not backed by long-term or even relatively short-term historical evidence. However, there is a possible silver lining. Given that house prices in Sydney are now lower than they were in 2003, they are now more affordable and, importantly, have returned to the longer-term growth rate of nominal incomes and profits; which, in this country has also grown for the past 20 years at 5.2 per cent per annum.

It may mean that, in this city at least, real estate has now possibly entered good-value territory.

Got it? Sydney is now back on its long term mean growth line and represents good value. i.e. No bubble. What's more, the significant improvement to affordability thanks to interest rate drops means that these trendline valuations are well supported. It might yet overrun to the downside as mean reversions often do, but at least history suggests we're currently at fair value and well supported by affordability.

Another little thing I wanted to point out and alluded to above, is the implication of a 5.2% compound annual price appreciation. If we accept that we also receive rental income of around 4% yield and ignore negative gearing income as well, then we get a net Internal Rate of Return (IRR) of 9.2% from this asset category. By extension, provided interest rates to fund this asset class are below this level, then we make a positive return. With interest rates currently around 5% we make a 4.2% return above interest costs which when leveraged can be an astounding amount. Sure, there are cyclical risks, but the long run average returns suggests now is an awesome time to invest.

I like long-run numbers, and love the fact that this asset category currently represents fair value, is supported by record low interest rates, and returns 9.2% odd per annum over the long term.

Sydney resi property anyone? I'm in...

Cheers,
Michael

 

[Highlygeared]

I would concur with that analysis about LT growth in Syd. The first IP I bought in '97 has had about 5.5% growth on average since. Done nothing to it since purchase, no value adds etc.

 

[HiEquity]

Are the numbers in this study real or nominal? It doesn't say...

If real then this is not a fair reflection of the benefits of leverage and the declining real value of the debt. If nominal then Michael your IRR looks optimistic and needs to be discounted.

Also, I'm not sure of the merits of your analysis taking SVRs today at one point in the cycle and comparing that to long run average growth figures. To be fair you have to see the combination:

- Low SVRs = low holding costs at a time of low capital gain
- High SVRs = higher holding costs at a time of usually higher capital gain as a result of economic growth or inflation.

So there is natural support / compensation for the investor at most usual points in the cycle although you have to watch out during the transitions (eg high IRs and low cap gain like last year - on average across the market).

Bit like riding a bike into the wind - going uphill you're not that exposed to the wind which helps compensate for the difficulty of climbing. Going downhill you get greater wind resistance to compensate for the ease of coasting.

Either way you still keep going forward if you choose to put a little effort in...

 

[MichaelW]

Are the numbers in this study real or nominal? It doesn't say...

If real then this is not a fair reflection of the benefits of leverage and the declining real value of the debt. If nominal then Michael your IRR looks optimistic and needs to be discounted.

Good point.

But even if they are nominal, which I suspect, then the returns are still good. Even if we discount the IRR for the inflation rate at the top end of 3% then we end up with 6.2% IRR against a prevailing 5% interest rate. Now I know interest rates will rise, but if you take out a loan today then it will fall in real terms as its pegged to the debt level which remains a constant. Sorry if that time value of money stuff is all a bit heavy for some, but its the true strength of property investing IMHO.

And, of course, I just ignored the 1% odd additional return you might get from negative gearing your non-cashflow deductions such as depreciation. But I did that so that I didn't have to worry about countering arguments about other expense categories. Sort of balance each other out for a high level analysis.

I'll happily take 5.2% nominal compound growth and 4% rental yield rising with the rate of inflation. Put those two together against a fixed capital amount loan which falls in real terms over time and you have a winning formula.

Cheers,
Michael

 

[evand]

Looks like youre making lemonade from lemons there Michael, which of course is your perogative.

Expenses over interest payments are usually 2% of the asset value. I always calculate current interest rate + 2% for total costs.

As for neg gearing not everyone benefits the same of course due to varying marginal tax rates. Some don't neg gear at all.

 

[MichaelW]

Looks like youre making lemonade from lemons there Michael, which of course is your perogative.

Expenses over interest payments are usually 2% of the asset value. I always calculate current interest rate + 2% for total costs.

As for neg gearing not everyone benefits the same of course due to varying marginal tax rates. Some don't neg gear at all.

Good points Evand, thanks!

But thinking on this again, given the debt amount is fixed, then looking at it in nominal terms is not a bad approach. i.e. If you get 4% rent and 5.2% growth then your return is 9.2%. If it costs 5% in interest (assuming 100% loan) and 2% in other costs, then your total costs is 7%. I'll conservatively assume no negative gearing handback.

Still leaves a 9.2% return against a 7% cost in year 1.

In year 2, rent has increased in line with inflation so you're now yielding 4.12%. Also, your capital gain compounds so you're now getting 5.47% capital gain. Your interest costs are pegged to the locked debt amount so don't compound. Sure, cyclical rate movements if variable need to be considered, but even if you lock at 7% you'll still eventually see the compounding growth and yield outstripping your locked (depreciating in real terms) interest rate. In fact, 9.2% still beats 9% in year 1 so even from the outset if your interest rate is 7% you're ahead.

All good, and thanks for the 2% ready reckoner.

Cheers,
Michael

 

[HiEquity]

Hi Michael

I should just add your scenario there assumes CPI rental growth and (more than that - 5.2%) for capital growth. The logical extension of this is that yields trend to zero which of course won't happen. IMO the same factors driving capital growth drive rental growth over the long term. So I would expect the same nominal / real growth for rents.

Of course recent (10-15 years) history has yields dropping due to a number of factors, however this may not continue. Indeed, the main argument for buying your own place "back in the day" used to be to protect yourself against rapacious landlords upping the rent in big slabs. More recently (2-3 years) we have been seeing this happening again and with a combination of low construction rates and impending high inflation this might not be the end of it...

 

[black dragon]

They were nominal.

Cheers

Black Dragon

www.sqmresearch.com.au

 

[Pete]

Another little thing I wanted to point out and alluded to above, is the implication of a 5.2% compound annual price appreciation. If we accept that we also receive rental income of around 4% yield and ignore negative gearing income as well, then we get a net Internal Rate of Return (IRR) of 9.2% from this asset category.

My understanding is that adding the capital growth and yield rates does not give the internal rate of return. The internal rate of return is calculated over a given period as the interest rate that would give the same final position as acheived for (time based) cashflows in and out. I'm sure Wikipedia will have a much better description than that! Cause having read what I've written, it isn't clear. So if one started with a cash deposit of $100,000 at time zero and then accounted for all cashflows in and out - rent, interest, etc - and at some time the investment is worth $X, the IRR is the interest rate that when applied to all the monies in and out also arrives at result $X.

regards,

 

[HomeBuyAU]

House prices in Sydney were insane in 2003. I had just arrived back in the country in 2003 funny enough after living overseas for many years and I was shocked how expensive house prices were back then. I think they are still far too high compared to the rest of the world and I wouldn't be surprised if they hardly move up for another 7 years. But head out 2 hours from Sydney to smaller towns close to beach (within 30 minutes drive) that are much more friendly and offer clean air, no traffic congestion and all the other problems Sydney has and the prices are much more realistic and that is where the growth will be in the next decade.

 

[Bill.L]

Hi all,

Taking 20 year look at Sydney is being a little mischievous.

1989 was near the top of the boom, while today's prices are near a low, so a 20 year look includes 2 downturns and 1 boom. In the 3 years prior to 1989, house price medians rose from $98,000 to $170,000.

Simply taking a 23 year look instead of 20 years, so you include 2 booms and 2 busts, gives closer to 6.75% cap growth per annum.

It is amazing what you can do with statistics if you want to show something.

bye

 

[Trogdor]

My understanding is that adding the capital growth and yield rates does not give the internal rate of return. The internal rate of return is calculated over a given period as the interest rate that would give the same final position as acheived for (time based) cashflows in and out. I'm sure Wikipedia will have a much better description than that! Cause having read what I've written, it isn't clear. So if one started with a cash deposit of $100,000 at time zero and then accounted for all cashflows in and out - rent, interest, etc - and at some time the investment is worth $X, the IRR is the interest rate that when applied to all the monies in and out also arrives at result $X.

regards,

Correct - see the XIRR function in Excel (and also IRR for periodic cashflows).

 

[perky29]

Hi all,

Taking 20 year look at Sydney is being a little mischievous.

1989 was near the top of the boom, while today's prices are near a low, so a 20 year look includes 2 downturns and 1 boom. In the 3 years prior to 1989, house price medians rose from $98,000 to $170,000.

Simply taking a 23 year look instead of 20 years, so you include 2 booms and 2 busts, gives closer to 6.75% cap growth per annum.

It is amazing what you can do with statistics if you want to show something.

bye

Agreed.
Lets look at a figure for , lets say Padstow Heights. A suburb some 22 km from Sydney. My mothers house.
House bought in 1974 - for 35k.
Same house now, would be around 420k. So 12 times as much.
35 years , 3.5 times doubled (i.e doubled to make 2 times, doubled to make 4 times , doubled to make 8 then "half doubled" to make 12).
Therefore doubling every 10 years - equals 7.2% growth each year.
This to me would be a fairly consistent figure in most suburbs of Sydney....

 

[craigb]

I can understand the numbers, they are based on an average, non the less if you did however purchase for 400k and then a westfield poped up in your suburb, and then they added other infrestructure ie trains, planes and automobiles, then the increase might be around 60% in the 7 years, but i would'nt be saying sydney prices went up 60% , would i now?
But it does and it happens , this is why we are all on SS, because the more you learn, the more you earn

 

[topcropper]

Hi all,

Taking 20 year look at Sydney is being a little mischievous.

Great point Bill.

Taking Sydney prices from 1987 to 2003, would show incredible growth.
Taking Sydney prices from 1989 to 2009 would show miserable growth.

See ya's.

 

[Sunfish]

Great point Bill.

Taking Sydney prices from 1987 to 2003, would show incredible growth.
Taking Sydney prices from 1989 to 2009 would show miserable growth.

See ya's.

Here's another example in a regional town over a longer period:

Bought in '68 for $10,000 with a current value around $300.000.

This means it has doubled every 5 years. But when it was bought it was towards the edge of "civilisation", today it is at the demographic heart of the city with everything bar a cinema within walking distance, and has 1012 s/m of dirt with development rights.

I never felt I was growing rich though because I could never sell here and buy in Sydney or any sea/tree change lifestyle block. I couldn't even buy a large apartment off a developer if I were to sell and buy back. It has always just been "our house".

 

[keithj]

Great point Bill.

Taking Sydney prices from 1987 to 2003, would show incredible growth.
Taking Sydney prices from 1989 to 2009 would show miserable growth.

Great points Bill & TC. Those figures emphasise that over many peoples investment term (20 yrs or less) housing can either just about beat inflation, or it can be a great investment. Timing does matter.

Maybe a subject for another thread.....

Does timing matter more than location ?

 

[evand]

This is a good point and timing is very important imo. My first priority when buying IP is 'when' and the second is 'where', third being 'what'.

After that i dont care much and i dont get into the minute analysis everyone seems to love on here.

I have never been a 'buy anything, anywhere, whenever i can afford it' type of investor.

To me thats more like just accumulating properties for the sake of it....mom and pop investing as it were. Rather than maximising performance from property investing.

Does timing matter more than location ?

 

[willair]

I think timing and location are very important and understanding what the market within the market means,some we bought in 1990 for 75k and less inner city southside locations are now in the 900k range,some bought in 1998 for 50k are now worth 450plus k,one bought in 2001 FOR 50K is also in the 400k range so if you are conditioned to believe in the 7 or 14 years investment time frame that's fine, but i know for a fact property can double several times over a five years period or in one year in Brisbane,just depends on the land and location,and they don't make any more prime inner city RE..willair..

 

[Cherry Pro]

I possibly do not have the breadth of experience and knowledge of most of the people who have added to Michael's post, but let me add that I've gained immensely from reading these posts.

Keep 'em coming pls

Amelia