Is now a good time to invest in Real Estate?

Prices have gone through the roof for residential real estate in a number of countries including Australia. Quite rightly, people often ask is now a good time to buy real estate or should I wait?

Quick answer is if you can buy well, then conditions look good.?

Long answer below.?

My initial thoughts / concerns were sparked by the rumblings from the USA of inflation and interest rate rises. The dial for the property gains in Australia will be affected by interest rates normalizing over time driven by inflation pressures globally which will effect OS interest rates and eventually all non bank lenders and a large part of wholesale bank funding. I question a significant part of Australia's borrowers ability to service growing interest rates given our level of debt as per the first link.

https://datamentary.net/australian-house-prices-over-the-last-50-years-a-retrospective/

• The implication from this Article (see last section) is that in Sydney we are getting close to the affordability limits for mortgages only hit in 1990. Then we had a recession we had to have. Very different interest rate (17%) and employment situation I know. Now we have the lowest ever interest rates.?
• Melbourne and Brisbane hit that same peak in 2007 and we had the GFC albeit for other reasons.?
• The figures most importantly are adjusted for inflation.?
• Interest rates are at record lows, the money supply is at record highs. There is very little room for interest rate rises at all for mortgage borrowers. Many property investors are mortgaged to the absolute hilt and competing with each other. See graph of interest rate compared to private debt https://d3fy651gv2fhd3.cloudfront.net/charts/[email protected]?s=rbatctr&v=202108030509V20200908&d1=19960829&url2=/australia/private-debt-to-gdp .
• I speak to real estate investors each day and the entire industry is about making it as easy as possible for anyone to keep buying. Yields are falling below 4.5% for residential investors in many instances and that is cash flow break even. It is not that rents are not rising, it is that property prices are rising faster. Many people are extremely sensitive to interest rate rises as they keep borrowing every year or two to get another house and grow a portfolio. So they remain at max LVR in perpetuity with little interest in principal repayments as all they want to do is borrow against the capital appreciation for another one (hit repeat).??
• My understanding is banks currently stress test mortgages at 5.75%. Anything approaching even 8-9% mortgage rates would be catastrophic for those at high levels of debt. Let alone anything in the teens and I am old enough to recall my family nearly went under on a development in Manly in 1980 when rates were over 10%. In fact rates since 1968 were above 6% until about 2014 when we came out of the last recession and have continued down to remain at their lowest level ever. https://www.infochoice.com.au/wp-content/uploads/2019/08/rate-history.png . If you want to see how unique this time is in the last 200 years then check out this link for USA interest rates https://advisor.visualcapitalist.com/us-interest-rates/?
• This makes inflation signs anywhere of real concern. If Australian bank and non bank borrowing costs of money go up OS then so will interest rates in Aust. The RBA is easing back on bond buying with a view to eventually cut it out so Australian easy bank money will slow and end eventually.
• There is already significant building cost increases in the US (also Australia) so early signs of inflationary pressures.?
• P&G on the consumer goods side (not assets like property) are also seeing commodity and freight increases https://www.reuters.com/breakingviews/pg-puts-stark-number-inflation-2021-07-30/?
• Wages growth is virtually non-existent of late in Australia. Interesting to compare it to interest rates https://d3fy651gv2fhd3.cloudfront.net/charts/[email protected]?s=rbatctr&v=202108030509V20200908&d1=19960829&url2=/australia/wage-growth .
• The Government are being forced to subsidise First Home Buyers getting into the market. A sure sign that we are at or near affordability constraints.

But

• I am not suggesting for a second that the Australian property market is showing signs of problems at the present time and I join most commentary in suggesting that this will continue through 2022 and beyond. Migrants, backpackers and tourists are all set to come back at some point of course.?What I wanted to look for is where signs of a peak will show up.
• The interesting political finding during covid was that land prices went up and unemployment went down even in the absence of immigrants in Australia. Although you could argue that returning expats have had an impact. Tourists dried up so tens of thousands of airbnb apartments were repurposed into long term accommodation.?
• As tourism comes back in 2022 (we hope), some landlords will revert back to short term rentals leading so more long terms renter accommodation requirements in areas with traditionally higher vacancy rates during covid such as CBD, Waterloo, Parramatta, Macquarie Park. These will come back to long term vacancy rate averages and go lower I believe.?
• Additionally, immigrants will again locate to cities and straight into apartments further soaking up demand. It is a reasonable assumption to consider housing shortages in Sydney should immigration kick in again https://www.smh.com.au/national/nsw/significant-challenge-minister-says-migrants-will-need-apartments-that-aren-t-being-built-20210617-p581zk.html.??
• With low wages growth and continuing high demand for property lending, I do believe there is at some point constraints to debt to earnings (on average). The cost of servicing the debt is currently affordable in general (defaults are low). Interest rates are the lowest ever. Employment prospects in Australia look good. We may even see some slight wages growth in 2022 and future years. cool
• Interest rate forecasts 0.5% increase to the end of 2022. Not entirely cataclysmic I agree but on face value the likelihood of interest rate rises is increasing and not decreasing. https://data.oecd.org/interest/long-term-interest-rates-forecast.htm#indicator-chart

In researching this question of why is Real Estate is still a good investment, I was referred by John Rankin of Ibuynew to check out Phil Anderson who wrote a very thought provoking book “The Secret Life of Real Estate and Banking” (2008).??

My key takeaways from the book

• Read it if you enjoy the odd economics book as whether you end up using the cycle or not, it is a thought provoking book that helped me reframe my mortgage.???
• Phil Anderson is one of many authors to look at economic cycles. The book is well referenced and I have not rabbit dived on any of the other authors referred to.
• The author currently estimates the market is at mid cycle and therefore looking good for the next few years. https://propertysharemarketeconomics.com/18-point-6-property-share-market-economics/ ? . Check out this link also to see a summary and some of the visuals of the cycle.?
• It is US data centric and does touch on other countries such as Denmark, Russia, Australia and the UK. I have read some criticisms that you cannot apply the principles to other markets and for sure that is sometimes valid. The question is if you can dismiss all principles of the book on that basis and that is a much bigger question. I do not think you can as ultimately it is looking at credit growth that ends up with speculation which ultimately leads to a number of borrowers being unable to service debt. This leads to a drop in prices and a restriction of credit which leads to a drop in prices etc etc. I believe that the author demonstrates that cycle which is why it is worth considering. You can argue all you like about the causes but the recessions are economic history the book is about trying to explain them.???
• The credit is created by banks (with a stroke of a pen) which are licensed by Government so that private individuals or corporations can collect the rent on the land they own. The Government grants land title and banking licences being an important discussion point of the book.???
• The average 18.6 year cycle is 7 years growth, brief economic recession, 7 years growth with the last 2 years with even higher growth and referred to as Winners Curse. Then a crash and rebuild phase of 4 years. So on average 18.6 years but it can vary a little either way according to the author.??
• The crash phase wipes about 20-30% off land values on average. Of course there are instances where that was a lot higher. When I was reading about some of the Chicago real estate speculation in the 1800’s I kept thinking of Bitcoin.??
• The US data goes back over 200 years so there are a number of cycles that were studied. Interestingly it spans the time when land was being released to settlers (effectively created) and then right up to today when land supply is essentially fixed. Of course some land can be repurposed from agriculture to residential lots but ultimately the land supply is now fixed.?
• There are leading indicators suggested to monitor the phases of the cycle.?
• Bond yields spread. Means the short term interest rates are higher than the longer term government issued bonds. So people will rather get their money out of bonds (so they go down in value) and into higher short term interest. Interestingly the author points out the level of recession has no correlation to the yield curve. That is better explained by the prior level of asset speculation and therefore indebtedness. So an inversion late in the cycle can signal lower real estate prices to come.???
• Completion of mammoth towers and major infrastructure projects. Also a lot more office buildings gets completed in the second half of the cycle apparently. So after a slump residential recovers first, then commercial. There is a longer lead time on commercial projects also.??
• Copper. Apparently it spikes high late in the cycle. As I write today it is really low.?
• Interest rates rising late in the cycle. Lenders reliant on short term borrowings for long term loans are a concern. Credit gets tighter as Banks need liquidity.?
• Not all recessions are land corrections. The mid cycle recessions are typically shorter in duration and the economy responds well to stimulus. Land corrections are harder and take longer to get over.?
• A land recession is typically preceded by a peak in construction which is typically preceded by a peak in land prices (maybe 1-2 years before the recession which is a red flag most ignore). A banking crisis is common late in the cycle if they are overly exposed to the housing sector. The author suggests that the downturn in construction also has a significant wash on effect in the economy that leads to a larger more general recession. The link for housing into the economy is further explored here https://voxeu.org/article/housing-cycles-real-estate-valuations-and-economic-growth.??
• The Author notes land price is typically around 14-17 times rent. 100/17 = 7.1% to 100/14=5.8% yields. Interestingly in Australia that is what a commercial property yield range was up until recently. Anecdotally, a number of residential property investors are now targeting commercial property which has apparently seen commercial prices rise with a corresponding hit to yields. The point being commercial is closer to the authors land price average. What I find interesting in residential is that yields are lower in parts of Australia. In Sydney an existing house may pay a 2.5% and an apartment 3.5%. Some lower. 3.5% is 100/28 so twice 14. Contrast this to some other area’s in Australia where investors are looking for and often still getting 5+% yields. As investors chase yield they increase rents. Better yields means more borrowing leading to more speculation.?
• So are we paying to much for Australian residential real estate? My first thought was so see how we compare and some useful information here on yields https://www.globalpropertyguide.com/rental-yields. In Sydney at least there is an often cited justification for high prices as we are somehow like NY, HK and London being an international city.?
• I noted the Auckland stat here which shows that yields are not yet as bad as Sydney so in part explains why the price gains are so far justifiable in NZ.?
• Ultimately all yields need to be serviced directly by the productive gains in the use of the land or indirectly the gains in the economy that allow a land owner to service larger debt (wages growth). This is where I scratch my head? Land price is increasing far in excess of wages (in Sydney). Some land pays way more than really good jobs https://www.domain.com.au/news/houses-earning-more-than-australias-highest-paid-professionals-1077289/ . I still remember my year 12 economics teacher telling me that ultimately all economic gains are underpinned by productivity. One of those wow moments in my education so I took Bill Clints famous quote “Its the economy stupid” to mean “Its the productivity stupid”. Apparently not at the moment.?
• Side note. How good do the yields look in Africa. I wondered about that as I had watched this video previously having looked at population growth globally and its decline in most parts excluding Africa in this demographers documentary https://www.youtube.com/watch?v=FACK2knC08E . Summary being the next 4 Billion people on earth will be in Africa and world population should top out at 11 Billion. Really interesting point is that all societies population growth lowers as income rises so sustainable population levels are dependent on income.???

Conclusion

Real estate looks good at present. If the real estate cycle proves to be true then we are just starting out on circa 7 years of growth in land prices. So while land price growth may come back from some high rates in 2021, in general there is no imminent price correction brewing in Australia as long as we all get back to work after lock down.?