Why you probably shouldn’t buy your first home just yet
Home ownership. The great Aussie dream; but for the generation who have watched the value of their parents home move from dizzying high to dizzying height, a dream that is slipping further and further out of reach.
My parents picked up their first home when my mum was 25. Despite two kids to feed and a single income to support the family, they managed to buy what would be our place of residence for the next 18 years.
So what has happened in the 25 years since to change the reality from buying your family a home being a generally accepted norm to a now near impossibility for the average Gen Y?
A combination of aggressive speculation from property investors, lucrative tax breaks in the form of negative gearing, and an undersupply of dwellings (despite our geographic vastness) has resulted in tremendous increases in both value and demand for property. Demand that is now handily outpacing growth of real wages and rental yields:
House prices in real dollars
…and rewriting long term average housing price trends:
Long term houseing price trends
Rarely does a day go by when we are not bombarded by a media report of house prices doubling, or young people being locked out of the market permanently. This is creating a sense of urgency and fear that if we miss out now these opportunities will never again be repeated. Couple this with the absurd belief that renting is somehow evidence you have failed, people are doing just about anything to “get on the property ladder NOW”.
Is appears no sum is too high to gain entry, with mortgage repayments now exceeding 7 times annual income. To compare, a decade ago this was closer to 4 times annual income. The resulting effect is mortgages that take decades longer to repay than our parents endured, and a high degree of susceptibility to the impact of rising interest rates. To achieve this we now need to forgo lifestyle choices like starting a family in lieu of getting “ahead on the home”. Doesn’t sound like much of a dream to me.
“But buying a property is the only way to get ahead”
It would be disingenuous to suggest that homeowners have done “all right” out of the property market during the last couple of years. In the past 4 years – against the backdrop of the GFC – shares (both domestic and international) have tanked, bond yields have fallen, and fixed interest and cash investments has barely beaten inflation. Australian residential property prices, however, have managed to improve by a whopping 12.5 per cent annualised.
To put this in context, if you picked up a nice two-bedder in Brunswick for around $400,000 in 2006, you’d now be sitting on a property valued closed to $600,000. Invested the same amount in the share market? Well you’d be just about back to where you started right four years ago.
No one will debate what fantastic gains these have been for property investors; but what about the benefits for owner-occupiers? For those of us who want to live in the homes we buy, it’s a bit of a zero-sum game. Great, my house is now worth 50% more than when I purchased, but so are all the other houses in my street. Suddenly raising property prices don’t mean we’re any richer, they just mean housing is less affordable for those who don’t currently own.
“So I’ve got to buy now, or I’ll never be able to?! “
Hold on there sparky. Property has experienced a dramatic rise in recent times, but can this be sustainable?
Let’s take that figure of 9.5 per cent and extrapolate it a little. Our modest 2-bedder off Sydney Rd would now costs $600,000 if we were to buy it again. If this trend continues, house prices will double roughly every 7 years. Suddenly today’s 25 year olds are hitting their 30’s, and find entry into the property markets starts a $1m+.
Even with above average income growth, the average home now takes 11 years of full time income to pay the mortgage. There is not a western economy on earth that can support this level of commitment.
“So what’s going to happen then?”
When times are good, it’s easy to maintain a positive bias that times will always be good. Negative data is swept under the carpet and we rationalise current behavior as the norm, even when we can see it is anything but normal. I feel we are in a period right now that people will look back on and say “how could be have been so naïve?”
Australia’s property market is built on extremely shaky foundations of high investment, low interest rates, and expectations of continued capital growth. It is only going to take one of these to crumble for the entire market to fall.
This is an unpopular suggestion, but not a fringe view. Government understands the dramatic circumstances of a correction, or even slowing growth. Recall the recently high level of stimulus in the form of the doubling of the First Home Owners grant following the GFC. If the housing system were to fail at that time the effects would have reverberated through every facet of the economy. The government acted, and they acted large.
Out banking sector too is acutely aware or the risk. Try to get a loan as a first homebuyer today. Lending practices are be reigned in tightly, with deposits increased and strengthen due diligence. The banks have factored in a correction and are safe guarding themselves from default.
So if growth isn’t sustainable, how bad is it going to get?
There are two schools of thought on that one. In the best case, we will see prices dip, and then stagnate. In this scenario we may see the economy slow following an economic event such as weakening in China, or/and an increase in unemployment. The reserve bank will drop interest rates, but this alone will not be able to stablise prices. Speculation will decrease and investors will start to look for alternative assets to stick their money. Rents will increase, as remaining investors chase income over capital growth, but by how much will be a function of market demand.
In the worst case, we will see the type of carnage experienced in the US and the UK over the last few years. Prices will drop by 20 per cent, which might sounds great, but you probably won’t have a job to be able to afford the repayments if you did want to buy a place. The knock on effect across the entire property landscape will be dramatic as investors desperately try to sell property additional to their personal housing needs at whatever price they can get.
How do you prepare yourself for this?
I truly feel this isn’t an “if” but a “when”. This is the time to be building a suitable capital base that can act as your war chest when the panic hits. You will not be able to secure a mortgage with a 10 per cent deposit when the decline happens. Already banks want to see 15-20 per cent of the purchase price upfront and strong future repayment capacity. As soon as they start to get a bit more jittery they will tighten conditions significantly. If you want to capitalise on falling values by buying your primary place of residence (and maybe an investment property if you feel conditions will improve) during the downturn, then you need to start thinking more about holding 30-40 per cent of the purchase value of the property you are hoping to buy. This will provide you security in both the knowledge that you are someone the banks will want to lend money to, but also that you have a buffer against rising interest rates when they start to bite on the upswing.
There may be a lot of attractive reasons to start thinking about buying property now, but don’t let yourself be guided by the past. Research, understand, prepare, and only then dip your toes into what will probably be the single biggest financial decision of your life.
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Longstraws 
Good read. I think a lot of people who analyse the data objectively would be inclined to agree with you.
One factor that has been crucial in supporting Australian house price rises during the GFC has been the historically high rate of population growth (read: net migration), which has exacerbated the pre-existing supply side shortage of homes. Since March this year, better laws relating to skilled migration loopholes have helped to cut the rate of net migration by almost half. Not long from now, I anticipate that the reduced population growth rate will help to soften the housing market. With Gillard and Abbott both retreating from Rudd’s “I believe in a big Australia” statement earlier this year, the political climate seems to have shifted.
On the other hand, one of the key factors making capital city house prices so high is the reluctance of state governments to rezone the urban fringe to make it eligible for subdivision. The lobby against urban sprawl will only increase in the years to come, though it is worth noting that the Vic state government rezoned an enormous amount of land earlier this year. Sob stories from bogans demanding their right to a McMansion will probably keep state governments rezoning land periodically, and progressively undermining the benefits of their other urban density, transport, and service provision policies that require higher density. Fucking bogans.
One of your graphs was from debtwatch: Steve Keen’s “now, not when” wager sure got him on a bit of a long stroll the other month. The problem with objectively analysing data and predicting events is that the data is a lot more objective than the people making the purchasing decisions. The purchase of a primary place of residence brings the emotion of security (rightly or wrongly) to a lot of people, and the need for security arguably increases during periods of rising asset prices. Property investment, too, is driven by some sort of “empire” emotion that all territorial animals possess. This emotion-driven reality suggests to me that the price peak will arrive suddenly and then fall sharply (probably driven by a negative external event that shakes them out of their torpor), rather than the period of stagnation option that you offer.
You’ve got more experience with the banking side than me, but I was interested to see that you think loan deposit requirements will increase to 30-40% of property value. While risk management is surely an issue, a lot of the deposit requirement might depend on international conditions in the credit markets. If lenders are able to cheaply source funds, it’s likely that they’ll still want to lend to people with good credit histories. Even right now in the US, people with good credit histories are receiving unsolicited credit cards and mortgage offers in the mail. With the housing market so weak, the banks’ capacity to lend has become higher than the borrowers’ willingness to borrow. With asset prices already far below their previous levels, I’d think that US banks are of the opinion that additional major falls in property prices are unlikely. As such, anyone with adequate income and with a good credit history may well be able to source mortgage finance from a bank in a relatively straightforward manner.
Again, good stuff mate. Impressed that you put in that much work for an after hours hobby!
Oh, and in the 2nd para below graph #2, you’re referring to house prices, not mortgage repayments.
G’day mate – really appreciate the time you spent replying. My greatest fear was someone smarter than me, who actually knew what they were on about, would read this! As you can probably guess, a fair few of the assumptions behind this area are easily challenged, but hopefully it provides some background and context for those who haven’t read much more than the REIV reports stating that property values will only every continue upwards.
Thanks again for taking the time to craft such a comprehensive response.
Nice piece mate. Interesting comment about banks self-correcting with deposit requirements.
Same thing happened at the start of the GFC about 6 months before it hit Oz with retail evelopments. Banks started to require that otherwise sound developments have a major retailer signed up before the project’s finance would be available (effectively 40 – 50% of the potential rental earnings). This saw a dip in commercial & retail projects as would be expected, but the surprising thing was that it stopped a lot of projects at the very end of the pre-construction period. Deferral & abandonment rates at the stages just before works commence went from averaging 2% to around 10%, which represents a huge volume & made for not just a slowing of the pipeline of projects coming to construction but a sudden evaporation of projects almost at construction. The retail property became a 3 – 6 month forecast of the dip in the economy. At the other end of the period the 6 – 9 month pre-construction period for retail projects had a lag effect on the recovery, which wasn’t felt in the overall economy due to the timing of the education & infrastructure projects of the government.
Applying to the residential market, should banks dramatically increase deposit requirements for home loans, residential construction could not just slowly dry up but suddenly crash. Residential construction makes up 25% of building works by value and construction is one of Australia’s biggest industries. A slightly shorter pre-construction period of 4 – 6 months will mean that when it recovers it won’t lag as much, but will still have some effect. If we go into negative growth due to housing it can be reasonably expected that it will take at least 2 quarters to recover.
Of course first order economics would suggest that the bubble will burst, prices will fall, developers will consolidate, then a steadier middle ground will be found. However second order conditions (ie the real world) bring expectations into the picture & the question becomes whether the players involved will be able to deal politically the reality & bring about the correction sooner or later. The banks are already fairly conservative in Australia, it would silly to demand more of them than to voluntarily raise the deposit requirements. Individual consumers will behave with expectation-driven self-interest not necessarily related to the real sitiuation (hence the bubble in the first place as you point out). It is the government which must at some point face the economic reality of this mess, but for how long can they hold out? Negative gearing is too well established in Australia, even if we’re one of the last countries to allow it & all countries holds to the “truth” that the populace owning land & a house is the only real way to have sustainable growth. Developers are major contributers to both political parties in every level of government. Chances? Not good. Just to make things a bit more dramatic, Things Bogans Like is not quite right about land releases. There are some massive tracts of new land being released in Sydney & the Central Coast (search “land release” at http://www.planning.nsw.gov.au/SettingtheDirection/Contactus/MediaCentre/tabid/381/language/en-US/Default.aspx) also Brisbane & Perth. I doubt that this supply will stop until carbon taxes become a reality & effect demand.
Oh, and Daft Punk is going to be awesome.
Trust my only two econ mates to respond with such quality.
Daft Punk is going to be awesome? Sounds like they’re a small band that’s just about to blow up 🙂 Looking forward to the new soundtrack too.
Tidy work. With the deposit requirements stuff, the behaviour of banks that each of us were describing was at different points in the correction period. If it becomes apparent that there’s probably an unsustainable bubble and house prices are still riding high (i.e, your example of the retail property panic early in the GFC where the signal came ahead of time from overseas), then banks will tighten their lending requirements as a hedge against falling asset values. That was the bit you were referring to, and I agree. If the market peaks and falls in a more unexpected way, the banks might not have previously thought their risk exposure to be as high (such as US housing lenders in 2007, who thought things were great until it was far too late), then they’re likely to be more screwed (though not nearly as screwed as the US, due to a more sensible approach to risk in the first place).
The bit I was referring to was after a fall, when asset prices have already sustained much of their losses, and yields etc are rebalanced. If the bank didn’t topple during the dip, has access to capital, and a prospective borrower has a good credit history, they’d quite possibly be climbing over each other to sign the borrower up for a mortgage that is likely much more of a sure bet than half of the shaky stuff still on their books from a couple of years prior.
The points you made about land planning and releases are rad. 10 year vision policies towards urban planning are a favourite hobby of state governments, with all sorts of high minded goals like high density activity centres, urban infill, and mixed use developments incorporating apartments. During the 10 year period that follows, NIMBYs, housing industry lobbyists, and unforseen circumstances have the habit of prompting the government to abandon the key principles in the policy, and unlock another 30,000 under-serviced blocks in whoop whoop. Almost 50% of new dwellings approved in Melbourne this year have been medium or high density, though, which is well up on the historical average. Community sentiment does seem to be swinging towards more density and less sprawl, but it’ll take time, and there’ll be conspicuous slip-ups along the way.
The negative gearing thing is a massive reason why house prices have become so disconnected from rental yields. As you say, there’s next to no chance the policy will be changed in the next few years, because there are just too many Gen Xs and Baby Boomers accumulating major paper wealth from the tax breaks. But if in a few years, the number of younger buyers who have been priced out of the market and become pissed off reaches a critical mass, it could be that it becomes in the political interest of a government to win them over by winding back some of the negative gearing system. Will be a fair while off, though.
Nicely summarised. Completely agree. In other words, buy a sawn-off & an awesome black car instead. Someone’s gotta be Mad Max when it all falls apart.
First thought after readiing the headline, “don’t move in with your women”, that’s where emotions and security overtake economics my friend.
Considering myself, who just bought my first apartment a few months ago, it wasn’t too much of a concern about the quality of the investment, as I believe that there isn’t too much room for capital growth in the overall market, or shouldn’t be, but the ongoing future income that can be derived from it is something that was factored in. My search took place from 2009 to mid 2010 and in that time 2 bedders increased due to Govt policy such as FHBG propping up the market a good 20%. But when based on household income I don’t see a big issue in affordability; based on the SMH article today:
http://www.smh.com.au/opinion/society-and-culture/housing-bubble-toil-and-trouble-is-a-witches-brew-of-discontent-20101014-16lpr.html?autostart=1
The value of a residence based on income compared to past (when looking at Aus only, ignoring other countries) as it is now about 7 times average income to buy the average house, whereas back in 1994 it was about 4 times average income. But something important being forgotten here is the rise in dual incomes in a household, women have either moved into work, or increased to full-time and are on larger take home pay.
“That is why the Reserve Bank prefers to use household disposable income (i.e. after-tax) when considering movements in affordability. This measure paints a better picture of affordability – with the median house price just over four times the average household income of $95,100 a year.” (J Irvine: SMH)
Still as mentioned above, I can’t see how so called investors are going to make any money from property anytime soon. But the Govt allowing you to claim not only the expenses based on your property, but also to bring down your income, is always going to create so called property investors (speculators) making the property market overvalued.