Australia has experienced an astounding rise in housing prices over the last two decades which has rendered it one of the world’s most unaffordable. Accordingly, it is worth decomposing the returns to examine how housing as an investment class has fared over the long-term.
Housing has two forms of return: price change (growth) and yield (income). In terms of the former, it is simply the change in the market price of a property or entire housing market, usually on an annualised basis. The latter consists of the annual rent as a percentage of the property’s market price.
The data presented below are based on the following assumptions:
- The growth returns are unadjusted for taxes;
- Realisation of growth returns are unaccounted for;
- Gross yields are halved to arrive at net yields. Academic research, and ABS and ATO data demonstrate expenses (excluding debt payments) for owner-occupier and investment property are around half that of imputed and actual rents;
- Quarterly time series are adjusted for inflation using the Consumer Price Index;
- Annual time series are adjusted for inflation using the Household Final Consumption Expenditure implicit price deflator (HFCEIPD); and
- A 5-period moving average (PMA) has been applied to smooth the annual data and a 2-PMA for the quarterly data.
Real net yields are very poor, especially in the cities where price growth radically outpaced that of rents. This compares to the highest yielding term deposit of around 3%, and as there are no expenses, the gross yield is equivalent to the net yield. It is also protected by the government’s Financial Claims Scheme (deposit guarantee). Furthermore, while the income flows from a term deposit are constant, the same cannot be said of that from housing in the case of investment property (i.e. Perth and Darwin) or intermittent use of owner-occupied property (which is likely to be rare).
The forces of inflation and deflation play important roles in the economic welfare of residential land owners. Inflation is unequivocally detrimental as it decreases the real growth and income returns. Today’s low inflation, however, is assisting returns in two ways. First, there is less erosion of returns, and second, low inflation prompts low interest rates, which has helped to boost growth returns. This is especially true given debt-financed speculation (debt acceleration) determines housing price growth.
On the other hand, for those who have entered into the market with debt, inflation is useful as it inflates away debt payments. This is only the case, however, if the inflation is manifested in wages. As we have explained elsewhere, the low rate of inflation is a curse upon recent buyers, as they face an unenviable situation of bearing the largest debts combined with the lowest nominal wage growth in post-WW2 history. Housing affordability is presently the worst in over 130 years of economic history when the lack of wage inflation is taken into account.
Deflation enhances the welfare of owners as it boosts real growth and income returns. This occurred during the 1890s, 1920s and 1930s, helping to offset the negative returns to growth during the two economic depressions. For those with minimal or no debts, deflation is a benefit; our currently low rate of inflation could turn into deflation. It would not be good, however, for the many mega mortgage mugs chained to gigantic debts by our system of usurious rent extraction.
Given the paltry real net yields, it makes little sense to enter the market. Of course, the reason people do is because of the rapid returns from growth, driven by the household sector’s accumulation of a historically and globally extreme stock of household debt. As explained here, for as long as the returns to growth outstrip the net rental income losses (expenses plus debt payments), housing investment is a worthwhile endeavour.
While the net yield is always positive in nominal terms, inflation has often resulted in negative real net yields in the post-War era. Cumulatively, the income component has pulled down returns but has been more than offset by the growth component. While housing did post a positive cumulative return briefly during the peak of the late 1980s real estate bubble, it did not become persistently positive until 1997Q4.
Since then, the astronomical rise in housing prices has produced large windfall returns to owners. The down side of these stellar returns has been the rise in household debt that has driven the growth component but increases risks in the housing market.
If the returns to growth were to turn negative, let alone significantly, the present real zero income returns would not be able to offset these losses. Those with large debts (and therefore likely negatively geared) would be savaged; hence the total abandonment by government and regulators of measures (on debt, tax and planning) advocated by affordability proponents for reining in housing price growth.
The housing market has become too orientated towards returns from growth rather than from income. Fortunately, the rate of inflation has declined, lessening the erosion of income returns. As noted, the flip side of this dynamic is the creation of a large cohort of mega mortgage mugs who cannot rely upon wage growth to inflate away their debts as previous generations had the benefit of.
A shock from leftfield in the form of a Royal Commission and class action law suits seeking gargantuan levels of damages on behalf of defrauded borrowers would inevitably reveal the mortgage control fraud running rampant throughout the banking and financial system over the last two decades, aided and abetted by the regulators. Toxic jumbo-sized mortgages far in advance of affordable serviceability guidelines have been pumped out by lenders to maximise short-term profits.
These public and private (and fully justified) assaults against the banks and regulators would have the effects of reducing banking sector equity, increasing wholesale funding rates and seizing up capital markets. With borrowers unable to acquire ever-larger debts, housing prices could plunge, wreaking havoc upon the returns to growth. While this disadvantages all owners, those overleveraged at the margins would suffer the greatest financial losses.
Under these circumstances, the only option left for them is to pray.