Does Australia have a housing affordability problem?

There are a few key words that get thrown around time and time again when it comes to property in Australia. 

Take "shortage" for example. Someone bearish on Australian property as a whole might argue that with 10% of Australian homes empty (according to the latest Census statistics) we don't have a shortage of property in Australia (this level of empty homes has been relatively consistent for the last several decades). Another person who invests specifically in some Perth or Sydney suburbs where prices are rising sharply might argue that a shortage of homes in this specific area is driving rents and/or prices higher. Both of these individuals might be right (in the context of their own views), but they will probably squabble with each other for hours if you lock them both in the same room and tell them to discuss whether or not we have a shortage of property in Australia.

Another one of these key words is "affordability". It has been a very hot key word as prices rocketed to their peak on a national scale in early 2010 (using the RP Data/Rismark indices) and have slowly deflated since.

Some would go to the dictionary and grab the first definition of the word and throw that into the face of the property detractors who say Australian property isn't affordable:

"Afford: To have the financial means for; bear the cost of."

The "affordability problem" deniers will say things like "If Gen Y stopped spending all their money on iPods, LCD televisions, laptops, overseas holidays and widgets, then they would be able to afford a property" (and sadly this is almost a direct quote of the sort of rhetoric I see get thrown around). 

The "affordability problem" deniers will argue that younger generations are expecting too much for their first home. They will argue that living 40km out from the CBD is a reasonable expectation for First Home Buyers, when outer suburbs at the time they purchased meant 8km out from the CBD instead of 5km. They will argue that First Home Buyers should just buy whatever they can (even if it's a run down 2 bedroom hovel which the buyers will grow out of in a few years) to use it as a stepping stone in order to build equity and buy a larger home later down the track. 

The "affordability problem" deniers will argue black and blue that if a buyer can live off two minute noodles, take a cash handout from the government, leverage their savings (and handout) 20:1 (95% LVR) in an environment where interest rates are near historical lows, to buy the worst house on the worst street in the worst suburb of the city they live in then property is still affordable.

Personally I would use this definition for affordability of housing:

"Afford: To manage or bear without disadvantage or risk to oneself."

Both of the above definitions were from the same dictionary, yet both put a fairly different spin on what affordability means in the context of buying a home.

The first definition suggests that if it is financially possible then it is affordable, the second if you can manage it without putting yourself at risk then it's affordable.

Affordability of Australian property cannot be calculated on a mathematical equation alone. 

Some historical measures of affordability have attempted to formulate an affordability measurement based on the percentage of your income which is taken by housing costs. Typically 30% has been a level to gauge affordability (e.g. if you're having to spend more than 30% of your income on housing then it's not affordable), but the problem with this is spending 30%+ on housing could have a much larger detrimental effect on someone with a low income.

Another issue I see with this type of measurement is that the calculations today are being made in an environment where interest rates are near historical lows and pose a pretty big risk if/when they start to increase again.

Take a mortgage holder in the mid 1990s for example who may have had a mortgage rate of 12%. A 1% increase in rates for this borrower is an 8.3% increase on interest costs for the loan. With current low rates a 1% move higher where the borrower is on 6% is a 16.6% increase in cost of interest. For a new borrower this will increase the repayment by a significant amount and poses a significant risk, especially where they have borrowed with a high LVR.

One of the arguments made by housing commentators such as Chris Joye is that the low interest rate environment has allowed for appreciation of house prices and that the price rise can be justified almost completely by the fall in interest rates. Take for example this quote from an article he posted on Property Observer yesterday:

There is a sound explanation for this innovation: the long-term cost of mortgage debt in Australia declined by north of 40% between 1980 and 1995, and 1995 and today. This was largely a function of the long-term reduction in realised inflation and measured inflation expectations, which in turn allowed Australia’s central bank, the RBA, to permanently lower its cash rate.

The radical reduction in the day-to-day cost of mortgage debt permitted Australian households to significantly increase the amount of debt they were servicing without a noticeable rise in underlying mortgage default rates.

Although this argument holds water on a serviceability level, if we look at the effects that a doubling price and halving interest rates have on a mortgage holder over the term of their loan it's a real eye opener (use this mortgage calculator to run your own scenario):

$300,000 borrowed @ 6%

Repayments of $2000 per month

23 years, 2 months to payoff loan

Total repayments = $555,903

$150,000 borrowed @ 12%

Repayments of $2000 per month

11 years, 7 months to payoff

Total repayments = $278,643

The initial interest costs on a $300k loan at 6% is the same as a $150k loan at 12%, however the smaller loan is repaid at a much faster rate if the borrower has the capacity to repay either loan at the same rate.

So are lower interest rates making property more affordable? Not if prices rise to fill the serviceability gap.

By taking on a larger amount of debt, even if the interest rate is half of some historical levels, borrowers are taking on significantly larger amounts of risk and hence by the second definition perhaps can't be considered as affordable as some would make them out to be.

Many bullish housing commentators have been talking about falling interest rates bringing back buyers to the market, but I think that buyers are starting to smarten up on the whole "lower interest rates makes property affordable" lie. Even following two cuts in late 2011 and two more this year (including a 50 point cut in May) we have buyers sitting on the sidelines waiting for lower prices. As Leith points out on MacroBusiness today:

CLICK CHART TO ENLARGE

What is most worrying about this result is that it follows the RBA’s -0.5% cut in official interest rates in early-May. While it is only one-month’s data, these figures imply that this rate cut had absolutely no impact on mortgage demand which, in fact, took another leg down over the month.

Housing credit growth continues to remain at very subdued levels, which ties in with the very low volumes of sale (from RP Data):

CLICK CHART TO ENLARGE

It seems that even if buyers could continue to buy prices at current levels, they are choosing not to afford property (given the risks). A wise choice in my opinion as the short term downside is a much greater risk than missing out on upside.

In my opinion the best thing that Government could do to help any perceived affordability problem is to step back and stop meddling with the markets, let them deflate.

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AUD Gold Price Exceeds Weekly Aussie Wage

The case is often made that Gold is an inflation hedge. However the volatile and cyclical nature of the metal shows that it doesn't practically work as such unless measuring over a long time frame.

For example suppose an individual had purchased some Gold in January 1980 right at the peak for US$850... did Gold keep up with inflation if this individual needed to sell some in 2001 at Gold's low point (US$250)? Of course not, in fact Gold hasn't even yet reached the inflation adjusted high after rising more than 600% from the lows (inflation adjusted high from 1980 is over US$2000). Gold is not practical as an inflation hedge over short time frames. However over long periods of time Gold does hold value in comparison to fiat currencies which continuously deflate in value as the supply is increased at unhealthily high rates.

There are examples from other commentators and authors showing that Gold has retained similar value over very long time frames (hundreds and even thousands of years) against livestock and against objects such as a fine suit. However the problem with this is you are taking two specific points in time to reach a conclusion that may differ if you varied the time frame selected by as little as a decade.

The reality is that Gold cycles in value against assets from overvalued to undervalued and back again (some would argue that it's other assets which cycle against Gold). Some of these cycles might be short term (such as the Gold/Oil ratio which I covered here) or medium term (such as the Australian property priced in Gold ounces, covered here). There are other (non-tangible) things that Gold cycles in value against as well. One of the most interesting I have covered on the blog before was an average Australian wage (see previous post here).

You can see the previous post for the data sources I have used (have spliced RBA/ABS data for wages). For wages I have taken the printed number from the last quarter in each year (as it's not volatile and generally is consistently rising), for Gold I have averaged monthly prices (AUD price) across the year due to price volatility.

Here is the average weekly wage of an adult Australian plotted against the annual (average) price of Gold in Australian Dollars since 1972:

Click Chart To Enlarge

As you can see on the above chart, the spot price of Gold in Australian Dollars has surpassed the weekly Australian wage for the first time since 1989.

Chart in log form (requested by obakesan):

Click Chart To Enlarge

And if we divide the price of Gold into the weekly wage we are presented with this ratio which shows Gold cycling in value against Australian wages (Gold undervalued as the ratio peaks and overvalued in the troughs):

Click Chart To Enlarge

As I pointed out the last time I calculated this ratio, the weekly wage has cycled between around 1/2 and 2 ounces of Gold for the best part of the last 100 years.

1901:

Based on the above figures from the ABS the Wage/Ounce ratio was around .51 ($4.35 wage / $8.50 oz) in 1901. Source

1920:

In 1920 the Pound was valued at USD$3.66, so in USD an Australian weekly wage was around $38.43 and bought 1.86 ounces of Gold. Source

If we took the peak monthly price (instead of averaging over the year) the ratio actually dropped to around .37 in January 1980 rather than the .42 by averaging the Gold price over the year. To get back to these ratio levels we would need to see Gold climb to AUD$3750 or AUD$3300 respectively, assuming the average weekly wage remained at $1391 where it is today. In my opinion either of these ratios is possible (I would suggest likely) within the next few years as Gold shoots to overvalued status against Australian wages.

Despite that I blog on a site which might suggest I am a permabull on precious metals, that is certainly not the case and when I believe that the metals have reached a cyclical high against other assets (and other indicators such over valuation against wages) I will be looking to move a majority of my positions from Gold and Silver related assets into income producing/productive assets.

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Soundtrack to the Global Financial Crisis

And now for something a little different :)

A recent comment from obakesan got me thinking... if I could pick a song per year for the last several to form a soundtrack (backdrop to the major events in each year), what would they be? I came up with the below:

2006: Lilly Allen - The Fear

The US housing market was already seeing volumes drop in early 2006, however the peak national price was achieved in mid 2006. Consumers were spending their new found wealth by drawing equity out of their homes and putting everything on plastic. This level of spending was not sustainable, although few realised it at the time.

Lilly Allen catches some of that consumerist attitude in her song "The Fear":

Life's about film stars and less about mothers
It's all about fast cars and cussing each other
But it doesn't matter cause I'm packing plastic
And that's what makes my life so fucking fantastic

And I am a weapon of massive consumption
And its not my fault it's how I'm programmed to function
I'll look at the sun and I'll look in the mirror
I'm on the right track, yeah we're on to a winner

2007: Freestylers feat. Belle Humble - Cracks

In 2007 the cracks really started to show in the US subprime market. Ben Bernanke famously said in March 2007: "At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained". How wrong he was.

The lyrics from this Freestylers song "Cracks" could almost be a reference to the subprime borrowers, forced to leave their past behind, handing back the keys to the house they couldn't afford and just walking away (following which we saw cracks appear in subprime and the western debt bubble).

Leave the past behind
Just walk away
When it's over
And my heart breaks
And the cracks begin to show

2008: Basement Jaxx - Red Alert

We saw the financial crisis reach it's darkest moments in late 2008 as some of the largest US banks were allowed to fail, while others were gobbled up by larger competitors. The markets started to crash and we may never know just how close we came to a complete financial system meltdown.

The simple lyrics in this track "Red Alert" by Basement Jaxx perhaps sum up the fear seen in the markets at this time:

Red alert! Red alert!
It's a catastrophe
Don't worry.....Don't panic
Ain't nothin' goin' on but history, yeah
But it's alright, don't panic

2009: Hayek vs. Keynes - Fear the Boom and Bust

This song could be considered a bit of a cheat entry, given that it's worded specifically around some of the actions taken by central banks over late 2008 and 2009 to combat the financial crisis, dropping their rates, increasing their spending/stimulus... it's all here in this tune.

Here are some lyrics from the rap:

You see it’s all about spending, hear the register cha-ching
Circular flow, the dough is everything
So if that flow is getting low, doesn’t matter the reason
We need more government spending, now it’s stimulus season

2010: Muse - Uprising

Riots in Tunisia started during December 2010 and were in part fueled by high food inflation, many would argue this was a direct result of Fed stimulus (but this was denied by Bernanke). The revolution spread to Egypt, Libya, Yemen, Bahrain and elsewhere over 2011 and became known as "Arab Spring".

The Muse song "Uprising" works well with this video of Egyptians at a battle over the Nile:

Rise up and take the power back, it's time that
The fat cats had a heart attack, you know that
Their time is coming to an end, we have to
Unify and watch our flag ascend, so come on

They will not force us
They will stop degrading us
They will not control us
We will be victorious, so come on

2011: Spandau Ballet - Gold

2011 was an exciting year for Gold and Silver. Silver seeing it's peak early in the year, putting in a top around the same level as the January 1980 peak (US$50).

Later in the year Gold had a strong rally and peaked over US$1900. There's probably a better song to capture the metals performance in 2011, but for now "Gold" from Spandau Ballet will have to do:

Gold (gold)
Always believe in your soul
You've got the power to know
You're indestructible
Always believe in, that you are
Gold (gold)
Glad that you're bound to return
There's something I could have learned
You're indestructible, always believe in...

2012: Open to suggestions?

We're not even half way into what has already been a turbulent year for the markets. The debt crisis in the Eurozone is already underrepresented in the above themes, perhaps something from Rage Against the Machine "Killing in the name" or "Township Rebellion" in reference to the rebellion against austerity measures? I'm open to any ideas...

Perhaps you have your own version of a soundtrack to the GFC, if so feel free to share!



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Tax free threshold allows tax free golden retirement

Note: I’m not a licensed financial advisor, taxation specialist or an accountant, so this information should be considered as an FYI only (NOT FINANCIAL ADVICE).

It’s been known for sometime that significant changes are coming to the tax free threshold for Australians in 2012 and it was confirmed again the other night in Swan’s budget.

From July 1st 2012 the tax free threshold will be increased to $18,200 (up from $6000 for the financial year 2011/2012) and will be bumped up to $19,400 by 2015-2016.

One of the biggest concerns for those saving for retirement in physical Gold is the potential for large amounts of capital gains tax to be payable in the likely event they sell at much higher nominal prices than today, even if the real value has simply kept pace with rising costs.

A high tax free threshold (coupled with the existing 50% capital gains tax discount for assets held longer than 12 months) opens up the potential for those saving for retirement using Gold to deplete their Gold savings during retirement sans tax.

Take the example of someone (let’s call him John) who has been saving in Gold for retirement since 1990 and has purchased Gold every month in equal quantities since that point in time. John’s dollar cost average is around $690 (AUD). With Gold currently trading around AUD $1600 each of John's ounces of Gold are sitting on $910 profit (average).

How does he avoid paying tax on the profit during retirement while keeping within the bounds of the law?

To calculate the maximum which John could liquidate in 2012/2013 for retirement we take his profit per ounce ($910) divide it into the tax free threshold ($18,200) which equals 20 ounces, we then double the ounces as tax is only paid on half of the capital gain (due to 50% CGT discount), so John could potentially liquidate 40 ounces for $64,000 and pay no tax on the proceeds.

Further explanation: Of the $64,000 funded by the sale of 20oz of Gold, $36,400 is profit, but he only needs to pay tax on half the profit ($18,200) and because this is below the tax free threshold he pays no tax.

It wouldn’t matter if he’d purchased the Gold at $1 an ounce and sold it at $1600 for $1599 profit…. as long as John:

- Holds the Gold longer than 12 months allowing 50% CGT discount

- Is comfortable retiring on double the tax free threshold (max)

Based on a $1 purchase price for Gold and $1600 liquidation price John could sell up to $36,400 worth of Gold and avoid tax using the same method. So for those worried about how high Gold might get in the future and the tax payable, as long as you can live comfortably from double the tax free threshold (whatever it is at the time of Gold liquidation) then you can avoid paying tax.

Warren Buffet once said “If you own one ounce of gold for an eternity, you will still own one ounce at its end”. Funnily enough this was in an argument to suggest reasons not to hold Gold, but those who save in Gold are often doing so for this very reason, to preserve purchasing power, with the expectation that over the long term Gold will be able to fulfill this need.

How much Gold would you need to save in order to retire? A little while ago I looked at the average weekly wage (before tax) priced in Gold ounces, here is the chart:

Average Weekly Wage Priced in Gold Ounces (Click Image to Enlarge)

Basically an average weeks wage has fluctuated between ½ and 2 ounces of Gold even dating back over 100 years. This example from the previous article, showing the ratio was .51 (number of Gold ounces the average weekly wage would buy) in 1901:

In 1901, the average weekly wage for an adult male was about $4.35 for a working week of almost 50 hours, which after inflation equates to $217.50. However, wages have grown much faster than inflation, with the average weekly ordinary time earnings for adult males in May 2000 being about $830.00 for around 37 hours work, in far better conditions.

The price of gold has often been used as a measure of inflation. At Federation, the price of gold was $8.50 an ounce, or $425.00 in today's money. The actual price of gold in 1999-2000 averaged about $460.00 an ounce, showing that it has generally maintained pace with inflation. ABS

If we take the midpoint (1.25oz), minus tax we would have paid on the equivalent income (-30%) and multiply it by .7 (as we will assume John has a freehold home resulting in lower living expenses) and we get around .6125oz per week required x 52 (31.85oz Gold per annum) x 15 years of retirement = 477.75oz Gold required to fund John's retirement. Your figures may vary depending on inputs.

I wouldn’t advocate relying on a single asset class to fund retirement. Personally I will be looking to build a portfolio of income producing assets (which also rise in value), but it’s an interesting exercise nonetheless.

Of course there are any number of risks that could void tax free retirement working in this way such as Gold confiscation, a windfall tax being applied to Gold, changes to the tax free threshold, changes to the 50% CGT discount. Or perhaps Gold doesn't retain a similar value against Australian wages/goods/services as it has over the last 100 years. Anything is possible and the turbulent times we have ahead are likely to result in significant changes to the way we live today...

This above post was inspired by the following from projack on Silver Stackers:

If you buy gold for retirement you do not have to worry much about CGT as an average person. Selling $40,000 value gold a year for your lifestyle for example even if the original purchase price was only $10,000 means $30,000 "profit" and only half of that amount is counted as CGT and used as assessable income, and that is 15,000. With the new $18,200 tax fee limit from the 2012/2013 financial year (and will go up further) this is no problem and you do not have to pay any CGT.

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Are Perth Mint damaging their reputation?

Those of you who follow my posts on bullion forums that I frequent might have picked up that I'm not a huge fan of purchasing bullion Chinese Panda coins. This has nothing to do with their designs. Having seen several in the flesh I would agree with many of the enthusiasts that they are a stunning coin. 

The main reasons I avoid Pandas are:

- They have a reputation of many fake coins circulating and I think this will make them difficult to resell.

- The mintage has been announced and then increased part way through their production year (they did this in 2010 and 2011).

- Slight variations in many of the designs due to being minted across multiple locations each with their own set of dies (although to be fair this has actually increased the value of some anomalies).

- There are lower mintage coins available (such as those from Perth Mint).

So two of the key things I am looking for when choosing bullion Silver coins to buy is a consistent product and a mintage number that can be trusted.

Are Perth Mint keeping to their previously high standard in these areas or are they releasing opportunistic products which harm existing collectors and investors who hold their products?

The Russian Red Back Spider

Most collectors who are familiar with high value modern numismatic coins would know of the Perth Mint Red Back Spider from the Deadly & Dangerous coin series. It was a 1oz Proof coin released as the first in the series. The price soared with some paying in excess of $1500 for the coin and prices now are still well elevated at around $1000 for a coin which contains $31 worth of Silver. The coin was released in 2006 with a 5000 coin mintage:

Original Red Back Spider Coin, 1oz Silver Proof, 5000 Coin Mintage

What you may not be aware of is that the Perth Mint produced a "copy" coin especially for the Russian market 5 years later in 2011 (2000 coin mintage):

Russian Red Back Spider Coin, 1oz Silver Proof, 2000 Coin Mintage

So they've slapped an extra ring around the existing design, imprinted some Russian text and then they are flogging this off as a new coin? In my opinion this sort of activity reeks of a Mint who do not have respect for their collector coin customer base.

But are such tactics only a problem for their numismatic coin releases?

The Privy Mark Dragon

The Perth Mint has had strict mintage limits on their bullion coins over both 1st and 2nd Lunar Series coins. The limits having been set at 30,000 coins for 1oz Gold and 300,000 coin for 1oz Silver. These (previously strict) limits have made them a popular choice for both collectors and investors given that most other bullion series coins have much higher limits (which in most cases range from 1 million to tens of millions).

A couple of weeks ago I wrote about the forthcoming Privy Dragon design (on SilverLunar.com), little did I know at the time that this was to be a bullion release rather than a low mintage premium coin. As pointed out by a user on Silver Stackers and later blogged on at Silver Lunar this coin is being produced with a 200,000 mintage limit and is being sold for bullion prices. Assuming that these coins sell out (or have already been minted in full), it will result in a 1oz Silver bullion coin mintage of 500,000 rather than the 300,000 of previous years, with only a small lion privy separating the two.

Spot the difference: 2012 Perth Mint Bullion Silver Lunar Dragon vs Privy Mark Lunar Dragon

In March 2011 Stephen Ward of the Perth Mint blog had this to say in relation to the 1oz bullion coins:

"For investors, we offer bullion quality versions in capsules. These coins are made in much larger quantities, enabling us to keep the sales premium to a minimum. Even though Lunar bullion coins are made for investors, we do acknowledge that they attract significant collector interest in many quarters.

1oz Lunar silver bullion coins have a maximum mintage of 300,000 each." Perth Mint Blog

This statement is now void as there will be 500,000 Silver bullion coins.

Then in September last year Ron Currie said this:

"Throughout the course of the first 12-year Australian Lunar bullion coin series and also during the second 12-year series, 1oz releases have been limited by mintage: 30,000 gold and 300,000 silver. As well as investors, these mintage quotas have also attracted collectors to the series.

To increase mintages of 1oz coins during a particularly popular year could be interpreted as opportunistic and possibly damage our credibility as a Mint." Perth Mint Blog

While the bullion Privy Dragon is technically a different design to the standard bullion coin, it is obvious to investors and collectors that the Perth Mint has used a backdoor technicality to workaround their own mintage limits and this is (as Ron Currie hints above) an opportunistic action which has the potential to damage the Mint's credibility.

As I pointed out in a recent blog post on Silver Lunar it appears that this Privy Mark coin will continue in the Year of the Snake (2013), so assuming the sale of these coins goes well we can expect the mintage of bullion 1oz coins to be permanently increased for the rest of the second series (and maybe the Perth Mint will even work on getting the previous Series 2 releases, Mouse, Ox, Tiger and Rabbit also minted with the Privy)...

There are other examples of opportunistic behavior from the Perth Mint, but to list/describe them all now would take more time than I have available to write this post.

It seems to me that of late the Perth Mint strategy is to squeeze every dollar they can out of their customer base, releasing as many designs as the market will soak up with little regard for those who have already purchased based on expectations previously set by the Perth Mint and it's representatives. 

While pumping out these releases might improve their bottom line in the short term, it's more than likely going to make buyers a lot more wary about purchasing their releases in the future and in my opinion has the potential to devastate a well established reputation which the Perth Mint has spent a long time building. Here's hoping they can get things back on track.

BB.

 

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