Is Property More Affordable Today Than 30 Years Ago?

This is a continuation (that I have written) of a conversation written by fellow Adelaidean Peter Koulizos, see here for the prologue.

 

[Son enters room]

 

Son: Hey dad, I just heard you spinning a whole lot of nonsense to sis about housing affordability.

 

Dad: What do you mean son? I was just telling her how it was back in my day.

 

Son: Well you know finance and history aren’t her strong points…

 

Dad: Speak nicely of your sister please.

 

Son: Ok, as I was saying, you claimed that it took mum and you longer to save a deposit, because a 25 per cent deposit was required to buy, but isn’t it true that some building societies loaned up to 95 per cent, meaning similar loan to value ratios were available even 30 years ago?

 

Dad: Well, yes, but the interest rates were often higher than the major banks...

 

Son: But isn’t it also typical today for the lenders offering the easiest credit conditions to have higher interest rates?

 

Dad: You have me there son.

 

Son: And isn’t it true that in the early to mid-1980s that the First Home Owners Scheme was far more generous paying up to $7000 in benefits, equalling more than 10% of the purchase price you mentioned?

 

Dad: That is true. Your mum and I took full advantage of that and the First Home Owners Grant isn’t nearly as generous today.

 

Son: You did pay 17% interest rates for a short period of time, but isn’t it true that the higher level of inflation at the time reduced the real value of the loan rather quickly with wages rising faster than they are today?

 

Dad: Yes, but it was tough for the first few years…

 

Son: Didn’t you brag to me one time that you paid off your first home in less than 10 years because interest rates fell in the years after you purchased allowing you to pay off the mortgage much faster? Do you think that it will be made so easy for sis who would be borrowing at historically low interest rates with rate rises more likely in the future?

 

Dad: I hadn’t considered that.

 

Son: You mentioned her trip to Bali, but you know she got those tickets for only $300 return and the accommodation, food and entertainment over there is far cheaper than in Australia. In real terms wouldn’t her week in Bali be cheaper than the long weekend holiday you told us you took to the Gold Coast in the early 1980s while saving for your first home?

 

Dad: You are probably right.

 

Son: It’s also the case that a median house in Adelaide today will be on a far smaller block than you got in 1985. In fact if I recall correctly you said your first home was on a subdivisible block once the council changed the zoning, do you think sis will be able to do that with the typical 375sqm blocks of today?

 

Dad: No, I suppose not.

 

Son: Look, I know you think you had it tough with the mortgage and for the first couple of years that may have been the case, but if sis takes a larger mortgage today, to buy a smaller block, in a lower wage growth environment, with the possibility that interest rates may rise making it difficult to make the repayments in the future, isn’t she taking a greater amount of risk?

 

Dad: If you look at it that way...

 

Son: And shouldn't being able to afford something take into account the level of risk associated with doing so?

 

Dad: I’ve had enough of this, I am going to watch some TV in the lounge.

 

Son: Weren’t you going to have some dessert?

 

Dad: I’m going to put it aside until your sister returns from her friends place so we can sit down and eat it together while I explain that I wasn’t as right as I thought.

 

Son: You don’t say.

 

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Martin Armstrong: New Supply Could "Crush Gold"

I read Martin Armstrong's blog on a near daily basis (I have his site bookmarked in my Feedly reading list). Sometimes he has interesting predictions and theories to share, sometimes he adds some historical perspective, other times he pumps out some absolute garbage. Here is one example of the latter:

"Well, when it rains it pours. A new discovery of gold has been made and the quantity expected is up to 46,000 tons of gold, whose market value is estimated to 298 billion US dollars if the market stays the same. The entire USA gold reserve is 8,000 tons. So we are talking about a sizable discovery in the Sudan. From a supply-demand perspective, this could crush gold." - Martin Armstrong

Armstrong's source? Sputnik News, the BuzzFeed of Russian propaganda. Here are some key points from the Sputnik article and a couple more sites I found carrying the news (none of which I would have any confidence in).

- Feb 2014 Sudan grants 9 Russian companies permission to explore for minerals.

- Sudan's total Gold production during first half of this year reached 43 tons.

- Russian company Siberian for Mining discovers Gold reserves of 46,000 tonnes.

- The market value of this gold is U.S. $298 billion.

- Zhukov (CEO), plant will be €240M and have production capacity of 50t/pa.

A few things I see wrong with this picture.

It would not be possible to firm up 46,000 tonnes of (proven) Gold reserves in 18 months. The mobilisation of drill rigs, geological expertise and utilisation of laboratories for testing would have been breathtaking, like no other mining and exploration venture you had seen before. After all, 46,000 tonnes of Gold is roughly 25% of estimated above ground Gold that we've mined through all history and would almost double the proven Gold reserves we already have waiting to be extracted. Exploration for Gold reserves is an expensive and time consuming process, Gold mining and exploration companies often take years to firm up a 1-2 million ounce (30-60 tonnes) deposit, let alone something of this scale.

Furthermore 46,000 tonnes of Gold (in above ground form) is worth far more than US$298 billion at market value. Try $1.6 Trillion.

My initial though was that perhaps the 46,000 tonnes was a reference to the total volume of dirt containing the $298B in Gold, but that still doesn't make sense as Gold content of the earth would be way too high... maybe the figure was supposed to be $298M (not billion) worth of Gold, but even that by my calculation would have required Gold content of around 200g/t (not a chance, most miners these days operate on mining ore around 1-2g/t).

If anyone else can make sense of the figures or find another source with better information about the find, I'd welcome your input in the comments below.

But just for a moment lets imagine that Martin Armstrong wasn't spreading nonsense that has no basis in reality and that this company had proven up 46,000 of actual reserves ready to mine and "crush Gold" as Armstrong so eloquently puts it... I have had other commentators say "what if" about a massive Gold find in the past.

This company is spending €240M (US$263M) on a Gold plant with production capacity of 50t/pa. How fast are they going to bring that 46,000 tonnes of Gold to the surface and what would the cost be to do so? Even if they spent billions of dollars building new massive plants with the intention of bringing 1,000 tonnes of Gold to the surface each year from this one find (increasing current annual mine supply by around 35%) and assuming global Gold infrastructure expanded to process this additional capacity, it would only add a little over 0.5% to total above ground supply each year.

Meanwhile, global debt has increased by an astounding 40% since 2007, despite having a Global Financial Crisis during the same period.

Somehow I don't think Gold has much to worry about from the discovery of a massive new deposit. Of more concern is the supply / demand of and for existing above ground Gold.

[postscript]

Martin Armstrong has since edited his article. Google cache had most of that I quoted above so took a screenshot comparing old with new (though the old version I found was still missing some paragraphs from the end, so presumably has been edited a couple of times over the last day or two).

So it appears that Sudan will be mining only an additional 20 tonnes of Gold in 2016 (100 tonnes, versus 80 tonnes in 2015). Will that be enough to crush Gold (or "crush gold psychologically" as Armstrong rewrote)? Probably not if sold as mined, although Bron notes in a recent article that it only took 22 tonnes on the Futures market to knock $48 off spot price in the recent price smash.

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Who's to Blame for Australia's Expensive Property?

Picture a science lab with a square metal table in the centre. On top of the table lies an intricate wooden maze. The maze itself is completely enclosed. In the middle of the maze, at the end of the one way walled passage, is a block of cheese. In a small cage not far from the maze is a rat, who hasn't been fed for a day and whose nose is going haywire smelling the nearby cheese. The three researchers (who were responsible for building the maze) are standing nearby, one of them removes the rodent from the cage and places it into the maze, soon after which the rat finds it's way to the cheese and consumes it.

I would liken this scenario to the Australian property market, where the researchers represent the three levels of government (federal, state and local), the maze walls are policies they've introduced, cheese symbolises investment properties and for the purpose of this exercise the rat is us, investors (though it could also represent other home buyers who are also herded by government policy).

Now you may think human investors are smarter than a rat, but history shows us that time and time again we will rush toward the cheese (investment returns) often foregoing rational thought in order to do so. Just take the recent bubble and crash in the Chinese stock market (Shanghai Stock Exchange Composite Index pictured below), which was largely driven by retail investors and fuelled by margin lending.

Shanghai Stock Exchange Composite Index

If you spoke to the rat, told it not to eat the cheese from the maze, you are about as likely to receive a positive response as if you told investors (as a group, there are some investors who do act rationally as individuals) to only bid the price of an asset to a sensible valuation before stopping.

Historically (at least since the 1960's) home ownership rates have been fairly stable at around 70%, but this has since declined slightly to 68% in the 2011 ABS census and recent investor lending statistics indicate that it's probably getting worse with investor finance overtaking that of owner occupiers (lacking the balance of historical ratios).

The argument over whether Australian property is in a bubble is beside the point, as Former Treasury secretary Martin Parkinson said, "Do we have a bubble? I think that's the wrong question to be asking. The real question is why are house prices so high?" 

There's no denying that Australian property is expensive, so who do we hold accountable?

I hold no animosity toward investors who buy property. Sure there are landlords who do the wrong thing from time to time, but as a group they are just acting in unison because it makes sense to them, in an effort to better their personal situation and largely due to the policies implemented by government. Blaming them for making home prices expensive is a bit like getting angry at a rat for navigating the maze and eating the cheese. The stage has been set, barriers and incentives have been put in place for investors to take advantage of the situation, why wouldn’t we expect them to do so?

The invisible influence of government policy, at least much less obvious than solid walls, is controlling almost every aspect of the property market, on both the supply and demand sides. 

On the demand side they influence the cost of servicing a mortgage using the Reserve Bank of Australia (RBA) Cash Rate Target, regulate bank lending through the Australian Prudential Regulation Authority (APRA), encourage specific segments of the market to participate in transactions by using incentives (such as the First Home Owners & Downsizing Grants) and set the rules that allow foreign investors to buy our homes.

Tax policy can also contribute to demand, a strong rise in property prices followed the introduction of the 50 per cent capital gains tax discount (having held an asset for 12 months) suggests it was an inflection point for an increase in investor interest in property, also illustrated by the flood of investor finance that followed the change in 2000.

Negative gearing, whilst also available for other assets, further exacerbates demand for property, making it cheaper to service the negative cash flow of a mortgage, allowing investors to pay higher prices, buy sooner than they may have otherwise and carry a larger portfolio of properties.

It’s not only the demand side that government policy affects, supply too is impacted as government controls what land is available to build on, the building types that are allowed on that land, they set the fees and taxes associated with building, as well as on the sale of a newly constructed home and ensure the undertaking meets strict standards and a lengthy application process, all of which can contribute to increasing the cost of and deter bringing new supply to market.

On top of policies they implemented prior, since the Global Finance Crisis (GFC) the government has also intervened at times in ways that have both indirectly and directly boosted the property market. Examples include guarantees that were introduced to protect our banks (e.g. wholesale funding and deposits), the RBA taking on tranches of mortgage backed securities to support lending and the introduction of a temporary First Home Owners Boost which according to Treasury Executive Minutes, “was designed to encourage people who had already been saving for a home to bring forward their purchase and prevent the collapse of the housing market.”

I've seen investors who've benefited from this generous environment complain that no changes should be made to the status quo, the "free market", the suggestion of which is laughable. 

The government can and should act to reduce speculative demand and increase supply (if warranted) in the Australian property market, with a view to lower prices and improving affordability. Even the Liberal Party of Australia's Federal Constitution in Part II (Objectives, section n) says:

"...in which family life is seen as fundamental to the well-being of society, and in which every family is enabled to live in and preferably to own a comfortable home at reasonable cost, and with adequate community amenities."

Not that this objective is embraced by senior members of the Liberal Party such as Prime Minister (Tony Abbott) or Treasurer (Joe Hockey). Joe Hockey recently said “If housing was unaffordable in Sydney no one would be buying it, but people are still purchasing housing,” and Tony Abbott welcomed rising prices, clearly not seeing the contradiction with affordability, "I want housing to be affordable but nevertheless, I also want house prices to be modestly increasing." Neither seem to have a solid grasp of what constitutes 'reasonable cost'.

If you want someone to blame for Australia's expensive property, turn your eye away from the property investor / speculator, they are just another rat in the same maze as the rest of us. It's government policy at fault and that is what needs to change. With change of policy will come a change in investor behaviour.

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How About Fair GST Treatment For Bullion?

In an article I was reading yesterday about the GST-free threshold for imported goods, which postured support for a lowering the cap from $1000 to $20, there was a video containing this message from Craig James (CommSec's Chief Economist):

"Certainly we believe this is a fair tax because if it is the case that people are traveling overseas and over the net to buy goods, bypassing Australian goods. Well really the same goods should be charged the same price whether you're buying overseas or getting it domestically."

There has also been recent talk of raising the GST in Australia from 10 to 15%.

As a proponent for small(er) government and less taxes I'm not particularly fond of the latter suggestion, but I do concur with James' view that a fair tax should see comparable goods charged the same amount of tax. Not only for consumer goods, but also for investment assets. This is one area that bullion (as an investment asset) is short changed.

A guide I wrote on buying Gold and Silver in Australia describes when bullion is GST free:

GST (Goods & Services Tax): Investment grade Gold (99.5%+ fine) and Silver (99.9%+ fine) bullion is not subject to GST. Bullion products of a lesser grade (for example 22k Gold coins like Sovereigns & Krugerrands or 92.5% sterling Silver coins) do attract GST when sold by a bullion dealer.

That results in some of the most commonly purchased bullion investment coins being burdened with GST as they don't meet the minimum finesse (Gold sovereigns and the 1966 Australian fifty-cent piece are just two examples).

1966 Australian fifty-cent pieces, only have 80% Silver content

This unfair addition of GST to an investment asset is something I would like to see changed as I wrote  2 years ago:

Increase the scope of the definitions "precious metal" & "investment grade bullion" for taxation purposes to include coins containing Gold, Silver, Platinum or Palladium (any finesse) which are now or once were legal tender of Australia or any other nation and which trade as a function of the spot price.

Precious metals are often traded in widely recognised investment forms which don't meet the strict scope defined by the Australian Taxation Office. Investment grade bullion below 99% for Platinum, 99.5% for Gold and 99.9% for Silver is subject to Goods and Services Tax (GST). This means dealers are required to charge GST on coins which many hold for investment purposes, but aren't exempt from GST, for example American Gold Eagles (91.6% Gold), Gold Sovereigns (91.6% Gold) and Round Australian 1966 50 Cent Pieces (80% Silver). Such legal tender coins which trade as a function of spot price (consistently trade at spot + x% premium) would be made exempt from GST.

I was also recently made aware (thanks Bron!) that there are other limitations to the GST free status of bullion (that I wasn't familiar with), such as a requirement for the metal to have been refined by a refiner:

"To have this GST-free status one of the requirements is that the metal has been refined by a refiner of precious metal. To be a refiner of precious metal, an entity has to satisfy the Commissioner that the entity regularly converts or refines precious metal in carrying on its enterprise." ATO (What is 'precious metal' for the purposes of GST?)

That means despite the hallmarking of these hand poured Silver bars I recently purchased, if they'd been sold in Australia by a dealer they may have needed GST applied (I bought them direct from the overseas producer in a package that was lower than the current $1000 GST-free threshold).

Home Made Redwood Poured Silver Bars

I think it would be fair to see GST removed from all bullion that is bought for the purpose of investment and where it trades as a function of spot price as I wrote last year:

Perhaps the exemption could be expanded to cover any precious metal which trades as a function of spot price, so that tax fraud is no longer as simple as defacing investment grade bullion, changing it into a form which can suddenly benefit from input tax credits.

That would put the precious metal asset class on a level playing field with others (such as shares), surely that's something that even Craig James could get behind!

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Rising Prices Aren't Always Good For Home Owners

Contrary to popular belief that all home owners benefit from rising prices, that is not always the case.

Younger generations who are yet to buy a long term home, who may have purchased a smaller property that suits them for the short term or just to get themselves onto the “property ladder”, may be disadvantaged if they intend to upgrade in the future.

Take the case of a Sydney family who bought a $400k 2 bedroom apartment to tide them over for a few years. They had a 75% LVR to begin with, putting in a 25% deposit, but lower interest rates have assisted them in paying down the principal aggressively and as it stands have an LVR of 60% on purchase price ($240k mortgage). They’ve outgrown the apartment with a new addition to the family and want to now purchase a 3 bedroom house. Let’s look at three scenarios in which they sell their apartment and buy back into the same market.

Inputs:
Original value of 2 bedroom apartment: $400k
Original value of 3 bedroom house: $550k

Sale fee (real estate agency to sell apartment): 1.5%
Stamp duty (to buy house): Calculated on NSW rates

Scenario 1: No Price Change. ($400k apartment, $550k house)

Stamp duty: $20,500

Sale fee: $6000

Cash left for new purchase: $133,500

That’s a 24% deposit leaving a $416,500 mortgage on the new home.

Scenario 2: Prices Rise by 10%. ($440k apartment, $605k house)

Stamp duty: $23,000

Sale fee: $6600

Cash left for new purchase: $170,400

That’s a 28% deposit leaving a $434,600 mortgage on the new home.

Scenario 3: Prices Fall by 10%. ($360k apartment, $495k house)

Stamp duty: $18,000

Sale fee: $5400

Cash left for new purchase: $96,600

That’s a 19.5% deposit leaving a $398,400 mortgage on the new home.

So in the three scenarios above, while the steady or rising prices result in a larger deposit for the new home, allowing a lower LVR, it also sticks the owner with a larger mortgage.

Which of the above 3 mortgages would you prefer to have for the same 3 bedroom house (all else being equal)?

Of course not every situation is the same, a larger fall than 10% may result in Lenders Mortgage Insurance being payable or result in the apartment owner being underwater (mortgage exceeds value of home or is high enough that selling won't leave a large enough deposit) and locked into their unsuitable abode.

The point of this short post was just to highlight the furphy that many spread to suggest that all homeowners benefit from rising prices, when the reality is that it often just means a larger mortgage when they upgrade to their next home.

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