Adam Carr Wrong on Australia's Housing Affordability

Adam Carr had this to say on housing affordability in Australia (via Business Spectator)...

"...housing is still actually very affordable."

Carr was prepared to dive head first into showing how an $800,000 property is affordable on a $100,000 salary.

"A household on $150,000 could afford a $1 million-plus house -- no dramas. Someone on $100,000 could afford anything in the vicinity of $650,000 to $800,000. A lot depends on the loan-to-value ratio they’re taking -- I’ve used 70 per cent -- but it can be done."

Ok, let's break this down. $100,000 would be roughly $73,000 net, $1403/week. Carr is working from a position that they've saved a 30% (+ costs) deposit. Using $32,000 for stamp duty and fees (I went with NSW figures) and ignoring any other transaction costs (such as legals)... that's $272,000 required in savings (the deposit) before we can even start checking the affordability of the remaining mortgage. Based on a savings rate of 30% of net income ($21,900 per year, very generous if you ask me), it has potentially taken this buyer more than 12 years to save the deposit that Carr says they have on hand. That should already be raising alarm bells on this so called "very affordable" property market we have.

Now we could make any number of assumptions about this buyer, maybe he/she had property that appreciated in value before buying this one, maybe they have bank of mum and dad chipping in, maybe they're a gun investor who has turned a little savings into a lot of capital to fund the deposit... but these would be unfair presumptions to make. We could scale back the price and incomes at a comparable ratio and it would still look awful... e.g. someone on $50,000 buying a $400,000 property (for their first home) and using a $135,000 deposit will have to save for 10+ years using the same measure.

The mortgage repayments (on the remaining $560,000 loan) work out to $655 weekly (at 4.5% interest over 30 years). That's over 46% of net pay (34% of gross) and doesn't take into consideration the extra costs of ownership such as council rates, maintenance, insurance and more. It also doesn't take into consideration the possibility of interest rates rising, if they normalised to 7% the repayments would rise to $860 per week (61% of net income, 44% of gross).

Call me mad, but I don't consider Carr's examples to show affordable property any way you cut it (at least not in the way I think the word should be used)...

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Rent vs Buy: An Adelaide "Cost Comparison" Revisted

One of the very early articles I wrote on this site compared the cost of buying a home with renting one in Adelaide (Rent vs Buy: An Australian "Cost Comparison"). Earlier that year I'd sold a property I owned in Adelaide (returned to renting), I put my money where my mouth is and at the time it made more sense from a financial (and personal) perspective to forgo the security of owning (or more accurately "paying off") my own home.

Almost 5 years later I am still renting the same property, the lower cost of which (less than the mortgage I had) has been an enabler to put away some extra savings and investment. In the meantime property prices have basically gone nowhere (fell around 8-10% over 2010 to 2012 and have since rebounded back to 2010 levels) and interest rates have dropped.

The comparison I did previously using figures in Adelaide, at the time most other Australian capitals were quite comparable (i.e. yields around 4-4.5% for houses), but today Sydney and Melbourne are in a league of their own. The figures I lay out below make owning look quite attractive, but that same argument probably doesn't hold true in Sydney and Melbourne where prices have gone gangbusters and yields are woeful.

I have revisited the figures from the original article and compared them with today.

Rent vs Buy - The Figures

Property: $500k House

Rent (2010): $25,000pa / 52 = $480pw
Rent (2015): $26,520pa / 52 = $510pw

(Residex shows yields have slightly improved for Adelaide over the past 5 years)

Buy (2010):
$500k + $24,000 (stamp duty and transfer fee#) x 7.25% = $37,990
1% of property value for maintenance and insurance = $5000
Council and water rates = $2000
Total = $44,990 / 52 = $865pw (interest only)

Buy (2015):

$500k + $25,000 (stamp duty and transfer fee#) x 4.15% (3 years fixed) = $21,787

1% of property value for maintenance and insurance = $5000
Council and water rates = $2200
Total = $28,987 / 52 = $557pw (interest only)

# Adelaide based figures, this would differ between states

As I pointed out last time, this still doesn't account for all costs of ownership (or for that matter renting), but you can see that there has been a squeeze in the gap between the two. In 2010 the cost difference was $385 per week, in 2015 that has narrowed to $47 per week, mainly as a result of falling interest rates and a small increase in rents. The above example shows a 6.25% jump in rents, in my personal situation I have seen a 13% rise in 5 years (which reflects the local market, different areas in Adelaide may have seen higher or lower). Over the last 5 years I have also seen my income rise which would make servicing the gap easier.

In Adelaide a $500,000 house would actually buy you something quite nice, a modern 3 bedroom house around 10km from the city, maybe even closer or a small house in the city if that is a preference. If you are prepared to look at modest homes you can buy something more dated, 15-20km out from the city, for around $300,000. Assuming a 10% (+ costs) deposit (leaving a $270,000 loan) and 3 year fixed interest rate of 4.15%, the principal and interest repayments would be around $300 per week. Rent for the same house might set you back $320-340 per week. Suddenly a home in Adelaide is looking quite obtainable, maybe even for a household on a single income.

Now I'm not saying Adelaide is cheap, it's still expensive on a global or historical comparison (if we look back at the property to income ratios of the mid 1990s), but it is definitely obtainable for those who've had the capacity to save a reasonable deposit (circa 10-20%).

There are still some risks to the Adelaide property market, as I outlined a couple of years ago (What's next for Adelaide property prices?) the economic conditions are not positive in the state, we already have one of the highest unemployment rates in the country and things may be set to get worse before they get better as the car manufacturing industry shutters. Further to this Adelaide property is at risk of being affected by recent changes to investor lending (that is likely to tighten further), falling wage growth and a crackdown on foreign investment (some of which was well described in a recent article by Callam Pickering). These factors are likely to continue weighing on Adelaide prices, but in my view with prices being the same level as they were 5 years ago, the risk of a substantial correction (i.e. 15%+ nominal) is unlikely barring a complete meltdown of our banking system or huge spike in interest rates (neither of which I consider to be likely).

FT describes an asset bubble like this:

When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely - at which point the bubble "bursts".

Those referring to all Australian cities as being in a bubble (I do agree Sydney and Melbourne potentially are) are either wrong or have come up with their own definition of the term. Perhaps they think it's likely we see a return to the historical price to income values we had in the mid 1990s (or earlier) and that we've been in a long lasting bubble since that time. I think that is an unlikely scenario (returning to ratios from 20+ years ago) given the political and financial system we have today.

On a personal note I recently started looking at property in Adelaide (to buy) for the first time in 5 years (looking at PPOR and/or investment) and I expect to purchase (perhaps more than once) in the next 12 to 24 months. Price growth may be slow to begin with and won't rule out some negative growth (what a term! e.g. falling prices) in the short term, but there are some reasonable yields out there now and the time to buy will be while sentiment remains poor.

And if GFC 2.0 comes knocking on Australia's door and smashes the price of all Australian property in half... well at least I'll still have my Gold ;)

Martin Armstrong on Australia's Bank Deposit Tax

Yesterday I spotted an article by Martin Armstrong (Australia First to Introduce a Compulsory Tax on Money Itself) that I think is misleading (no surprise that Zero Hedge was quick to republish it).

Before delving into Armstrong's claims, let us take a look at what he is presumably talking about (I say presumably because his article rant is light on facts & details about the subject at hand).

From the AFR, a tax on bank deposits:

"The federal government is planning a tax on bank deposits at the May budget in a move that will raise about $500 million a year but which bankers warn could be passed on to customers.

Sources have told AFR Weekend that the government is set to proceed with the bank deposits insurance levy, first proposed by the former Labor government, to shore up revenue and to act as an alternative to forcing banks to hold extra capital as insurance against collapse."

What does that mean in practice?

"The money would be put in a Financial Stability Fund and be used to protect depositors against the highly unlikely event of a bank collapse. In the meantime, the fund would also be used to offset gross debt. If the Coalition adopts the same model as Labor and if banks pass the levy on to customers, it would mean a term deposit currently paying 2.6 per cent would pay 2.55 per cent."

So to correctly frame the situation we need to define what this tax is, is it a tax on money (as per the headline) or a tax on savings as Armstrong suggests in his article?

"The new compulsory control is provided in the 2015 Australian budget, so that everyone who has any savings must pay taxes on their savings. The measure is expected to serve as a global test balloon for Europe and North America, who will watch for the outcome in Australia. If there is no massive resistance of Australian savers, the rest of the world should expect this outright confiscation very rapidly."

In my opinion framing it as a tax on money or savings is implying (wrongly) that bank balances will be reduced in order to fund it. Really it's a tax on deposits and it's levied on the banks, not customer balances. Of course any cost to the bank will likely be passed on in the form of higher fees or lower interest rates, but very unlikely to touch balances (i.e. it's not outright confiscation).

The original Labor proposal was for the levy to apply on deposits under $250,000. Why that amount? Probably because that is the deposit size per customer, per Authorised Deposit-taking Institution (ADI), that the government guarantees. Is it fair that depositors insured by the government (taxpayers really) fund the cost of their own bailout should it be needed? I think so (but welcome opposing views in the comments below).

I wrote about Labor's proposal back in 2013 ($250k+ in an Australian bank? Beware the bail-in.):

"The banks are up in arms over who will foot the bill and there has been a media storm over the tiny fraction of a % that this insurance will cost (for example a bank would need only lower the interest rate paid on a deposit from 3.50% to 3.45% in order to recoup the cost). While the media, banks and politicians get into a scuffle over who will fund the minuscule cost of insuring funds under $250k, there seems to be no investigation or reporting by the media on what might happen to funds over the 'guarantee' limit in the case of a bank failure..."

I'm no fan of 'Too Big To Fail' banking institutions and don't pretend to have all the answers on the best way forward from the position we're in. Ideologically I think banks should be allowed to fail and individuals could organise their own insurance against such events, but would it be responsible of the government to just implement a change like this and pull all guarantees in one swoop?

Armstrong continues:

"Take your money and buy tangible assets, even gold, but you just cannot store it in a bank. Movable assets will be the key and buying equities in the USA may be the only real game in town to protect money."

Now anyone reading this blog for some time (or even if you are looking at it for the first time) should be able to deduct that I'm an advocate for Gold ownership, but that doesn't mean I think you should take out all your savings and buy Gold. Also I think keeping your Gold stored in a safe deposit box with a bank is probably just as safe as any private facility (in Australia) as I concluded in a recent article focusing on this very topic (Storing Gold & Silver: Safe Deposit Box In Australia):

"Bank SDB facilities get characterised as unsafe due to their connection to the banking system, but in my opinion there are some pros and some cons that result from this association and on the whole I don't see bank SDBs as less safe than their private counterparts."

Armstrong concludes on this note:

"The introduction of this tax on money in Australia led by Tony Abbott is the trial balloon for the global economy. The IMF’s Christine Lagarde has led the battle to impose French socialism/communism upon the entire world. I have warned that she is the most dangerous woman on the planet. Do not forget, it was the French elite who sold the idea of communism to Marx – not the other way around. Now the French elite have control of the IMF and they have persuaded all other global financial institutions to also require such a compulsory levy for several years because they see it as the only way to resolve the debt crisis – just confiscate the people’s money."

We've already identified that this isn't really a confiscation of people's money, but rather a levy on the banks to fund a Financial Stability Fund in order to support depositors in event of a bank failure. Is Australia really the first country to implement such a scheme as suggested by Armstrong in the paragraph above and even his article's title (Australia First to Introduce a Compulsory Tax on Money Itself)? No. Perhaps Armstrong should take a look at the history of the FDIC, which could be seen as an equivalent to this fund, guarantee & levy, it looks to me as if the US has had something similar implemented for almost 100 years or more (from: A Brief History of Deposit Insurance in the United States):

Assessments on participating banks. All of the insurance programs derived the bulk of their income from assessments. Both regular and special assessments were based on total deposits. The  assessments levied ranged from an amount equivalent to an average annual rate of about one-eighth of 1 percent in Kansas to about two-thirds of 1 percent in Texas.

Australia's 0.05% levy looks rather small in comparison. And from the FDIC's website:

"The FDIC receives no Congressional appropriations - it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. The FDIC insures approximately $9 trillion of deposits in U.S. banks and thrifts - deposits in virtually every bank and thrift in the country."

Australia is hardly the first country to implement such a scheme and we won't be the last.

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The Politics of Negative Gearing (Australian Property)

Debate over the ability for investors to negatively gear property (claim losses from property against other income) in Australia has been fierce of late.

In a recent news.com.au article Sinclair Davidson (Professor of Institutional Economics at RMIT University) was reported as describing public debate around negative gearing as “a complete load of rubbish” (sadly his comments were no less bin worthy). Rather than tackle the issue with any seriousness he resorted to ad hominem attacks on those making the case against the tax policy, claiming that "ACOSS and other people who don’t actually pay tax themselves don’t understand much about the tax system". He went on to say that other countries (US, NZ, Japan) allow such deductions (so why shouldn't we) and suggested the campaign against negative gearing is just an attempt to raise more revenue.

Jessica Irvine also suggested negative gearing is a budgetary matter (in an article yesterday), calling negative gearing a "loophole" and suggested it's closure would "raise billions".

The reality is that an end to negative gearing for property wouldn't be a huge budgetary boon (as these commentators have suggested). Most advocating for it's removal suggest a 'grandfathered' approach, which means properties already owned by investors aren't affected (until the asset is sold). Even when investors make a purchase (following negative gearing's removal), any losses which would have previously been deducted in the same financial year against other income could be carried forward to claim against future income or profit from the same asset class (property). While it might delay when deductions are made (and some investors may not make a future profit in property meaning it never is), improving the government budget in the short term, it's long term impact would be negligible.

Furthermore, it's likely that over time investors would adjust their expectations and reasons for investing in property. Currently a large number of investors buy for the tax advantages that negative gearing (and other tax breaks) offers (graphic via Digital Finance Analytics):

It's removal would result in a lower number of investors prepared to speculatively purchase at higher prices knowing that (as it stands now) low yields (& resulting losses) are partially offset by a tax deduction against other income at the end of the financial year (or as they go for those investors using an Income Tax Withholding Variation). Over time this would likely result in a normalisation of rent to price ratios so that fewer investment property purchases would be loss making from the outset.

So why support an end or changes to negative gearing if it's impact on the government budget would be minimal?

Some propose that all investment assets should be treated the same when it comes to taxation (losses from shares or business can also be offset against other income in many cases), but not all assets are equal. Like food and water, shelter is one of life's necessities and although one doesn't need to own the land and home they live in to benefit from it's utility, the increasing cost of housing is having an impact on the ability of Australian families to enjoy a lifestyle we've grown accustomed to.

There will never be a day where every household is able to afford to buy (or have an interest in doing so if the flexibility of renting is preferred), but with a historical home ownership rate of 70%, the figures recently coming out suggest that balance is tipping unreasonably in favour of investors.

Being a Senior Fellow at the Institute of Public Affairs, Davidson would probably be an advocate for a free market approach to the property market and affordability problems that arise, but the Australian property market is far from free with government & public institutions involvement in almost every aspect, including where they will allow new construction and approving or rejecting applications, significant fees and taxes added to the cost of building and selling a new home, setting the cost of money to borrow, regulating lender rules, setting the tax policy which makes it attractive, boosting the ability of buyers to purchase using grants and concessions and guaranteeing the financial institutions who would be destined to fail should the property market ever experience a severe bust. The distorted property market that we have today has come from decades of poor policy decisions, any solution will likely need to come from the same place.

Negative gearing is a tax policy that gives investors an unfair advantage in the bid to secure a property. An investor obtaining rent from a property and the ability to deduct any losses made against other income gives them an ability to carry a higher level of debt than they'd be able to otherwise. One of several government based enablers that are driving the demand side of the market to the point we are seeing a speculative investment frenzy in some cities. It's time to wind back these demand driving policies.

Within the next month we can expect to see the outcomes from the long awaited Senate inquiry into affordable housing. After comments from Nick Xenophon last year in an open letter to Prime Minister Tony Abott, that we should consider tweaking negative gearing to encourage affordable new housing (which I read to suggest quarantining negative gearing to newly constructed homes, a reasonable alternative to dumping it altogether) I was hopeful this inquiry might result in some changes. Recent comments from Abbott suggest that he will not consider such changes.

Despite housing affordability being a hot topic at the last federal election, neither of the major parties had any policy specifically directed at tackling it. Though quarantining negative gearing to new builds or removing it completely would only be one part of a solution to tackle the problem, Abbott has made it quite clear that he's not interested in a sensible debate on the matter. Last month Labor released a discussion paper aimed at informing Labor’s Housing Affordability Strategy (to be taken to the next election). I'd expect that with the right mix of policies directed to tackling housing affordability and the right attitude (knocking back ideas before the results of the Senate inquiry into affordable housing as Abbott has done is one way to show you are not taking the national discussion seriously), Labor might just have an edge that could help them secure a win at the next federal election.

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Australian Property Market: Secular & Cyclical Trends

Barry Ritholtz recently framed secular markets this way, “The simplest way to think of secular markets is as longer eras driven by overriding dynamics that define the period either positively or negatively”. Wikipedia says a a secular market is a long term trending lasting up to 25 years which consists of a series of primary trends, "A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets."

However you want to define it, property in Australia over the last 20-30 years has been in a secular bull trend, not only in nominal prices, but also measured by real increases. Consider the rise in land values compared with GDP (via Prosper, Soos):

A measure of real house prices (via Prosper, Soos):

Or perhaps the most commonly observed, dwelling price to income ratio (via Christopher Joye / UBS):

Some argue that price to income ratios at current levels are not sustainable, but as the chart above shows (at least on a nation-wide basis), the current price to income ratio has levitated within a relatively tight range (4.5-5.5) for well over a decade now.

Price enablers and drivers have included an increase in dual income households, low interest rates, easier lending practices (high LVR loans), tax policies (including the restoration of negative gearing after a brief hiatus, introduction of GST and the Capital Gains Tax discount), strong income growth stemming from a resources boom and mining investment, government incentives (such as the First Home Owners Grant & Boost), supply constraints, strong population growth and more recently investment in residential property by foreign buyers. There is no one cause, but rather the overriding dynamics have resulted in prices in Australia becoming some of the least affordable in the world.

While some of these factors may change (housing affordability is becoming more politicised, especially in Sydney where prices are being driven excessively higher by an influx of investors), some of the changes that have occurred over the decades are unlikely to reverse course and I think those holding out for a significant crash in prices Australia wide (e.g. where we see price to income ratios return to the level seen in the early 1990s) will be disappointed.

It's likely we are nearing the top of the latest growth spurt (at least on a national measure), see this chart from RP Data which visualises the cyclical trend.

But the national rolling annual change doesn't give us a full picture of the performance of all capitals which makeup the series.

I expect that Sydney and Melbourne may be nearing major cyclical peaks (i.e. within the next 12 months). Sydney is showing many signs of rampant speculation that were similarly observable at the 2003 peak (e.g. investor loans reaching record nominal levels and as a % of all lending). Sydney's cyclical peak in 2003 saw prices decline and ultimately 5 years of lower/stagnant prices.

Perth has seen the cyclical climb higher that I predicted from mid 2012 ('Perth Property on Cusp of Price Growth?'), however a sharp drop off in mining investment (the 'capex cliff') and falling commodity prices are likely to take the wind out of the sails going forward (as I speculated might happen).

Adelaide is still playing out as expected with muted price growth given the underwhelming economic conditions ('What's next for Adelaide property prices?'). Despite the recent growth prices in Adelaide (at a capital city level) are only around the same as the last cyclical peak in 2010 and in some suburbs I am watching are similar to those seen in 2008/2009.

I expect growth to rollover to the downside (lower level or negative growth) as reality bites with the closure of the Holden factory, some major infrastructure projects come to an end (such as the new Royal Adelaide Hospital) and with a lack of good economic news in the pipeline. However, I think the next couple of years may provide a buying opportunity in Adelaide, the ability to lock in lower interest rates, with yields at a more reasonable level than the eastern states and prices which will potentially be little higher than they were 6-7 years prior, it's likely to be enough to coax me back into the property market (for the first time since the peak in 2010 when I sold).

That said I will be approaching the market cautiously and looking for opportunities where downside risk is limited if Australia faces recession or continued weak economic conditions.


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