28/10/2016 - 14:33

Getting lucky in the property market

28/10/2016 - 14:33

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Australia is often favourably referred to as the lucky country, although many who use the term misunderstand the irony intended when Donald Horne first coined the phrase in his 1964 book, The Lucky Country.

Getting lucky in the property market
Many, mainly younger, Australians have been locked out of the housing market.

Australia is often favourably referred to as the lucky country, although many who use the term misunderstand the irony intended when Donald Horne first coined the phrase in his 1964 book, The Lucky Country.

What is beyond dispute, however, is that many Australians feel they are not so lucky when it comes to the housing market, particularly younger generations.

Those lucky enough to have bought into the housing market in recent decades have seen their asset appreciate significantly; but one Australian’s gain is another’s pain.

However the pain is not limited to the fact that owning a house or an apartment in a major city has become almost impossible for many, mostly younger, Australians. For those who manage to buy a house, this often comes with a huge mortgage, which may significantly decrease the happiness of owning a property. Recent studies have also suggested that the focus on the housing market negatively affects the flexibility of the workforce and individual careers.

The stress associated with either owing a very large mortgage or desperately trying to obtain one is hard to measure, but should not be underestimated. And with a correction of house prices looming, some buyers may not only have to serve a huge mortgage, but also see the value of their property fall below the mortgage value.

Is such a scenario possible? Looking at the average house and unit price growth over the past 20 years, the implied returns are not only higher than a comparable investment in a diversified portfolio of stocks or bonds, but the fluctuations (and thus the risk) have also been significantly lower.

The average annual return of house and unit prices for the eight capital cities during the past 20 years clearly exceeds the annual return of a broad index of Australian shares (the ASX300).

A comparison of the average returns with their corresponding fluctuations, that is, risk, shows even larger differences. For example, the ASX300 displays the usual properties of an asset that outperforms a risk-free alternative, such as Australian government bonds; both the return and the risk is higher for the ASX300 than for the risk-free alternative.

In contrast, property prices provided even larger returns than the ASX but with smaller fluctuations. This is not consistent with financial theory that predicts a positive relationship between the risk of an asset and its return. In other words, the Australian property market clearly outperformed the stock market on these measures and the differences are so large that it seems reasonable to be concerned. Even the worst performing city on these measures (Hobart) still clearly outperformed the ASX. This low-risk high-return pattern in the Australian property market may well be unsustainable.

Meanwhile, there are signs of a correction beyond the historically high valuations and low risk. In the greater Perth region, there are several areas where buyers are offered discounts of up to $30,000 (and in at least one case even a brand new car).

This is not a good sign for those who recently bought a property, as it indicates an increasingly sluggish home sales market, and that prices will fall or continue to fall. However, it is good news for those who couldn’t afford to buy a house or an apartment until recently.

Hence, a correction of house prices is not necessarily a bad thing, if such a correction has only minor effects on the economy in general. It would be a redistribution of wealth from existing (multiple) property owners to the younger and often less well-off Australians.

Excess house prices relative to the median income are making the average Australian feel not as lucky as previous generations, and potentially jeopardise the wellbeing of all Australians. Policy makers should keep that in mind when they think about the housing market. Recent first home buyers with a 30-year mortgage will not like a temporary correction of house prices, but a large group of younger Australians may welcome a correction, eventually making all Australians feel lucky.

• Dirk Baur is professor, accounting and finance, UWA Business School

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