Will Property Prices Appreciate at 10 per cent Per Annum?

I was surprised to learn that reputable buyer’s agents are still promoting the idea that property prices will appreciate at 10 per cent per annum at their seminars and home-buying shows.

We’ve come to expect nothing less from property ‘clubs’, of course, as they tend to be somewhat evangelical in their approach, promoting property as a magical risk-free asset class which always goes up 10 per cent per annum.

It seems that sometimes people almost want to hear that prices will boom interminably – they find the phrase “property always goes up” soothing to the ears.

The tired old phrase “property goes up 10 per cent per annum” was spawned from the days when inflation was very high, and the cost of almost everything was going up rapidly.

Then a combination of factors including plummeting interest rates, deregulation of lending standards and a boom in the number of two income households allowed rapid price growth to continue through the 1990s and beyond.

Over the past decade, while some parts of Australia have forged ahead with very rapid price growth, others have by and large tracked the growth in household incomes.

If we take a look at the today’s economy, we find that:

– Inflation is currently tracking at 2.5 per cent, which is comfortably in the middle of the target 2-3 per cent range;

– Interest rates are sitting at 2.75 per cent , which is way lower than the double digit rates that were seen two decades ago – so these cannot fall much further; and

– Wages are growing at 3.2 per cent

The speed limit for the price growth of property is ultimately our ability to pay for it.  So unless you have an IQ that is diminishing at 10 per cent per annum, you can quite clearly see that long-term property price growth of 10 per cent per annum will not eventuate.

Let’s be generous and say that household income growth in the future continues to grow in perpetuity at 4 per cent per annum.

And let’s take the example of a capital city suburb where a dwelling costs $500,000 and household incomes are around $100,000 (these aren’t the national averages, but it’s a reasonable enough representation for the purposes of this exercise).

Here is how the incomes, dwelling prices and the dwelling price to income ratios would pan out over the years if prices grow at 10 per cent per annum:

As you can see, it is nonsense.

A dwelling will not cost $58 million in 50 years’ time and prices most certainly won’t reach 83 times incomes.

So if a buyer’s agent tells you that property prices will continue to go up at 10 per cent per annum, they either aren’t very clever, in which case you probably shouldn’t hire them, or they are lying to you, in which case you definitely shouldn’t hire them.

It’s pretty obvious that this kind of price growth isn’t going to eventuate absent a return to rampant inflation.

Ten per cent growth didn’t happen in 2011 and nor did it occur in 2012. And even in the past 12 months with interest rates now at record lows, none of the major capital cities has achieved 10 per cent growth.

Of course, it’s a possibility in any given year, but even if we allowed the introduction of Singapore-style 40 year mortgages and abandoned all pretence of macroprudential restrictions, it’s still a huge call to say that it could continue for long.

Naturally many markets don’t tend to move smoothly. Instead they jump ahead before falling back, and this happens in cycles. In Britain I recall prices storming along at double digit levels for year after year until Gordon Ramsay sounded the death knell.

Gordon Ramsay, you ask? I’m serious! There’s often a point in bull markets when “taxi drivers and shoe-shine boys” (in other words, every man and his dog) start to talk up the asset class as a sure thing, and in his 2007 book Humble Pie Michelin-starred chef Gordon Ramsay said that when young chefs came to him for advice he told them to buy a property to live in and then invest in more property.

Cue the property crash.

In most areas outside London, prices are still behind where they were in 2007, so the “10 per cent per annum growth” theory doesn’t seem to quite tally in the UK.

In Ireland, it wasn’t a chef who sounded the death knell, it was some other comedian. Again, I’m serious! In July 2007, Irish independent journalist and comedian Brendan O’Connor urged people to buy property, even though there was clear evidence that the huge price appreciation of the preceding years was in the process of bursting.

Cue the property meltdown.

Does this mean I am bearish on Australian property? No. We did have a moderate downturn through 2011 and 2012, which on balance was a good thing for our markets. But lower interest rates have reduced the repayment levels on new and existing mortgages, the markets have stabilised and capital cities are showing moderate growth.

We’ve avoided recession, to date at least, with a GDP growth of 2.6 per cent and unemployment has remained low at around 5.5 per cent.

There will no doubt be very challenging times ahead as the mining construction boom tapers off, but monetary policy can stimulate other sectors of the economy and with Australian population growth surging to a crunching 392,500 persons per annum, it’s my contention that property investors who are smart and stick to quality properties in supply-constrained capital city suburbs will do well over the longer term.

But property price growth of 10 per cent per annum? Send for the men in white coats!