A perfect property storm

So after doing some interesting calculations tonight on the current housing affordability crisis in some area’s of Australia I came to a very interesting conclusion. Sydney has hit the wall, prices are so rampantly out of control, so driven by speculation, and so dependent on continued value increases that the market can do nothing but turn.

So lets have a look. #

Recent statements by the treasurer have been copping a lot of criticism, some of it legitimate, some of it unfair, but all of it missing the point. The treasurer claims that with a decent job Australian property markets, although tough to enter, are still ultimately affordable due to the ready availability of cheap credit owing to our historically low-interest-rate.

Now lets ignore the fact that this historically low-interest-rate is exactly what’s fueling the rampant speculation in the Sydney housing market; and lets ignore the fact that inevitably interest rates will rise back to their long-term trend levels (if they don’t it means our economy is totally screwed and we have bigger problems to worry about). Finally let’s ignore the fact that when interest rates DO go back to their long-term trend levels the poor individuals who are sitting on enormous mortgages are suddenly going to find themselves unable to make their interest repayments, let alone pay off the principal of their loan.

Let’s just look at the statement that, with a ‘good job’, it’s still possible for people to break into the property market as a first home buyer.

The numbers. #

For the sake of this post I’m going to do my calculations based on the assumption that in order to break into the housing market buyers need to save around 20% of the purchase price of the property they intend to buy. This amount is to cover a decent 10-15% deposit so as to avoid lenders insurance and to cover things like stamp duty and other taxes.

Let’s then look at the median Sydney house price which recently rolled past the $900,000 mark and is growing by more than 12% per year. Now for arguments sake I’m going to put that growth rate at a conservative 10% for ease of calculation and so nobody can say that I’m dramatizing the numbers.

With these numbers in mind, you come to the conclusion that first home buyers would need to be able to front around $180,000 if they want to break into the property market.

The people. #

So, let’s take a young couple both working full time, sharing accommodation and saving a large chunk of their income (let’s be generous and say 25% of their after-tax income). With roughly ‘$1800 take home pay each week for both individuals lets say they’re scraping together $450 a week to go towards their house deposit. That’s $23,400 per year.

At this rate, it would take this couple nearly 8 years to save the $180,000 they would need to break into the market. So far Mr Hockey’s claims of a 'good job’ being enough to break into the market stands true… until you realise that one of the key aspects of an economic bubble is that in order to stop it from popping, one needs to make sure it continues to grow.

More than 60% of new loans are taken out by investors. These investors require this property to continue to grow in value if they are to keep their capital invested in the market. This is because, although house prices have risen at nearly 3X the rate of inflation, rent has remained relatively steady. This has created a market where renters no longer bring in enough cash flow to justify the investors interest in real-estate. This is OK because the investors can negative gear the rental property and then only pay half their usual tax rate on the growth in value. There’s one big problem with this though; if price growth slows, the shrewd investors will leave the market. If investors leave the market prices will begin to drop. If prices begin to drop the not so shrewd investors still invested in property will rush for the exits, competing for the small pool of remaining owner-occupier buyers at ever decreasing prices. This is why a property bubble can only do one of two things; grow or pop.

This then leads to my key point for this post.

What we’re in for. #

Assuming a conservative (for Sydney) property growth of 10% per year; that deposit of $180,000 that our couple from before needs to save will also grow by 10% per year. While, yes, the couples wages will also grow at around about 2-3% per year, the couples rate of saving can never match that which would be required to keep up with their growing house deposit.

Assuming around 6% earnings on their savings (once you take into account wage growth and interest) the couple would have saved $350,000 after ten years. However by this point their 20% deposit requirement would have grown to $466,000. After 20 years they would have saved $930,000; however they would now need over $1.2 million for a deposit.

What it mean. #

So you see, we’re already passed the point of no return… We actually passed it a few years ago when median house prices rose past $700,000. At this point, our example couple would have been able to just save enough money for a deposit after 10 years (again, taking into account 10% growth of housing prices).

By current Sydney standards (even when looking an hour from the city and most people’s places of work) generation Y couples who are starting their savings journey today have already been priced out of the market. The finish line, ever accelerating in its movement away from the races starting point, is now moving faster than the participants can ever hope to run.

And so, future owner-occupiers are now deciding to sit this boom out. To not buy in and to not take on that $800,000 mortgage. First home buyers, as a percentage of real-estate loan applicants, dropped to a historic low of around 5% in early 2015. And so, as every bubble does, this one is reaching the end of its growth. Soon investors will realise that Gen Y aren’t going to buy into the overpriced market. In Melbourne, developers are going to realise that the glut of overpriced, under-speced micro-apartments suddenly have nobody interested in buying them. In Sydney, Gen Y and Gen Z, ever mobile as everybody knows, are simply going to up and leave to find cheaper pastures. Property is only valuable while you have people willing to pay for it. You can’t buy food with equity, you can’t pay your staff with your great looking balance sheet. All investments are liquidated eventually and when they are this seller’s market is going to be turned on its head.

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