Our investment property no-go zone

The results of the sixth annual Demographia.com survey is out, and for a nation with an unhealthy and rather perverse ‘obsession’ with investing in residential property it makes for good reading. Ever heard the expression ‘it’s that popular nobody goes there anymore’?

Intelligent investing is not speculating and any investment in property at the moment is purely speculative. This is based purely on value versus price and I’ll tell you why – after you have downloaded and read the report here, if you are investing or intending to then this will give you a clear understanding of how to derive and understand where the ‘true value’ aspect of an investment property is calculated.

It’s quite clear that the national obsession has gone too far, way too far. You only have to watch channel 7’s Today Tonight roughly about every second night to hear where the ‘next’ boom property area will be.

Could I have some equilibrium please!

The normal metrics of the market are clearly distorted to a point of almost no return and the consequences for the nation’s long-term wealth are definitely serious. Mention it to our pollies and local council bureaucrats and they will have given it a very low to nil rating concern at all. The Lord Mayor’s reaction to media questions on the survey evoked a typified response “Well, that’s because everybody wants to live in Melbourne”… [sic] it’s not our fault.

As Australians we like to top the world charts in almost every sporting arena and there are many to be proud of and other not so proud titles like being officially the fattest people per capita in the world. Topping the charts as the most unaffordable country to live in the English-speaking world is certainly not another badge of honour.

The survey compares gross household income with the median house price, a metric bagged by property lovers. But really I don’t see how else you could effectively measure it?

How unaffordable do we rate?

There are no affordable markets even in regional cities like Ballarat, nor even moderately affordable markets (cities). There is but one, yes only one in the SERIOUSLY unaffordable category (Ballarat) with all other Australian cities (22 cities) described as SERVERLY unaffordable.

It’s quite clear the survey points the blame of the continuing boom at the iron heeled, malevolent stifling of the supply by our bureaucrat’s from all levels, releasing land painfully slow with ‘prescriptive planning’ rather than more responsive land use regulation, ie. supply being reactive to any demand needs.

Were they wrong to predict such big falls?

Many economists predicted falls in the residential property market of 30-40% due to the GFC, but they forgot to factor in the severe level of lap band surgery done on the supply of land lots for development. Had the property market been in equilibrium then falls of that order may have certainly occurred and should have occurred (as occurred in the commercial property sector), the current market is now some 50% overvalued and continuing to rise.

Many are of the misguided and mistaken belief (especially those in their 20s and 30s) that property just does not fall in value – sorry folks! I am old enough to remember back to 1993 when land release was more reactive to demand that property prices fell around 30% across the board. They also fell in the ’83 recession.

If you follow the mantra of the greatest investors in the world and follow the ‘smart money’ they tend to get very squeamish as price escapes value and when prices are hitting new highs, tending to get investor ‘depression’, then they jump out of their skin when a recession hits and sell off occurs.
“Recessions, I figure will always end sooner or later and in a beaten down market there are always bargains, but in an overpriced market it’s hard to find anything worth buying” – Peter Lynch, Fidelity Magellan Fund.

An Intelligent Adviser’s synopsis

As an investment asset, without the artificial support of a ‘prescriptive land’ release policy and the overly generous tax concessions applied since 1999, a fall in the order of 40-50% would likely occur and rates of return will fall to more normalised levels of closer to historical norm levels of about GDP growth of 2-3% (pre prescriptive planning).

If you understand price in relation to value you can see that being an intelligent investor requires a sound valuation policy, not letting emotions corrode that framework. Relying on only one metric to support continued rising prices for the longer term going forward is foolishness squared, but by all means this doesn’t mean you should not aim to obtain a house for yourself to live in.

At the moment the property bubble is caused by government inaction and it is artificially inflated above equilibrium. Sooner or later (hopefully sooner, so there is less pain in the long run) the bubble has to burst. I liken investing in property to investing in a company with a patent on a product with an undetermined time frame, one that could be taken away from them at any moment, as sooner or later the government will have to wake up to the fact that there is a massive over-allocation of resources toward residential property.

The final verdict

As an asset allocation typically no more than 10-20% of any investment portfolio should be place in such an overvalued asset class for an all important investment ‘margin of safety’.

That means if you had assets excluding your own home of roughly $5 million dollars, then $500,000 to $1,000,000 allocation is suitable.

According to the survey that amount would buy you several homes in many areas of the US and other places that may be considered to be truly ‘undervalued’. That is, where they are comparable to income and living standards and all other things being equal. Not just considered ‘undervalued’ comparable to other parts of Australia as is so often misrepresented in the press.

At 10-20% of your portfolio this would get you pretty much one investment property in a decent Melbourne, Sydney or other major Australian city suburb.

This is in line with the allocations currently being employed by the world’s very high net wealth investors and billionaires.

Nick Christian is a Financial Adviser and planner and authorised representative of Millennium3 Financial Services.

The views and opinions expressed within this letter are those of the author and do not necessarily reflect those of Millennium3 Financial Services Pty Ltd.

The above is general in nature and should not be acted upon without seeking the advice of a professional licensed financial planner.