The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, July 26, 2011

Who are the property losers?

[This is from my Property Observer column, which you can see live here.]

What’s the chance of losing money when you buy a home? Or, put another way, what percentage of all people who buy and sell suffer losses before accounting for costs? As simple as these questions may sound, they are not easy to answer. There are only a handful of organisations with the data and capabilities required to run this type of analysis.

Addressing this question is also important if you want to better understand individual property level risk, which is something that I have written about for years. In this column, I showed that the volatility of a home is akin to that of the sharemarket, and 3-5 times riskier than a broad-based house price index.

Commencing our analysis in 1990, Rismark’s team of PhDs collected 3.7 million purchase and sale pair transactions pertaining to the same home. We call these “repeat-sales”. In total, there were 7.3 million transactions. Of course, there are going to be many people who bought homes during this period, but who have yet to sell. They are, by definition, excluded.

The team then calculated the buy-and-hold annual compound capital return (excluding imputed or explicit rents). These are, to be sure, gross returns and do not account for the many transaction costs associated with holding a home. They also do not control for alterations and additions (viz., renovations), which are undertaken to offset the physical depreciation of the asset, or simply to improve it.

A number of years ago we took the ABS’s alterations and additions data and tried to estimate its impact on annual capital growth. The number we arrived at was about 0.55% per annum, which has been confirmed by other analysts.

The results of the first cut of our research are illustrated in the chart below. The median capital return to property owners since 1990 has been 7.8% pa.

This is interesting for a couple of reasons.

First, it is exactly the same compound annual growth rate we get when we look at RP Data-Rismark’s hedonic house price index over the last 10 years, which is a completely different methodology.

Secondly, it just happens to accord with the return we get if we calculate the compound annual growth rate attributable to a very simple ‘median’ house price index over the last 28 years.

Observe in the chart above that the distribution of buy-and-hold returns looks to be right skewed: more people are realising high returns relative to very low returns.

In particular, 9.3% of all home owners traded their property for a loss (note that these are pure capital returns, and ignore the rental income that you would have got along the way). This is also gross of all transaction costs, so you can be sure that the net number is higher. Ipso facto, around 90% of owners realise positive gross capital returns on their homes before accounting for rents and costs.

The next diagram breaks-out this analysis by capital city so that we can get a feel for relative performance over the last two decades. And the results are fascinating. Perth and Adelaide are the two best performing cities, generating compound annual capital growth rates of 10.3% and 9.5%, respectively. The worst performer was Sydney, which has yielded about 1% per annum less than the national average of 7.8% per annum.

Two other things to think about.

First, these returns reflect the change in the capital value of a home over time. What they do not tell us is what the home owner’s actual equity, or geared return, would have been. We can comfortably assume that the equity returns are far higher (likewise the losses for the one in ten folks that get unlucky).

Second, as discussed, this analysis excluded gross rents, which are currently around 4-5% per annum. It also ignores all transaction costs, which sum to around 1-2% per annum for the average home owner who stays in their property for 7-8 years.

In closing, what are reasonable growth expectations going forward? A simple benchmark is national disposable incomes. If we take the ABS National Disposable Income estimates, and divide by the number of households to control for population growth, we get a useful per household growth estimate.

Based on this measure, Australian disposable incomes per household have risen by 4.9% per annum since 1993, which is about 25% higher than wages growth. The differential could be attributable to the advent of multiple-income households, the tendency for marginal tax rates to decline, stimulatory government subsidies, such as middle class welfare, and as a result of the better portfolio diversification households are getting via superannuation.

Looking ahead, one might reason that disposable income growth will be a bit lower. This in turn implies that house price growth might be less than the circa 7-8% annual rate that it has compounded at over the last three decades.