Property Outlook for Next Decade

Superior returns in property investing requires the availability of mortgages. Post GFC, most central banks have an added motivation to control asset bubbles. It means that when prices rise too high, most governments will curb mortgage lending. To achieve superior returns, you need to invest in cities which just experienced a major crash, e.g. the US, Portugal, Spain, Ireland, Italy, and Greece. You can be certain the governments will encourage lending to boost construction jobs and banks.

In most other countries, governments are curbing lending. It means that house prices can only rise in tandem with wages in future. However, I believe that commercial properties may experience less interventions because they generally do not affect families. Residential property prices are political hot potatoes, but not commercial.

WHAT’S GOING TO AFFECT THE VALUE OF MY PROPERTY IN THE LONG TERM?

• Pete Wargent
 
• Michael Yardney's Commentary, Property Investment
 
• January 11, 2015

If you’re interested in property investment you’re probably wondering what in store for property prices, not just this year but in the longer term.

There are many theories about what makes property prices move, but in the simplest terms, there are two factors that determine price: supply and demand.

These factors are themselves affected by a myriad of smaller factors such as availability of financing, affordability and tax laws, to name but three.

So, what is my opinion on the future for Australian residential property? Well, the markets have a tendency to make monkeys of those who try to make forecasts. I will not make a definitive forecast, but instead I’ll look at the fundamentals of the market and the probabilities in order to make investing decisions.

Here are just a few of the fundamentals to consider:

Demand:
The population of Australia is predicted to increase dramatically to somewhere close to 30 million by 2040

Immigration:
The majority of immigrants will be heading for the capital cities, in particular to Sydney, Melbourne, Perth and south-east Queensland

Supply:
Statistics on this vary significantly, but it is generally acknowledged that Australia has an acute shortage of dwellings in certain areas and is not building enough new properties to house the expected numbers of immigrants; this is especially true in some landlocked city areas

Expected inflation:
The target inflation rate of the RBA is 2 to 3%, although core inflation is a shade below the target at the time of writing

Demography:
Generally, the population is marrying later, living in smaller two-income households for longer, and the younger generation overwhelmingly want to live near the CBDs of cities

Population density:
The increasing population will mean denser traffic, and rising fuel prices will increase the importance of transport links to the CBD.

My opinion is that property will continue to increase in value, but we are unlikely to see the relentless double-digit growth that we have seen in past decades.

Crucially, credit growth is extremely unlikely to continue to expand at such a dizzying rate, and it seems to me that the RBA is likely to be far more hawkish on inflation than governing bodies of decades gone by.

I also feel that the events of and fallout from the sub-prime crisis of 2007-2009 may force the world’s central banks to adopt a slightly different approach – rather than only focussing on controlling CPI and turning a blind eye to asset-price inflation, they may take a more active role in the controlling and deflation of asset bubbles.

For these reasons, I rationalise that the most obvious proxy for future property market growth is likely to be the growth of household incomes: logically, the more people have to spend on their residence, over time the more they will spend (though immigration may make the growth rate slightly higher).

Over the last couple of decades, median household income growth has been very strong, at times close to 6% per annum, but this has been partly fuelled by a significant increase in the number of two-income households.

Looking forward, it is reasonable to believe that the rate of increase may be somewhat lower, perhaps nearer to 4-5%, and consequently median dwelling price growth is likely to be somewhat lower than it has in the past too.

While this might be a reasonable assumption to make for a longer-term average, it is worth noting that in the short term property prices rarely move in such a uniform manner.

History shows us that growth asset classes are likely to spend long periods with values either flat or falling before seeing a period of accelerated growth.

As property investors, we want to remain invested through as many of these boom periods as we can.

We would do well to remember that between 1960 and 1990, the average rate of inflation was 8%, wage growth was 9.7% and property growth was around 11% (thus outperforming the CPI by around 3%).

Whether or not we have such high rates of inflation in the future remains to be seen, but we should note that the RBA’s target rate of inflation is now far lower than historical levels.

Property price growth is not the conspiracy that many people think it is. Much of the increase in property values over time is simply driven by the inflationary nature of our economy. Things will cost more in the future than they do now.

Unfortunately for the doomsayers, I believe that our property prices are likely to be heading upwards when we consider a reasonable time horizon. In future decades, Australia’s property prices are very likely to be far higher than they are today.

The question is, if median property price growth in the future is only somewhere around 5% instead of the 7–10% that has been seen in the past, is property still an asset class we should invest in? For my money, the answer is an emphatic ‘yes’.

Remember that, as property investors, we are not too concerned with median price growth.

We want to significantly outperform median price growth through investing in harmony with market cycles, picking properties that are in continual high demand and selecting properties that we can add value to through renovations.

Specifically, in Australia I will be investing in two-bedroom, two-bathroom units (and sometimes even one-bedroom units) with parking that are in suburbs close to the CBDs of some of the major capital cities.

I will be seeking investment-grade units in the supply-constrained, lifestyle suburbs that have transport hubs or links for easy access to the city.

Nobody knows what the future will bring, but if the median price of property grows by 5% over future decades, as a property investor I will be looking for my portfolio to outperform the median growth by at least 2%.

I believe that these suburbs and types of properties will achieve that because they are highly sought after as a result of their local resources and facilities. Properties in desirable suburbs are also impacted less by affordability issues than some of Australia’s housing stock.

How Fear and Greed Affects Investment Decisions

Most of my clients suffer from a basic investing mistake: they cut their winners, hold their losers. It seems counter intuitive but one should always cut loss from a losing investment and let winners run. Even I sometimes fail to heed this advice.

The level to cut loss is an art. I make my decisions based on the following:

1. If the asset is still undervalued, e.g.  For forex, I usually set it at around 200 bps. For stocks, if more than 30% below fair value, I will also set it at around 20%.

2. If the asset is over valued, e.g. If a stock is above its fair value, I will set the stop loss at 10%. But generally I will sell half immediately.

3. If the asset is AT fair value, or hovering around the fair value range, I will set the stop loss at 15%.

Stop losses cannot be applied to illiquid assets like property.

Most stock markets are on neutral territory now, meaning that I will set the stop losses at 15%. Remember that stock markets can fall over 50% in a bear market.

I recently noticed that the SGD yield curve is "kinked". The SOR was pushed above 0.6% to protect the SGD from sliding too far from USD. It is a bad sign for Singapore's economy and usually precedes a recession. I will avoid most Singapore stocks in general.

Thankfully, the yield curves of major economies, e.g. Eurozone, UK, the US, Australia, China are normal, but flat. It means we should see slow growth ahead but no recession.

It is not a good time to get greedy in 2015. Go for the bombed out sectors like oil and gas. Put your finger on the trigger but do not pull it. I see many fearful investors of oil and gas.

FEAR AND GREED

It is sometimes said that it is greed which drives investment markets up and fear which makes them plummet. But that’s not quite right.

The above chart intends to demonstrate that markets have a tendency to oscillate around a fair value, (however you may measure fair value) becoming well over-valued in a bull market and materially under-valued in a bear market.

The long-term trend is up (with earnings in the stock market or household incomes in property markets) but prices fluctuate around and tend to revert to the mean.

Bull markets often have a tendency to run for much longer than we think they will, but why? A part of the reason is that fear of missing out.

It’s very easy to sit out of investment markets when they are ticking along with inflation, but what happens when the next door neighbours, your work colleagues and mates down the pub are all “making a killing”?

Even at the risk of losing money, you might jump into stocks or property if only to avoid being the only person not “getting ahead”.

WHY HAVE OIL PRICES PLUNGED AND WHAT DOES IT MEAN FOR INVESTORS? | DR SHANE OLIVER

• Michael Yardney
 
• Michael Yardney's Commentary, Property Investment
 
• January 11, 2015

Oil prices have fallen more than 50% over the last year.

While lower oil prices are negative for energy producers and this has been weighing on share markets, ultimately it will be positive for growth in industrial countries, Asia and Australia and this should help drive share markets higher by year end.

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital explained the causes of this and it’s implications in a recent Insight. Here’s what he said:

INTRODUCTION

The past year has seen the world oil price fall by more than 50%.

Late last year as the fall accelerated this started to act as a drag on share markets and this has resumed at the start of this year as the oil price has continued to slide.

But what’s driving the oil price plunge and isn’t a fall in oil prices meant to be good news?

WHY HAS THE OIL PRICE COLLAPSED?

Put simply the oil price has collapsed because the global supply of oil has surged relative to demand.

Last decade saw the price of oil go from $US10/barrel in 1998 to $US145 in 2008.

Black lines show long term bull & bear phases. Source: Bloomberg, AMP Capital.

This sharp rise in the oil price both in nominal and real terms encouraged greater fuel efficiencies (use of ethanol, electric cars, etc) and more importantly encouraged the development of new sources of oil.

A significant example of this has been the surge in US shale oil production this decade which has taken US oil production back to 1980s levels.

We are now seeing benefit of this.

Source: Bloomberg, AMP Capital

This is similar to what occurred in response to sharp rises in oil prices in the 1970s, which then resulted in much weaker prices through the 1980s and most of the 1990s.

Other factors playing a role in the oil price collapse include:

• Slowing growth in the emerging world. The emerging world was a key source of growth in oil demand last decade but emerging country growth has slowed over the last few years in response to various economic problems. In particular Chinese economic growth has slowed to around 7% compared to 10% or so last decade.
• A rise in the value of the $US in response to relatively stronger economic conditions in the US. This weighs on most commodity prices as they are priced in US dollars. However, the oil price has also collapsed in euros, Yen and the $A so its not just a strong US dollar story.

However, the surge in the supply is probably the main factor.

In fact it was arguably OPEC’s decision last November not to cut production but rather to maintain it and try and force other producers to cut that has accelerated the fall.

In a big picture sense oil is just part of the commodity complex with all major industrial commodities – metals, gold, iron ore – seeing sharp price falls over the last few years as the commodity super cycle has shifted from excess demand to one of excess supply.

HOW FAR COULD THE OIL PRICE FALL?

How far the oil price will fall is anyone’s guess just as how much it would rise last decade was.

However, history tells us that it can fall much further than you think until supply is finally cut back.

In the 1980s and 1990s the oil price fell more than 70% before the bottom was hit (see the next chart). More recently oil prices plunged 78% through the GFC but the fall was short lived and supply in recent years has expanded not fallen as a result of the US shale oil revolution.

Source: Bloomberg, AMP Capital.

So a fall back to around $US40 a barrel or just below, ie a roughly 75% fall from the 2008 high is reasonably likely.

This level should start to force supply cutbacks amongst more marginal producers but, as we saw in the 1980s and 1990s, once prices bottom its likely to be followed by a period of base building rather than a quick surge back up.

WHAT ARE THE IMPACTS OF LOW OIL PRICES?

The plunge in oil prices has both positive and negative implications.

This has been reflected in sharp falls in energy share prices and a back up in high yield debt yields in the US, reflecting concerns about indebted US energy companies, and a collapse in the Russian sharemarket and Ruble on worries about the oil dependent Russian economy and a re-run of the 1998 Russian debt default.

And it’s these more visible impacts that have dominated the broad share market reaction to the oil price plunge over the last few months.

However, lower oil prices are a huge positive for the global economy generally. Oil price hikes lift business costs and are like a tax on households and so a surge in oil prices played a big role in the recessions of the mid 1970s, early 1980s, early 1990s and in 2008-09.

This all works in reverse for oil price slumps as business costs fall and the lower price of fuel provides a boost to household spending power. Rough estimates suggest a boost to growth in industrialised countries and in Australia from the 50% fall in the price of oil of around 0.7% if the fall is sustained.

Asia is likely to see a slightly bigger boost as most of Asia is a net importer of oil. Lower energy prices will also bear down further on inflation, which in turn will mean more pressure on China, Japan and Europe to ease further and a possible further delay in the timing of the first Fed rate hike.

In Australia the December quarter CPI to be released later this month is likely to show inflation running around 2% providing plenty of scope for further RBA easing.

For Australian households, the plunge in the global oil price adjusted for moves in the Australian dollar indicates average petrol prices have further to fall towards $1/litre (see next chart), as the usual lags work through.

In fact some service stations have already dropped the petrol price to 99.9 cents a litre.

Source: Bloomberg, AMP Capital.

Current levels for the average petrol price of around $1.13/litre represent a saving for the average family petrol budget of around $14 a week compared to mid last year. If sustained this will amount to $728 a year, which is a significant saving.

If the 99.9 cent/litre price becomes the norm then the saving will rise to $988 a year (see next chart). Some of this extra discretionary income will likely be spent.

Source: AMP Capital

So the fall in oil prices should provide a solid boost to growth over the year ahead.

IMPLICATION FOR SHARE MARKETS

Share markets have initially reacted negatively to the fall in oil prices because the negative impact on energy producers is what is most visible and this is being magnified by the steepness of the fall.

To be sure this impact could linger for a while yet and some sort of blow up – like further problems in Russia or a default by a more marginal energy company – cannot be ruled out.

However, the risk of a major threat to the global economy or share markets from energy producers is low:

• US energy production was a bigger share of the US economy in the 1980s and yet the mid 1980s collapse in oil prices helped boost the economy and share markets back then;
• While the Russian economy is facing a crisis (made worse by its own actions in Ukraine), a 1998 style Russian public debt default looks unlikely. Russian public debt is low at around 9% of GDP compared to more than 50% of GDP in 1998, public debt in foreign currency is trivial and foreign exchange reserves are much higher now. Private debt is more of an issue now but much of it is owed by just two companies (Gazprom and Rozneft) who have foreign exchange earnings and the Russian central bank has indicated it will help out companies meet foreign exchange obligations.

More broadly, its likely that over time the positive impact on global growth and hence profits from lower oil prices will dominate and this will help drive share markets higher by year end.

After oil prices plunges into 1986, 1998 and 2008 US shares gained an average 23% over the subsequent 12 months.

As a result any significant dip in share markets in response to lower oil prices should be seen as a buying opportunity.

Source: Oliver’s Insights.