The 3 biggest residential property myths

Property beats your industrial LICs any day Peter and you know that

Exactly.

Because plenty of people buy, renovate, and flick it and some other fool buys it for a stupid amount of money, and bar the transaction costs, it's tax free if it's your PPOR! The great Ponzi scheme at work!

Evan, there many logical flaws (prices haven't fallen, therefore, they will never) and incorrect statements ("Hence land values in good locations in those cities have been doubling every 8 years. For 100 years." - Prices in real terms in Australia were flat from the 1880's until the 1980s when the beginning of the home lending/borrowing boom started) that I won't begin to unpack them all. So I will leave with just a single point:

Clearly, the price of houses and land is determined by the willingness for people to buy and ability for people to pay. Borrowing power in Australia has increased in the last 30 years by the exact amount that houses/land have increased by.

The factors that overwhelmingly affect borrowing power:
- Incomes per household (1 income -> 2 incomes)
- Interest rates (how much can a household borrow/afford to service)
- Prudential lending limits (3x income to 7-8x income)
- Real Wages/Productivity

All have had huge tailwinds in the last 30 years. The correlation between borrowing power and subsequent (not first home) buyers/home values is undeniable (see the AMP charts).

Please tell me what will be the future drivers of borrowing power.

Suggesting that mathematical laws and normal market dynamics do not apply here, while they do in every other property market around the world is rather hubristic.

If it’s all driven by borrowing power, how come the asset class is only 22% geared. Nearly half the entire asset class by value has no gearing at all. How does borrowing power impact those prices as opposed to accumulated equity ?

The discussion on real v nominal is important and somewhat more complicated but happy to engage in that 1:1z

Prices are set by marginal buyers, not aggregate debt. The gearing ratio you cite (housing debt/housing value) includes the equity of every property in the country, but ignores that prices are determined solely by the tiny fraction that actually sell.

This mechanism is foundational to asset pricing. Housing valuations rely on "comparable sales," (Hedonic Regression) meaning the ~5% of stock that turns over dictates the value of the 95% that doesn't.

Take it to its extreme: Imagine the total turnover of the property market next year was a single house bought for 50% over market value. The increase in mortgage debt from that one transaction would be miniscule, yet the capitalized value of every house in the country would rise by 50% instantly.

It works exactly the same in reverse. Most downturns occur on low volume where the sellers are "forced" (distressed) and the buyers are constrained (job losses, lower borrowing power). If a single distressed seller sells into an illiquid market, every house on the street is revalued lower, regardless of the low debt/equity ratio of the neighbours.

Prices are set at the margin, not by existing owners. Average gearing might be 22% as many people purchased years ago and own their home outright or have paid down a significant part of their initial debt. The gearing/LVR ratio on properties being bought and sold today would be much higher.

Tom and Wayne, sure prices are set by marginal buyers. Most of whom are lowly geared due to equity from their previous home.

If your theories were correct, prices would indeed have plummeted as interest rates soared in the last few years as most commentators predicted using exactly the same logic as you have yet again here.

Did they ?? As the French philosophers might say your claim may work in theory but it doesn’t work in practise!

To other commenters, I never said prices won’t come down and your example of reductions in immigration, were they to be substantial and sustained, would indeed take pressure off land values - exactly as in the form I am arguing this works on the other side.

It’s really not that hard - if you put an MCG and a half more people into Melbourne every year - and likewise with Sydney and Brisbane, most of them will prefer to live in the same scarce well located spots and the value of said land will then keep rising.

And if interest rates were the main driver, why do properties which are 80% land values growing at twice the speed as properties which are 40% land values- there is no difference in gearing levels.

Please … try analysing every sale price of every property in the last 50yrs (such as they are available in the public data and largely they are) and keep trying to explain capital growth or lack of it with your gearing theory and see how it works out for you.

No, really, I do this for a living. But thanks for confirming the very point made in the opening paragraph.

And David, yes I read Alan’s article and my reply was published in the following Quarterly. Here’s our White Paper which has stood the test of time.

https://blog.longview.com.au/hubfs/whitepaper-what-drives-australian-house-prices-over-long-term.pdf

"If your theories were correct, prices would indeed have plummeted as interest rates soared in the last few years as most commentators predicted using exactly the same logic as you have yet again here."

Evan, there are two distinct buyers in Australia, and they are not in the same league:

The Median Buyer: This is the "real" market ie: the dual-income family, the first-home buyer. Their ability to pay is based on their income, their savings, and APRA's 3% serviceability buffer and the many many incentive programs governments are applying to prop up the market. They were tapped out months ago before the new incentive schemes hit.

The Marginal Buyer: This is the price-setter. The downsizer with $3 million in tax-free capital ie: the Bank of Mum and Dad, bypassing serviceability/the investor for whom the asset is a speculation/tax-saving vehicle.

An auction with ten median buyers clears at the "market" price, set by their shared borrowing capacity. An auction with nine median buyers and one marginal buyer clears at whatever price the marginal buyer dictates, which can be hundreds of thousands of dollars higher.

This is the entire story of 2020-25. The "record" price is simply the last price this small, unconstrained, price-insensitive cohort was willing to pay. And there is a huge gulf between that marginal bid and the maximum bid of the median buyer.

This entire charade works only as long as transaction volumes/stock on market remains at record lows and animal spirits remain high. The moment "normal" supply returns from investor exhaustion, a tick-up in unemployment the marginal buyers will be exhausted. The market will have to turn to the median buyer to clear the stock... This is normal market mechanics, especially in an auction driven market and explains why higher interest rates have not affected prices as much as expected.

Also, we actually have the counterfactual argument to observe re: borrowing power:

Ireland has the same housing shortage and population pressures we do. But because they capped borrowing at 3.5x income post GFC, their prices didn't recover their 2007 peak until 2024. Prices were mathematically forced to wait for wages to catch up. In Australia, we let borrowing power float, which is why our prices detached from wages.

This is a pretty lightweight article on what actually should be a serious topic. It is full of the type of the selective logic favoured by residential property spruikers. Others have commented already below on some of the article's shortcomings (such as the misguided point about 22% leverage).

For a more reasonable, fact based account of state of residential property in Australia, readers should consider Alan Kohler's Nov 2023 Quarterly Essay 'The Great Divide: Australia's Housing Mess and How to Fix It'. https://www.quarterlyessay.com.au/essay/2023/11/the-great-divide/extract

i stopped listening to mr Kohler,shortly after he was boldly
forecasting a 25% plus drop in property prices just as peak covid
hit in march 2020.on ABC tv news
property prices took off the moment the reserve bank flooded the market with
cash,soon after mr Kohlers comments

"property prices took off the moment the reserve bank flooded the market with
cash":

Obviously RBA heard. One disaster at a time.

Many in Canada and New Zealand though they couldn't have decent drop in house prices too. Then migration was cut and interest rates rose and they now understand that trees don't grow to the sky.

A Federal Government that was focused on the long term prosperity of Australia would cut migration, reform the tax system (lower income taxes, higher land taxes), end the RBA's negative real interest rates after taxation and end the taxpayer funded schemes that inflate house prices (taxpayer debt guarantees, shared equity, rent subsidies). It's unlikely to happen soon, but all of these would be great for productivity and negative for house prices.

Almost all of Australian's wealth is tied up in property (most people end up asset rich, cash poor due over investing in family home) and the ~$4T superannuation sector. Not a lot of productive industry investment. Then again we're the smart country that digs s..t up, sells it cheap and then buys back finished goods at 10x the price. Go figure.

Australia, a proud country of cafes, barristers, virtue signallers, excessive entitled public servants and middle class welfare recipients and workers! What could possibly go wrong?

Family home yes, otherwise investing in residential real estate is a very poor choice in my opinion. The amount needed to buy a property is huge, it is inflexible and the buying and selling costs very high. On selling there is one massive capital gain, difficult to offset. This is not the case with investing in shares ,ETF's and even better gold bullion.Much lower starting capital needed and great flexibility to meet life's unexpected demands. It is easy to gear into those investments and not an issue to decrease it if required. Then there is the benefit of dealing with CGT, by realising gains over several tax years.Having tried investing in rental homes and been moderately successful, the ongoing management and tenant issues was too much of an impost on my busy professional life.

It’s always done my head in. Ppl claim resi makes so much money but the data is incorrect. Property price growth comes from settlement data, mostly pexa now I think but used to be the state revenue offices when they collected stamp duty.

If you buy a property for $1m and sell after a decade or more for $2m the data will show 100% (2/1) gain. But if you spent $500k on renovations and repairs the return is 33% (2/1.5) in reality. As they don’t have the data on contributed capital and yes I did simplify for time value of money. The claimed property price growth data is therefore complete and utter bunkum.

I total agree with the authors points that property goes down in value (as you need to keep spending money it to make it as good as it used to be) but land goes up in value. Anyone who buys a unit thinking they’ll make good money is just plain lucky, a vast majority make a terrible return. Either that or they don’t have the maths ability to do a discounted cashflow analysis.

The misleading part of the article was the growth value quoted in $$ terms. Sounds like a real estate agents way to say things. A small number multiplied by a MASSIVE number still gives a big number. At roughly 6% the real numbers not nothing. However super is doing better AFTER expenses and this number is before expenses. (Yes I know it’s only the growth number but yields are crap anyway, esp after all expenses including amortised capital improvements over the life of the asset).

Lastly on negative gearing. You lose 47 cents, have to get a capital gain to recover it, PAY TAX on the recovered gain to get back to zero and make no money. Just invest the dollar you started with in a low tax environment. The biggest positive use for negative gearing is real estate agent spin to sell it to you in the first place. I agree it’s not material in the property data but just quarantine the losses to the property itself to shut down the argument plus will give it the same tax treatment of quarantined losses for trusts and companies.

Buy and hold resi investment properties are a very poor investment for most investors. Only the really astute or very lucky do well after all expenses. That’s not you, you’re one of the astute ones?? Other than Dudley on these blogs who can do a discounted cashflow analysis? Not many would be my bet which means you don’t actually have any idea what your return is. Truth is you have no idea

Property is a credit fueled feedback loop!
1. Rising prices ? more collateral value
2. More collateral ? more lending capacity
3. More lending ? higher demand
4. Higher demand ? rising prices again

Policy engineered wealth machine.

Hmmm. Boxes for people to sit in rising in value more than the national sum of all human endeavour. That's miserable. We don't produce enough, and we pay for our excess by greedily selling off our country one block of land at a time. Forget AUKUS. we are not going to have our country taken. No. Were selling it !

Spot on in breaking down the old RE agent clech'es Evan. "Position, position, position" made me a wealthy man. Remember the drawing in all the RE offices back in the 70s/90s, of a bent over old man, with the caption "the young man who waited for the price of RE to go down". If you didn't get a piece of the action then, it's not to late. REITS are one way to get in with limited capital, and soon we'll see fractional blockchain investments offering opportunities. But remember, POSITION, POSITION, POSITION, and as Evan warns invest in "dirt" not 'pie in the sky'.

Derek, you are correct when you say that REITS are one way to get in with limited capital (and APZ and EGH) are two smaller listed companies focussing on residential real estate in various states of Australia. An investor in APZ will be up over 120% in the last 12 months and 45pa over the last 3 years. That beats the hell out of any residential real estate I hold and it would have been cheaper and easier to get a foot in the door. That’s assuming that someone who is focussed on property isn’t so fixated on the image of bricks and mortar that they can’t see that there’s more than one way to achieve their property goals (and with significantly less ongoing expenses). To this degree, Evan is probably correct, that sometimes it would be wiser (and more profitable) to leave property management, either direct, unlisted or listed to the experts.

Good to see your still firing Derk.

How sad it is that so many Australians see residential property as nothing more than an 'investment' for wealth creation, rather than providing the shelter for people that it's meant to be. All helped along by tax breaks and other various schemes that are supposed to help with 'affordability', but do the opposite. Not to mention the countless property flipping/reno shows that are rammed down our throats on TV and social media every day.

Thank you for a brilliant article. This should be published in every major newspaper.

HOUSING CRISIS. Not an issue 5 years ago, NO WORD ON MASS MIGRATION BEFORE PREVIOUS ELECTION, now we have 2 million migrants in 6 odd years and NOW WE HAVE A HOUSING CRISIS?
WATER CRISIS. A decade ago water was THE PROBLEM, from 1970 till 2020 Australia’s population DOUBLED, in that time water storage increased 4%. It’s NOT RIGHT V LEFT, it’s RIGHT V WRONG.

Global debt both private and goverment have us now in uncharted waters. Mass immigration is the tool of choice to drive up both house prices and GDP to try and avoid recession. How sustai able this model is has yet to be seen.

"buys back finished goods at 10x the price.":

Give Temoo a look. Anything cheaper or better value to make in Aus?

[ I manufacture in Aus ]

How do the main newspapers get away with continuing to publish stats on real estate performance?

Up until recently Nine/Fairfax owns Domain and News Corp owns most of REA.

The performance they source is usually from Cotality (formerly CoreLogic who formerly acquired RP Data).

Does their residential property performance statistics take into account renovations and improvements?

Terrific article, none of the attempted critiques trumped made a dent for me and I’d certainly take Evan’s take on Housing over Alan Kohler’s every day! Wonderfully written and constructed too. I’d recommend reading The Land Trap by Mike Bird to understand further Evan’s point on Land.

I love the old billboard poster outside Real Estate agents' offices - a picture of an old man saying "this was once a young man who waited for housing prices to go down". Thankyou for your article -very sensible.

“obvious correlation between interest rates and house prices”

The graph shows a positive relation between mortgage interest rates and house price index until the 1990s when there was a shift and the graph then shows an inverse relation between mortgage interest rates and house price index. In my view the reason for the shift is that there was a significant rise in inflation during 1970s-1990s which meant that real interest rates were much lower than nominal rates. Hence you would need to show relationship between real interest rates (after inflation) and house price index to ascertain any real correlation.

Australian residential property prices cannot be allowed to fall substantially because:

1. Local Council''s are almost totally dependent on rate income geared to capital value assessments,
2. State income from land taxes is also geared to values,
3. Federal politicians are afraid of losing votes if people feel poorer,
4. The size of our bank's exposure to residential gearing is huge, and
5. The near certainty of long-term inflation.

In summary, It's our built-in Australian system that keeps values rising. Do you know any politician game to take the risk of proposing large, risky system changes? You would need lots of them.

"correlation between interest rates and house prices?":

Hardly likely to be a correlation between a rate and a value.

House price traverses 1 to 1000, any dips and bumps due to whatever factor will appear insignificant, swamped by larger change in value of money.

A more plausible comparison would be house value and the cumulative value of money compounded by mort-gage interest rates.

The debunking the myths part is correct, but basically the rest is not. Eg, property values boomed between 1993 and 2007, but the next 14 were a relative disaster.
Also average the asserted average 6% net return is highly misleading. Means returns are much lower, especially now with confiscatory type land tax and high renovation and repair costs.

Most families purchase an investment property with the view of forced savings whilst raising their family sure place in a reit or shares or other like investments is seen as risky or similar to super ,but the property investment can also become the childrens property down the track as they know how hard is a purchase first time around and in twenty five years maybe much harder so decision is not always as seen by the experts ,

Interesting/balanced article and doesn't seem to be picking a side (anti- or for- property) which I thought was good. Evan seems to be in the business of "managing/operating" rental properties rather than "owning the asset", essentially an asset-light business model which seems to be the only way to truly earn money in property - the middle men are the ones that have a high chance of making a profit - not the buyer or the seller!

The Australian hobby of buying overpriced "investment property" is truly mind boggling as to why would one want to hold on to such high cost "investments/assets" all to secure a 30c - 50c tax credit from the Govt while still losing 70c - 50c for every $1 spent all to feel good that one is being financially savvy by using "leverage"!!!

As Evan states, the only high probability of making a decent return on property is investing in well located land close to major city centres rather than the usual Mum & Dad "investor" buying property in suburbs 40 - 50+ KMs away from city centres where honestly all Australian capital cities continue to have a LOT of available land supply.

I was surprised by the statement "Because we have the second highest population growth rate in the world".
Wikipedia's "List of countries by population growth rate" lists 240 countries or states, of which Australia is 79th in percentage population increase (2024 figures) !