Not so long ago investors were hearing warnings to expect less spectacular returns from shares, but now the same warning applies to housing.
After a decade of strong gains, including pre-tax returns averaging 21 per cent per annum for stocks in the S&P/ASX 200 in the five years to December 2007, investors were being warned routinely that they should not be getting their hopes too high for the future.
The argument was based on earnings fundamentals.
Earnings yields on Australian stocks were higher at the end of 2007 than for almost all of the time since the early-1990s recession, but further big gains in share prices depended on big rises in corporate profits continuing year after year.
Since the end of 2007, thanks in large part to the global financial crisis (GFC), the S&P/ASX200 has lost investors and average of six per cent annually.
Even in the absence of the GFC, the warning would have been appropriate – outsized increases in share prices and profits cannot continue forever and it would be a mistake to assume they might.
It is a warning that translates easily to the housing market at the moment.
The latest figures from the Australian Bureau of Statistics (ABS) show established house prices rose by 0.1 per cent in the September quarter.
Annual growth is still a strong-looking 11.5 per cent, but virtually none of that was in the most recent quarter and the latest half-year has accounted for only about one fifth of the increase over the whole year.
There is plenty of debate about whether or not the housing market is in a bubble.
The most recent salvos in the verbal battle have been fired by prominent investment manager Jeremy Grantham and the Real Estate Institute of Australia.
Last week, in a newsletter, Grantham reiterated his view that Australia’s housing market was in a bubble.
That assessment is based largely on his observation that housing prices have risen sharply relative to household income.
“The problem is that we live in a mean-reverting world (ie a world where things tend to return to their average level) where all of these things eventually change,” he said in the newsletter.
“In Australia’s case, the timing and speed of the decline is very uncertain, but the outcome is inevitable,” he said.
This latest assertion of Grantham’s view was met with a sharp riposte from the Real Estate Institute of Australia (REIA) on Monday, which dismissed Grantham’s opinions as “outrageous”.
REIA president David Airey repeated an earlier argument from his institute that “if Australia was in the midst of a so-called housing bubble, then we have been there for some time”, saying median price relative to incomes have been “relatively stable for the past ten years”.
What is often missing from this debate is an acknowledgement that housing is a financial asset.
The income to be derived from an investment and its expected growth rate can be used to gauge its value, in the same way a share or a bond can be valued.
The REIA’s own figures show rental yields – making an allowance for expenses but not for income tax – in the capital cities have been steady around three per cent for six or seven years, as strong rental growth has roughly matched price rises.
Ongoing rapid capital gains over the long term will depress rental yields to unrealistic levels, unless there is matching rapid growth in rents, which would in turn make rental accommodation unrealistically expensive.
So while it is debatable that the housing market is in a bubble, there is a strong argument that prices are already so high that another run of price rises measured in double-digits is highly unlikely.
Investors will most likely just have to get used to lower returns from rent and capital gains than they have enjoyed in recent years.
A run of big price rises could still happen, of course, if investors throw caution to the wind and buy in at lower and lower yields.
But if prices do undergo another boom, the argument that there is no housing bubble will become truly unsupportable.
By Garry Shilson-Josling, AAP Economist www.tradingroom.com.au
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