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Reproduced with permission.
In the first article of this series, What determines house prices?, I introduced the concept of house prices being determined by the demand and supply for housing. I also outlined which were the demand factors and how they can impact on prices and explained the two most important demand factors (interest rates and the economy).
Here I will cover demographics, government, finance, rents, prospects of capital growth and finally, returns on alternative investments.
Demographics include not only the total number of people but also the household formation rate. Obviously the more people in Australia, the more housing we need but it is actually the household formation rate that is more important than population growth.
Let’s imagine there is a small country town, which has a population of 100 people. There are an equal number of males and females – 50 males and 50 females. Let’s imagine that they all get married to each other.
Question: How many households do we need? Answer: 50. Fast forward seven years and let’s imagine that they all get divorced.
Question: Now how many households do we need? Answer: 100. There has been no increase in population but demand for housing has doubled as the number of households has doubled.
In the recent past, Australia’s population has increased by 24 per cent but the number of households has increased by 45 per cent. According to the ABS, in 1911 the average household size was 4.5 people. Fifty years later, the average household size had dropped to 3.55. The average household currently has approximately 2.5 people living in it. More houses but less people living in each house.
The government, in particular the federal government, plays an important role in the residential housing market. To illustrate this point, cast your minds back 10 years.
1999 – The capital gains tax discount was introduced. This encouraged investors into the market because if they held an investment property for at least 12 months, they only had to pay half of the capital gains tax when they sold it.
1999 – The introduction of GST was announced and there was a frenzy of activity in the property and construction market. People were busy building, extending, buying and selling as they thought that property would automatically cost an extra 10 per cent on 1 July 2000.
2000 – GST was implemented, as was the First Home Buyers Grant. This was introduced to compensate first home buyers for the extra costs brought about by the introduction of GST. However, the impact of GST was felt mainly in the new home market. Consequently, it wasn’t long before the government doubled the grant to $14,000 if first home buyers were buying a brand new home.
The above events helped fuel the last property boom as they increased demand from owner-occupiers and investors. We are currently witnessing similar initiatives with the First Home Owners Boost (FHOB) being introduced late last year. The effects of the FHOB have not been as great as 10 years ago because of the major negative effects of the Global Financial Crisis. However, the FHOB is one of the reasons Australia has avoided a recession to date.
The availability of finance has a large impact on demand for housing and prices. You only need to look as far as the US and its sub-prime mortgage crisis to see how easy credit increases demand and consequently increases prices.
Just before the collapse of the US housing market, money was being lent to almost anyone at ridiculous honeymoon rates. This encouraged virtually everyone to buy property. This greatly increased the demand for property, therefore driving prices up. Now the world is paying for the loose lending policies of US banks and their affiliates.
It is currently quite difficult for people to borrow money, especially first home buyers with little or no deposit, and property developers. The over tightening of the credit market has reduced demand for property and this is one of the reasons property prices have stagnated and in some cases fallen.
If rents get too high, tenants start looking at the option of buying property instead of renting it. This increases demand for property.
With rental yields in some more attractive suburbs of our capital cities of 6 per cent and interest rates of 5 per cent, it doesn’t take a professor to work out that in many cases, you are better off buying than renting.
Prospects of capital growth
If investors feel that property prices are about to increase, they are more likely to get into the property market and capitalise on the opportunity to make money. This increases demand for property and consequently price.
On the other hand, if investors fear that the property market is coming to a halt or even worse, property prices are about to fall, some will panic and sell their property.
Returns on alternative investments
You will often hear that when the property market is up the share market is down and vice versa. The assumption is that if investors feel that they can get a better return from shares, they will buy into the share market. If they think that property is better, they will sell their shares and buy property.
I am not so sure about this assumption. In all my years of teaching property investment, I have not met one property investor who has sold property to buy shares. In my academic role, I have also met many share investors. I have not met one share investor who has sold property to buy shares.
What I have found is that property and share investors are different ‘creatures’. Property investors will stick to property and share investors will stick to shares. In the main, property investors don’t like shares because they can’t ‘see, touch and feel’ shares and share investors don’t like property because they don’t want to deal with tenants. I have met some investors who have both property and shares but property investors will have the vast majority of their wealth in property and a very small amount in shares.