Real Estate

Australian’s Property Love Affair And The Greater Fool

property and the greater fool theory

In Australia, property reigns supreme, permeating everyday conversations and dominating media headlines. It’s nearly impossible to escape a discussion related to real estate, particularly in light of the recent surge in interest rates from historically low levels. The question on everyone’s mind is the trajectory of the property market.

Reflecting on the past decade, and even further back, those who ventured into property ownership found themselves reaping substantial rewards. In hindsight, the decision to leverage one’s investments to the hilt appears remarkably prescient. Buyers should have eagerly seized every available property opportunity.

Amidst accessible credit, subdued inflation, and robust disposable incomes, property values continued their upward climb. Traditional investment metrics seemed to lose their relevance, as Australians proudly embraced the strategy of negative gearing.

Accountants routinely advised their clients to invest in property for the attractive tax benefits it offered. In essence, Australians were ecstatic about the notion of losing money in the short term because their true gains stemmed not from rental income but from capital appreciation.

The relentless ascent of property prices fueled optimism, with the belief that there would always be someone willing to purchase at an even higher price—a risky proposition often referred to as the ‘greater fool theory.’ Yet, time and again, this approach has defied expectations, continuing to deliver positive outcomes.

As someone in search of asymmetric investment opportunities, property doesn’t immediately grab my attention. Mainly because I do not see a future in how these property valuations can be sustained. However, perhaps I’ll discover I’m mistaken, and only time will unveil the truth.

Property vs Shares

Some argue that property holds a tangible allure, while shares are merely pieces of paper traded in markets. However, it’s important to note that each share represents a genuine ownership stake in a business.

Another compelling aspect of shares is their liquidity as an investment. Property, in comparison, often lacks this advantage and can require months to secure a sale.

While property has enjoyed significant capital growth returns, it doesn’t necessarily shine as a cash flow investment. In fact, many property investments may result in a real negative yield for owners.

As an investor in shares, I find this quite perplexing. Essentially, people buy property with the expectation that someone else will buy it at a higher price in the future – The Greater Fool Theory.

Warren Buffett’s philosophy dictates that the value of a business lies in the present value of all future cash flows, discounted at a suitable rate. Applying this perspective to property can be mind-boggling.

Essentially, people appear content to invest in properties that, when looked at through this lens, seem overpriced and yield negative real cash flows, all while being leveraged.

Imagine being offered the opportunity to purchase a company at 50 times its earnings, with negative real cash flow, and leveraged at a 5-to-1 ratio. Many would steer clear of such a proposition. However, when it comes to property, such concerns seem to dissipate.

Revisiting the Vanguard Index Chart

Of course, it’s possible to cherry-pick specific property or shares investments and argue for their merits or drawbacks. There’s always a better or worse case depending on your perspective. Nevertheless, it’s worth revisiting the Vanguard Index Chart for 2023 to inform your investment decisions.

Vanguard Index Chart Shares vs Property

In the last three decades, shares have consistently outperformed other assets on average. It’s worth mentioning that the realm of Australian listed property extends beyond residential housing, but the fundamental evidence remains consistent

Property Investment As A Whole

Australians, including myself, have not witnessed a prolonged housing downturn, and thus, we tend to extrapolate from our experience, assuming such an event is improbable.

Over the past five decades, residential property has generally shown resilience, punctuated by brief downturns. This resilience can be attributed to factors such as robust migration, limited housing supply, favorable tax incentives, shrinking household sizes, and relatively low interest rates.

However, when we examine longer timeframes, the Australian residential property market reveals a history of cycles—periods of prosperity followed by declines. For instance, in the 1980s, capital city prices plummeted by over 20%. In 1890, Melbourne’s property values experienced a staggering 51% real-terms decline, with national housing prices remaining stagnant until 1950.

While we’ve enjoyed decades of uninterrupted property wealth, it’s essential to recognize that a downturn remains a possibility. Basic mathematics alone can clarify this reality; property prices cannot perpetually sustain their upward trajectory. There is a limit to what people can afford.

On average, Australians witness a yearly wage increase of 3.7% while historically experiencing an inflation rate of approximately 2-3%. Considering these statistics, we can deduce that the real wage increase for Australians hovers around 1.7% to 0.7%.

Property Prices Out Of Reach

If property prices continue to appreciate at a rate of 10% per year, it becomes evident that the available income for the average Australian does not keep pace, even with a nominal 3.7% wage increase.

This chart illustrates the contrast between a 3.7% and a 7% compounded growth rate over a span of 50 years. Although the disparity may appear negligible at first glance, it doesn’t take much time before this gap significantly expands.

Back in the 1990s, the home loan debt-to-income ratio stood at around 5x. Fast forward to 2023, and we’re approaching nearly 15x. Call me a pessimist, but I can’t help but think there’s a limit to how much valuations can keep climbing.

Property Vs. Housing

For years, the discussion about the financialization of housing has been closely linked to issues such as foreclosures, evictions, and the struggle for affordable and adequate housing. At the heart of the matter is the perception of property as a mere tradable commodity, driven by speculation.

For millennials and younger generations, securing housing has become an undeniable challenge, unless they have substantial financial backing or support from family.

Contrary to the notion that their lifestyle choices, like enjoying avocados and coffee, are to blame, the real issue lies in the disconnect between wage growth and the escalating property values. It’s not a fair comparison when pitting younger generations against the circumstances faced by baby boomers.

Consider this: in the 1980s, when interest rates were as high as 17%, baby boomers could still afford homes. Today, people struggle to manage mortgages at 4.1% interest rates.

The scale of debt that Australians have taken on in pursuit of the ‘Australian dream’ is unprecedented. The question looms: how high can property prices climb before they become affordable only to a minority of high-net-worth individuals?

Housing is undeniably a fundamental human right, and the financialization of housing raises ethical concerns. The true value of property extends far beyond capital gains; it provides a sense of security and stability. When properties are traded purely for speculative gains, it adds little to economic productivity.

Ultimately, the primary beneficiaries are the intermediaries who profit from each transaction. I don’t take sides as a pro- or anti-property investor, but it’s challenging to envision a scenario where property valuations can continue their historical growth trajectory without unsettling the broader economy.

Australia ranks among the top nations for housing stress worldwide. The question lingers: how long can this persist before the housing bubble bursts?

Key Takeaways

  • Shares as an investment that historically outperformed not to mention it offers ownership in businesses and liquidity as investments. In comparison property often yields negative cash flows, while investors appear willing to overlook this for speculative gains.
  • Australian property market resilience has prevailed over five decades, but longer trends reveal cyclic downturns. Rising property prices and stagnant incomes suggest potential challenges ahead.
  • The financialization of housing, driven by speculation, poses challenges for younger generations, with rising property values outpacing wage growth, risking housing affordability and ethical concerns

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