By Bill Zheng, October 2011
By the end of this article, you will discover I have made a prediction which is the exact opposite of what most people believe. You'll also discover why I am happy to put my prediction in writing so that you can verify my claim in the future.
Let's check out what determines property price movements. From my observations:
- Short term property price movements (within 1-3 years) are usually determined by human emotion (also known as human insanity ☺).
- Medium to long term price movements (3-10 years or more) are more likely to be beyond human insanity, hence they are more predictable and controllable.
Can we really predict human insanity? Some of the most intelligent people have been put to the test and still failed miserably. Economists have the unfortunate job of predicting human insanity, hence they earn the reputation of "having successfully predicted 9 out of the last 5 recessions".
What is the difference between human intelligence and human insanity? There is a limit to human intelligence ☺.
So what does determine property price movements over the medium to long term? In my opinion, amongst many other things, property prices are predominantly determined by two factors:
- The money supply of a nation.
- The wealth of a nation.
Let me explain.
The money supply of a nation.
Let’s take an extreme example to create a simple demonstration.
- Let’s say on this little island country called Australia, a few thousand years ago, there were only 10 houses (probably called sheds back then ☺), and there was no money being used at that time.
- The island chief decides to issue some money called Australian Dollars for circulation. For the sake of simplicity, he decides that the money issued can only be used to buy properties and nothing else.
- The island initially issues only $10, so each house is therefore priced at $1 each. (Amount of money available divided by number of houses.)
- A year later, the island decides to increase the money supply to a total of $100 still with the same usage restrictions (can only be used to buy houses). Without any improvement to the properties, each house is now priced at $10 each. ($100 divided by 10 houses, equals $10 each.)
Now you can see how property prices can go up just by increasing the money supply of a nation. We don’t even need to discuss the supply and demand situation as these only influence short term price adjustments.
If we look at the median property price in Melbourne and Sydney:
- In the 1920s, property was priced at around £30;
- In the 1960s, property was priced at around AUD$10,00;
- In the 2010s, property was priced at around AUD$600,000.
You know that the median priced properties are not better than those from 90 years ago when you compare their land size, location and quality of the building. But the price tag just keeps going up and up with no end in sight. This is the power of money supply increase.
(Take a look at the diagram below to see how Australia has been increasing its Money Supply at around 9% a year compounding non-stop, and how it “coincidentally” aligns with the property prices increase over the same period.)
(Data source for Australian Broad Money Supply: Economagic.com)
The wealth of a nation.
Have you ever noticed that regardless of which particular industry caused a nation to prosper at any given time, the wealth of that nation always ends up sitting in its residential properties? It has been estimated that around 70% of an industrial nation’s wealth exists within its residential properties. You can test this yourself, by looking around at 10 of your friends to see where their wealth is. You will quickly discover that the majority of their wealth is in their home, regardless of what line of work they do.
In other words, every 20-30 years you will see new industries come and go, in cycles of boom and bust, but the wealth left behind those industries tends to stay in residential properties.
Let’s take a look at some of the nations over the past 100 years. Each has had some incredible industries at different times that have tremendously increased the wealth of those nations. For example:
- The automobile industry, steel industry and IT industry each brought America enormous wealth during their individual eras. But where has most of the wealth ended up? In their residential properties.
- The manufacturing industry of China, the oil industries of Dubai and Saudi Arabia and the electronics industry of Japan, all these industries have come and gone, but the wealth they created remains behind in their residential properties.
In 2006, I had the chance to work with a multi-billion dollar international hedge fund to finance a AUD$1.5billion residential property development project. The managing director of this fund happened to be the head of the Asian Pacific division of one of world’s largest investment banks. His rationale for investing around AUD$200Million into this residential development project is too simple to believe, at least for people who don’t handle multi-billion dollars every day.
On the trip to make his final decision to invest into the project, he said to me that it is always safe to invest, not speculate, in residential properties in a country which is becoming wealthier, regardless of which industry was predominantly responsible for creating that wealth. The reason is that the majority of the extra wealth is always going to end up sitting in residential properties anyway, with no exceptions. It’s just a matter of time.
So the question to ask yourself is, will Australia become wealthier or poorer over the next 10-20 years?
With the decline of the US & European economies, we are now firmly in the “Asian Century” as our Prime Minister recently put it. Australia is unusually well positioned to benefit from the growth of Asia, which represents 50% of the world’s population.
Let’s look at what Australia has in terms of resources*:
- The world’s largest resources of brown coal, lead, nickel, uranium, zinc & silver;
- The world’s 2nd largest resources of iron ore, bauxite, copper & gold;
- The world’s 3rd largest resource of industrial diamonds & lithium;
- The world’s 4th largest resource of manganese ore;
- The world’s 5th largest resource of black coal.
(*Source: Geoscience Australia)
Australia is by far the world's richest country in natural resources per person with an unstoppable demand coming from 50% of the world's population over the next 20 years alone. According to investment firm Credit Suisse the median wealth of Australians is the highest in the world already, its Global Wealth Report shows the typical Australian adult is worth nearly four times the amount of an American. In fact the research reveals that half of all adults in Australia have a net worth above $216,000.
Unfortunately most people living in Australia do not see that. Like the saying that "fish discover water last" we can't see what we are in because we are surrounded by it.
Let me give everyone a different perspective so you can see the impact on Australian property prices.
I came to Australia from China in 1988. At that time there were almost 1 billion farmers in China and it wasn’t doing very much business with Australia.
Now it is 2011 and China has 102 cities with an urban population of 5 million people or more. While Australia has none (Sydney has only 4.5 million people). China has become heavily dependent on Australia’s resources.
China’s massive urbanisation process, which is continuing to move an incredible 400 million people into cities, is creating the demand for an extraordinary amount of resources such as steel and coal just to house all these people.
If you have difficulty visualising what all this means to Australia’s wealth, imagine moving Australia’s entire population of 20 million people into a nearby fairly undeveloped country, say Papua New Guinea. Just to enable all these people to live a decent lifestyle would require building millions of new properties and supplying energy to these 20 million newly arrived residents. Then imagine doing the whole process 20 times over within the next few decades.
If you happened to own a business that had the mandate to rebuild the entire Australian nation from scratch 20 times over within a couple of decades, and your business has been selected as the largest supplier of resources needed for the task, how do you think this business would do financially? Some people worried about the Chinese economy slowing down could hurt Australia, but really if they slows down by 10% (i.e. a serious recession), instead of building Australia 20 times over, they are now only doing it 18 times, what difference does it make? Australia still couldn't keep up with that demand anyway.
The above Chinese scenario doesn't include the demand coming from other heavily populated countries such as India, Indonesia and Japan. For example, India is currently in the process of building over 300 shopping centres the size of Australia's largest shopping centre - Chadstone Shopping Centre, it so heavily relies on Australia's resources too.
Recently BHP Billiton has predicted Australia's resources industry will need an extra 170,000 workers in the next five years alone, not to mention jobs needed to be created in other industries to keep these workers functioning. Australia is not called the Lucky Country for no reason.
Cutting through the noise.
Many Australian property investors have been distracted recently by the events in US & Europe. Amidst all this noise, many have forgotten the fact that Australia was one of the few developed countries that didn’t go into a recession during the GFC, and still retains the highest credit rating for its government and major banks.
Let’s look at some facts to compare Australia to the rest of the world.
When you look at the US Government’s budget* for this year you can understand why their credit rating was recently downgraded:
- U.S. Tax revenue: $2,170,000,000,000
- Federal Budget: $3,820,000,000,000
- New debt: $ 1,650,000,000,000
- National debt: $14,271,000,000,000
- Recent budget cut: $ 38,500,000,000
(*Source US government budget papers)
To make their situation easier to understand, let’s remove 8 zeros and pretend it's a household budget:
- Annual family income: $21,700
- Money the family spent: $38,200
- New debt on the credit card: $16,500
- Outstanding balance on the credit card: $142,710
- Total budget cuts: $385
Now let’s compare that to the Australian economy*:
- Annual family income: $29,840
- Money the family spent: $34,610
- New debt on the credit card: $4,770
- Outstanding balance on the credit card: $8,460
- Total budget cuts: $2,200
Many people believe that the decline of US property prices over recent years was due to the global financial crisis. I see them more as symptoms rather than the cause, as residential property prices over the longer term tend to reflect the wealth of a nation.
The underlying cause of the US property price decline is that they are becoming poorer as a nation due to their heavy indebtedness which was mainly caused by a long period of over-consumption, a lack of highly competitive industries in recent times, and a few very expensive wars.
People ask me why Australia’s property prices didn’t drop like US after the GFC, here is my view on this:
- On the surface, it looks like our banking system is more prudent to avoid properties being over supplied, as Australian banks won’t lend you money to develop new properties until you have pre-sold most of them, whereas you can get finance to build 200 new homes in US without knowing who is going to buy them.
- Below the surface, it is mainly because Australia is getting wealthier as a nation, and US (& many European countries) are getting poorer due to their heavy indebtedness; To make matter worse, US (& many European countries) are in denial of such situation and trying to use more debt to solve their debt problems. Do you think using more cocaine is the solution for a cocaine addict?
So it is important for property investors to see the new trend where Australia has now permanently departed from the general decline of wealth in the rest of the developed world, and the performance of property in other developed countries bears very little relevance to Australian property performance.
I believe Australian residential properties are on the verge of a major bull run over the next 20 years, because of 3 major reasons:
- The Australian dollar, as a relatively small currency in size, is at the mercy of the rest of the world’s money supply, and the rest of the world has been on a money supply increase path for the last 100 years. With no mechanism to stop printing more money around the world, Australia’s money supply will have to continually increase, hence the price tag on everything will continue to go up, including residential properties;
- Australia will continue to grow wealthier over the next few decades and property prices will rise to match the wealth created through this process;
- Australia is now aligned with the Asian region which is where the majority of growth will continue to come from and so the negative impacts of US & Europe will soon become less and less relevant.
Here is my prediction: the next 20 years will be a golden era for Australian residential property investors, regardless of what will happen in the short term.
I recommend all our clients to follow good money management principles and put more money into residential properties as early as it is safe for them to do so within their own circumstances.
At a practical level, Australian property investors need to take into consideration the impact on property prices from the baby-boomers’ impending retirement and follow the banks’ lead to park your money where the next income generating group will be residing.
For example, a family with 2 kids with both working parents earning an average income of $60k each, can obtain a mortgage of $640k from any bank today. If they borrow 80%, they can afford a property as high as $800k. If you see a suburb full of families with similar incomes or better and it is still only selling houses at $400k each, you know that the banks will help push that suburb towards $800k as soon as they can. If you buy in those suburbs, you have will very limited downside risk.
(For more information on the rationale behind this article, please read the article titled "How Do You Find Value in Any Real Estate Market?")
The above information is supplied by Investors Direct Financial Group Pty Ltd..
Disclaimer: while due care is taken, the viewpoints expressed by sponsors do not necessarily reflect the opinions of Your Investment Property.
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