Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Invest in Sydney/Brisbane property markets, or for media/public speaking requests, email pete@allenwargent.com

Saturday, 9 November 2013

Planning, land prices and house prices

It's common to see comments on Australian house prices which say "lift planning restrictions and release more land and prices will fall" or "if you want lower house prices, build more houses". Such mantras are, of course, intended to be gross over-simplifications, yet when you dig deeper the economics of planning and housing are infinitely more complex, and if you drill down to a micro level, perhaps sometimes even beyond comprehension.

Another old favourite line is that "if you increase the supply of potatoes, the price of potatoes falls". This may be a reasonable theory when it is applied to potatoes, because one potato is easily substituted for another and, as a general rule, people don't get all that emotional about purchasing their spuds. Apply this to housing, however, and to some extent the potatoes theory turns to, um, mash.

Substitutability

What is substitutability? A $300,000 house in Penrith clearly has a low level of substitutability with a $30 million house in Point Piper: the distance between the two locations is one factor, the demographics of the respective suburbs another. Chalk and cheese, as the old saying goes. Yet a 3 bedroom terraced house in one inner-west suburb might easily be substitutable for another 3 bedroom house in an adjacent suburb. 

The low supply of prime location land in our major capitals means that over the long term the capital growth in the well-located housing stock is likely to be strong. However, prime location land in Australia is extremely expensive, yields are woeful and in these 'thin' premium markets being a forced seller at an inopportune time is a salient risk.

Investors and homebuyers in the major capitals therefore often look towards the more affordable apartment stock. Arguably, apartments can be substitutable for one another, so investors need to be wary of changes in supply. These are key considerations when calls are made to increase the stock of high-rise apartment buildings in our major capital cities. Is there a genuinely high demand for this type of stock?

Externalities

What if two neighbouring landlords agree to improve their terraced houses in Marrickville to raise the 'tone' of the street? How do these externalities impact house prices? What if an entire street of houses agree to make improvements? What if one owner decides to skimp and improve their house slightly less thoroughly than the rest (aka the prisoner's dilemma)?

These small and sometimes imperceptible externalities may appear relatively trivial when applied to, say, a row of terraced houses in the inner west. But when the externalities instead relate to education, crime and public health they become more serious and are inextricably difficult to gauge. 

Effects on land prices

Michael Oxley in Economic, Planning and Housing:

"The demand for factors of production is derived from the demand for the commodities they produce. If the only commodity that a plot of land can help to build is potatoes, the price offered to buy and use the land will reflect the demand for potatoes".

It is fairly common to hear people say that the supply of land in cities such as Sydney is fixed. It is true that the total stock of land is fixed (except to the extent that, for example, land is flooded or land falls into the Pacific Ocean) but the supply of land made available for housing is variable. 

All else being equal, you might expect an increase in the supply of land for housing to apply downward pressure to land prices, but the price of land is also driven by the willingness of developers to pay for land and still make profits from constructing housing developments. 

In other words, land is a 'factor of production' and the demand for it is derived from the demand for housing. Thus if any increase in the building of houses reduces house prices then it might reduce land prices? Oxley again:

"Changes in house prices may have consequences for land prices, but it does not follow that changes in land prices will necessarily have consequences for house prices."

If land prices fall, do developers reduces house prices? If they don't have to, then the straightforward answer is no - they simply increase bottom-line profits. Therefore, it is equally as important to consider...

Effect of new builds on house prices

New houses and established houses are not two entirely separate markets. There is a level of substitutability between the two. 

Developers of new housing in fringe suburbs cannot easily charge $500,000 for a 3 bedroom house where there exists reasonably supply of established stock at prices of $300,000. If the new stock has substantially better decor, appliances and insulation (product differentiation) the developer may be able to charge a "newness premium", but where there is quality existing stock this premium is likely to be capped.

Oxley's underlying argument is that housebuilding companies "are price-takers not price-makers".

It is not only the volume of new building which affects land prices. It is the location and the characteristics of the new dwellings which determines what happens to house prices. 

Further, where the ratio of new stock to existing stock is low, the impact of new stock on the price of existing dwelling prices is diminished (which is why buyers agents often advise buying in capital cities, not in small regional centres or towns).

Oxley takes the example of London: "With only 6% of all houses in London being newly built, the idea that house prices in London would fall in the event if there being an increase [in the building of new houses], even a massive increase, is highly implausible". And since Oxley wrote that sentence, he has been proven exactly right.

Ultimately, you need to come back to substitutability. In Sydney, developers who have converted warehouses into apartment stock have at times been able to charge solid premiums because they are providing a product for which there is demand which is not being met by the existing stock.

But what is the substitutability between a two bedroom art-deco style apartment in a boutique 4-unit block, on a quiet leafy street of the lower north shore, as compared to a unit in a 60 storey, 235 metre tower block in the heart of the Sydney CBD? The level of substitutability is arguably low.

This is one of the reasons a certain level of foreign investment in new apartment stock to stimulate supply. Would this new high-density stock ever be built without the capital from Asian investors and developers? 

This is also why as buyers agents we tend to steer investors towards established apartments in boutique blocks, quiet streets, close to entertainment, close to transport links and units with an element of scarcity, (such as a view, a balcony or outdoor space). We might suggest north-facing apartments...unless there is a great ocean view to the east, of course. What the buyer should look for is an appeal or feature that cannot easily be substituted.

Future for Australia

Perhaps one of the most interesting things about the economics of planning and housing is how people so often tend towards forming their conclusions first and then work backwards to seek out the evidence which supports their pre-conceived notions. Here is what is likely to happen to Australia's population over the coming decades.


Source: Australian Bureau of Statistics

Given that the Reserve Bank of Australia has an inflation target of 2-3% and given that in cities such as Sydney, the total stock of land is essentially fixed, I know what I believe a vastly increased population to 6.5-7.5 million will do to land prices and dwelling prices over the long term.

This is even more the case when I see the NIMBYism and planning restrictions facing proposed  new developments in the desirable inner- and middle-ring suburbs, and when I hear people remain adamant that they flatly refuse to live more than 30 minutes away from the city or the beach.

But it's not important what I think. What is important is what you think. And, ultimately, it's what you choose to believe about the economics of planning land prices and house prices that should determine your decisions to rent, buy or invest.