Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

5 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 finest property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete 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'.

"The level of detail in Pete's work is superlative across all of Australia's housing markets" - Grant Williams, co-founder RealVision - where world class experts share their thoughts on economics & finance - & author of Things That Make You Go Hmmm...one of the world's most popular & widely-read financial publications.

"Wargent is a bald-faced realty foghorn" - David Llewellyn-Smith, MacroBusiness.

Thursday, 15 May 2014

RBA insights into Aussie housing

Ego and Confirmation Bias

The other day I bought a parcel of shares in an industrial stock for $1.10, the share price zoomed up to above $1.20 in double-quick time, but then the price fell back to my entry point at $1.10 and I was stopped out with short shrift. 

I know beyond the shadow of any doubt that when I was 25 I would have let the price fall well below my entry price before even thinking of selling, and then hoped for it to 'come back'. 

It's an ego thing; you never want to admit to making a poor selection.

By the time I turned 35 I'd learned that if you want to be a successful share trader you must have the discipline to cut your losses and let the winners run (rather than precisely the opposite, which is what most losing traders do).

Even the best stock pickers might select perhaps four trades which don't co-operate from every ten. That doesn't make them bad trades, as such. You simply must be disciplined, and cut the losing selections ruthlessly, and 'trade right'.

The process is as important as the outcome. Twisting on 20 and getting an ace doesn't make one smart, only lucky.

Ridding yourself of that pesky ego is vital to ongoing success as a trader. If you let the losing trades fall and fall in the vain hope that they one day come back to save you at break-even, eventually one of them will keep falling and wipe out all of the other accumulated gains in your trading account and then some.

Human nature dictates that it's very hard to admit being wrong. This is non-sensical: we all get things wrong all the time!

The only reason I reckon myself to be a half-decent investor today is that I've made no many balls-ups in the past - pretty much every mistake you can name, in fact, I've probably made it or a variation thereof. 

Indeed, making all the mistakes in the book is sometimes the only way to learn about what works and what doesn't, and to some extent it might be described as the hallmark of an expert investor - one who has made every mistake, but has resolved to learn the inherent lessons.

Capital growth

Is there ego in a lot of our property market commentary? Gosh, yes! 

How often do people admit to being wrong? Even when they've had a complete shocker and recommended speculating in mining towns where prices have since collapsed?  Occasionally? Rarely? Ever?!

As I blogged about here, unfortunately for me, I've made mistake after mistake as an investor, although luckily a long term outlook can be forgiving of errors.

Was it Oscar Wilde who said: "Experience is the name we give to mistakes"? I think it was. Oscar Wilde said most of those things after all. It's true. Mistakes are how we learn as people, and also as investors.

Inner suburbs, or outer?

There has been a long-running debate in Australia about whether capital growth is stronger in suburbs closer to the respective city centre (aye), or in outer suburbs (nay).

Clearly, historically, there is no debate to be had. 

Median house prices in Sydney's inner suburb of Point Piper obviously did not get to exceed $5.832 million with moderate capital growth.

And, just as obviously, median house prices of $228,000 in Spencer, Gosford, or median unit prices in Vineyard, Hawkesbury of $162,000 are hardly representative of rampant dwelling price appreciation.

The price growth has necessarily been in some way inversely related to  relative proximity to the city with its employment, infrastructure, amenities, and so on.

It's a debate we've had over and over again in London and the UK over the years. And every time we carry out research into the issue, the results are precisely the same. 

Regional price growth in Britain remains relatively poor, outer London suburbs show moderate growth, and prime central London continues to outperform massively.



Australia?

While it has been common knowledge in Aussie real estate that inner suburbs have demonstrated stronger capital growth over the long term, in the past 15 years or so there has sprung up a debate as to whether regional centres and outer suburbs might now be the outperformers.

Why would that happen? People working from home? People seeking to move outwards for a cheaper lifestyle?

Unfortunately, study after study after study shows that the answer is: no. It's not happening. Indeed, if anything, we seem to have the opposite problem.

Younger generations often want to live close to the city, even if they have to pay to rent or buy an expensive apartment to do so. 

What can happen, in my experience, is that cheap suburbs can get a sugar hit as they gentrify thus experiencing a spurt of capital growth, but over the long term price growth is stronger in better located suburbs closer to the city.

See here and here for the charts from AHURI which prove it, both over the long term and across recent years too. 

The evidence is as clear as daylight, yet some will still cling to perming carefully selected data over short term time horizons in order to defend their arguments.

Inner suburbs are STILL seeing higher capital growth

And so to the RBA's Luci Ellis and her excellent presentation on Australian housing at a conference in Sydney this morning, the full transcript of which you can read here.

Ellis started by highlighting how household debt has hit a plateau since 2005, which implies that Australian dwelling price growth in aggregate will be slower in the future, and far more closely tied to household income growth in the future than it has been in the past, when lending criteria were deregulated and a structural shift to lower inflation and lower interest rates took place.

I'd suggest, though, that property investors will likely still be able to attain strong enough returns over the longer term, provided they know in which locations and what property types to buy.

Ellis highlighted what I've discussed on this blog a thousand times, that being the geographical constraints on some of our cities such as Sydney, which is surrounded by ocean, national parks and mountains, as well as pointing out how exceptionally low the population density is in our urban locations.

We have spacious plots, large houses and relatively few people per square kilometre in urban Australia, which does little to help combat housing affordability in detached dwelling types. 

Graph 3: Urban Population Density

Ellis also went on to discuss the concept of the Central Place model - which is akin to what I have previously referred to here as the bid-rent curve - it suggests that prices and rents tend to decrease as you move away from a city's central point. 

Figure 1: The Central Place Model

Although Australia's cities are not monocentric and do have smaller sub-centres, the RBA notes that when you look at the spatial pattern of employment in Australia, the single centre model "is not a bad fit".

That's correct and accords with what I have seen unfolding in Sydney. We do have employment centres such as Parramatta and Macquarie Park/North Ryde, but they remain very much secondary locations to the main event of the CBD.

We kind of already know all this.

Jobs growth, population growth and capital growth in residential property and much commercial property has been strongest near to the centre of cities in the past.

But what of the future?

At present job density is much higher in the central city areas as the RBA's research shows. In fact, read this point from the RBA carefully:

"Population density is higher near the centres and declines rapidly: again, the scales on these graphs are exponential, so each darker shade is an order of magnitude higher density. 

Some of the outermost districts still contain agricultural land and a good fraction of national parks, so it isn't surprising that population densities are low in these places. I find it interesting that even some middle-ring districts are not that much denser."

Job density:


Graph 4: Job Density

And, for that matter, so is population density far more heavily concentrated on central areas:

Graph 5: Population Density (Persons per square kilometre, 2011)

That's all fairly inherently obvious, but what is more important is how are these trends changing over time.

"The power of the central place is even more striking if we directly contrast where the jobs are with where the employed people live...in all of these cities, the CBD is still the job magnet."

Aha! As I've been arguing forever and a day - yes, we have secondary employment centres in
Sydney (and other cities), but no, they most certainly do not draw more jobs to them than the city and the respective central zones.

Firstly, job density is clearly increasing in central areas at a far greater rate than it is in outer areas:

Graph 8: Change in Job Density

And, secondly, which is more, the population is increasing in density in inner and middle suburbs at a much greater rate too.

RBA:

"In fact, many of the inner areas have become even greater job magnets in recent years; some middle and outer areas added people, but not so many jobs, so their job-to-worker ratios actually declined."


Graph 9: Change in Population Density

Impact on dwelling prices?

What people, I suppose, are often really interested in is how these demographic shifts impact dwelling prices.

The answer, concludes the RBA's research, as indeed does every other credible study undertaken on the subject for that matter, is that the ratio of inner ring to outer ring house prices is actually continuing to increase, and the ratio is notably increasing at the greatest rate in the largest cities.

Luci Ellis:

"Declining job-to-worker ratios in some of the outer areas mean that many people are likely to face longer commutes than before. 

The trade-off between space and place is getting steeper. 

Locating on the fringe is relatively less attractive than it used to be, and not only because the fringe is moving further out.

You can see that trade-off in relative housing prices over time. Inner-ring properties have become more expensive relative to outer-ring properties in recent years. And the larger the city, the greater is that premium."
Graph 11: House Price Gradient

This trend has played out in all five of the major cities so the conclusion is inarguable on an aggregate basis.

The causation is simply a matter of increasing demand for living close to the city versus scarcity value.

A word of caution, though. This chart represents the ratios for detached housing only, which inherently tends to have a certain level of scarcity value, particularly in fully built out areas.

If you're going to buy unit or apartment stock, look to those with an inherent scarcity value, which does not mean generic, over-priced high rise shoe-boxes which are purchased off the plan.

Outer suburbs and regional centres are struggling

With a few exceptions, outer suburbs and regional centres are struggling across a range of metrics. Ellis again:

"Even social infrastructure doesn't easily follow population to the low-density fringes. Sydney's newest university, Notre Dame, could have chosen an outer-ring location where land was cheaper and it had more room to grow. 

But instead it put one campus right next to two other universities not far from here on Broadway and another in Darlinghurst."

And on the challenges facing our regional centres:

"I also can't help noticing how difficult it seems to grow the smaller cities in this country relative to the bigger cities. With the possible exceptions of Newcastle, Geelong and maybe Bendigo and Ballarat, few centres outside the state capitals have many corporate headquarters or other job magnets. 

These self-sustaining job magnets seem to be necessary to create the variety of job opportunities that would attract large numbers of former city dwellers. 

Over recent years at least, these smaller centres had rates of employment growth and changes in employment-to-population ratios that were similar to or a little below those in the big cities, and a bit below those of inner-city areas. 

At this rate, it will be hard for the smaller centres to start catching up with the bigger cities, relatively speaking. That means that if big-city housing prices should rise too high for some residents, smaller cities cannot provide alternative locations that are any more viable than they are today.

Instead of jobs coming to people, at least some of the people have been coming to the jobs, enabled by the pattern of building. In recent years, not only is a lot of the new housing in infill developments, it is much more likely to take the form of high-rise apartments than in the past. "
And so, yet another independent study concludes unequivocally that inner suburbs are more desirable, are magnets for jobs growth, have greater access to essential infrastructure and amenities, have higher population growth, are more self-sustaining and show higher residential property capital growth  - both over the long term, and over the last 8 years too.

Summary

The debate about whether inner or outer suburbs will thrive will drag on, of course, since that is the very nature of confirmation bias.

But the conclusions drawn by the RBA and independent research institutes are about as black and white as it is possible to find.

Ships will sail around the world, yet "the Flat Earth Society will continue to flourish"...yet those listen to what the data is clearly telling them rather than continue to rally in vain against it, will prosper.