Is property safe as houses?

The housing recovery is gaining momentum, and many see it as fragile. But is it?

Summary: The residential property market is rebounding strongly, and some pin its rapid acceleration on an investment-driven demand. Yet, the statistics point to the market being driven by owner-occupiers rather than investors.
Key take-out: Rental yields are set to rise, with potential first home buyers renting rather than buying. That will make the property market less risky for investors, and puts the recovery on a surer footing.
Key beneficiaries: General investors. Category: Property.

There is no shortage of arguments as to why investors should be concerned about this latest housing rebound, or be wary.

One of the more recent is that because the rebound is driven by investors, this somehow makes it fragile or more vulnerable to a correction. A counterpoint I guess to recent concerns over a housing bubble. I think the gist is that it makes a bubble more likely, and more likely that bubble will burst.

The argument rests on the idea that these investors are typically lower-income and highly geared individuals, who are susceptible to an employment shock. This then makes our banks vulnerable and investment into this housing recovery highly speculative - at least on that logic.  

Should you worry, or be cautious about investing into property then? Upfront I’ll say no, and while it always pays to be prudent, history has shown that it doesn’t pay to be scared. At least, unnecessarily so.

For starters, this housing recovery, like all others, is being driven by owner occupiers – not investors. Take a look at chart 1.

The chart shows that the proportion of investors taking out new loans – at around 36% -- is only slightly above what it is normal (34%.) Fair to say that investors have punched above their weight in terms of driving new loan growth so far this year – just over half of it. Yet that’s not to say growth has been modest for the established home owner market – or what’s termed the ‘changeover’ market. In reality, 17% annual growth is not soft. And the fact is that nearly two-thirds of new loans still go out to the owner-occupier market, and that’s about the same in terms of loans outstanding (closer to 70%).  With that in mind, I don’t think it’s quite accurate to say that this spurt is being driven by investors as such, which as you’ll see below is probably a pity in terms of financial stability.

Really, the only subset not getting in on the action so far, as readers will already be aware, is first home buyers. To be frank – and steering clear of any social commentary on the matter – this is only a good thing for the stability and longevity of this housing rebound. And a good thing for investors.

That’s not to say that first home buyers are a threat to the housing market or anything like that. In terms of this demographic’ income and wealth metrics, they are doing fine on any standard. So, for instance, average income for this group, at $2,000 per week is 20% higher than the national average and nearly two-thirds are in the top two income quintiles. And while the average loan principle outstanding for first home buyers might be between $282,000 and $300,000 (necessarily an approximation because the latest figures are from 2010), first home buyers actually have, on average, a positive net equity position of about 40% of their principle. That is, if all first home buyers sold their houses and paid off their debt, they’d have money to spare of about $120,000.

That’s not too bad. Yet it is quite a way below the national average net worth position – or over $700,000. More to the point, it’s much less than the net worth position (assets less liabilities) of property investors, which is over $1.5 million - and that was in 2010. It’d be a bit higher now. Equity in an investment property (for the other ownership types, equity in total property, not just investment property, is shown) was only about 30% of that net wealth – so about $400,000. That’s net equity, and obviously a very strong wealth position – a great balance sheet.

It is misleading then, I think, as some investment banks do, to refer to the low-income characteristics of property investors as a cause for alarm, even if it was true that investors were driving this resurgence in property prices. This overlooks the fact that many investors would be retired and perhaps have lower-than-average income, but much higher-than-average net worth. Similarly, referring to Tax Office statistics to derive the characteristics of investors also wouldn’t capture the true underlying picture. Households, not individuals, would be the correct data set to look at, given consumers naturally seek to minimise their tax burden within a given household.

Investor statistics collected by the Tax Office may reflect that fact and not give accurate reads on total household income.  Really, we would be better off if house prices were driven by the investor market. Recall that the crisis in the US was a subprime crisis – people borrowing money who couldn’t afford it. It was not a crisis led by investors.  

The final concern, that investors would be more exposed to any employment shock, is also easy to dismiss then – they’ve got the wealth to cover it. In any case investors, and indeed other owner occupiers who are driving this rebound, are much less exposed to an unemployment shock, not more exposed. The reason for this is that at times when unemployment rises, it is the youth who suffer most. 

For first home buyers, about 70% are under the age of 35, whereas for ‘changeover’ buyers and investors, that’s more like 70% are over the age of 35. This is an important distinction, as this age group has much, much lower rates of unemployment (an average of about 4% compared to 5.6% for the national average) now.

It is true to say that investors are a larger proportion of the market in Australia than in perhaps New Zealand or indeed in other countries, but this is a meaningless statistic. Why? Because of tax (negative gearing and capital gains), cultural, wealth and other considerations – e.g. demographic and supply factors that support property investment. These are very favourable in Australia, but not so elsewhere. Having said that, some European countries – Switzerland and Germany have owner occupier rates around the 40% - 50% mark. Australia’s is closer to 70%.  

So in sum, I don’t think this housing recovery is fragile at all, and it’s worth noting research from John Edwards of Residex at this point. He’s of the view, and I would agree, that rental yields are probably on the up, or in his words, “yields will rise to be around the home loan rate”. 

Why? Because potential first home buyers are renting, not buying. That’s regardless of whether they’ve been priced out of the market or because they’d prefer to go travelling, or live inner-city or whatever. When I spoke to John about his view, he also made the very valid point that this actually makes the market less risky for investors, not more, and it puts the recovery as whole on a much surer footing.

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