Mortgage secrets by demographic
Based on the latest data, Australia's housing debt among mortgage holders is comparatively low and intriguingly dispersed between rich and poor, young and old.
Most of the people reading this column will be either employees of small and large businesses, or owners of these companies.
Yesterday I gave a one-hour speech alongside Yellow Brick Road’s Mark Bouris to a seminar of 500 small business owners. As you might imagine, my presentation was chock-a-block full of economic analysis. If you want to have a look at some of the charts, you can view them here.
Today I want to highlight two – rather unrelated – things I canvassed at the seminar. The first touched on the distribution of housing debt amongst those owners that have a mortgage. The second was about the key lessons I have learned starting disruptive businesses.
Based on the latest available data, the RBA estimates that the total value of all Australian household debt to their assets is just 19.4 per cent. So the absolute "debt-to-assets ratio” in the household sector looks pretty low. A company with this level of leverage would not be regarded as risky.
What about the level of gearing within the housing market. The RBA’s analysis puts this figure at about 30 per cent. That is, there is circa $1.2 trillion worth of mortgage debt held against $4.1 trillion worth of private housing. Again, this looks good: it is around half the equivalent ratio in the United States.
But Chris, I hear you say, what about the level of indebtedness for those, and only those, with a mortgage? And how does this change according to age and income?
The RBA has kindly obliged and supplied this data as well. The first chart below tells us for home owners with a mortgage (i.e. excluding those who have paid off all their debt), gearing rises to a peak of 63 per cent for those aged 25-34 and then declines steadily to a nadir of just 9 per cent for those aged 65-74. Importantly, the median level of gearing across all home owners with mortgage debt is just 44 per cent.
The second chart teaches us that the level of leverage in the housing market rises as a function of income. As you move rightward along the X-axis you are migrating up the household income bands. The median home owner in the bottom 20 per cent of income earners only has a debt-to-assets ratio equal to 22 per cent. This then peaks at more than 45 per cent for those owners in the top 40 per cent of earners.
The second thing I shared with yesterday’s seminar participants were the insights I had gathered through my own experience starting businesses. Hopefully there will be some practical take-aways here for those of you who are in the midst of building a new business, and those who are considering whether to make the leap.
The first observation was that simple business models are often the best. Put another way, you need to "risk-adjust” the returns you expect to get from investing in a new company. Reinventing the wheel is great if you want to become the next Mark Zuckerberg. But for every winner there are many more losers. Unfortunately, we only see the "survivors”, which creates a downward bias in our perception of the execution difficulty. It is harder than you think!
Creating new products that have never been conceived of before can bequeath tremendous rewards, as Apple’s journey has demonstrated. At the same time, there is only one Apple, and innumerable skeletons that have been left in her corporate wake.
My own view is that innovation can be incredibly gratifying. But it is also bloody hard work. So when you start a new business, consider whether you want to grab the low hanging fruit and execute a safe strategy, or whether you have the financial resources to weather the long, hard road to building a truly "disruptive” enterprise that is going to reshape the world in which we live.
A second learning was that "corporate structure” counts. It sounds boring, but most new businesses take quite a while to get to cash-flow break-even. You will, therefore, be accumulating tax losses along the way. Your ability to harness these losses in future years will be impacted by both the corporate structure you choose at inception, and how this changes over time.
Your corporate structure will also affect your ability to capitalise on the attractive research and development subsidies the government offers through the tax system. These can be invaluable financial oxygen for new businesses engaged in genuinely inventive activities.
A third insight was that almost all "personal partnerships” fail. If you do a study of the history of personal partnerships you will see that they have an astonishingly high attrition rate. Corporate partnerships, on the other hand, are different. A company has a much better ability to transcend personalities and the idiosyncrasies of individual relationships. While corporate partnerships can also be taxing, they are, in my experience, easier to manage. And they can be more lucrative over the long-run.
When entering into partnerships, you need to always assume the worst. You should have comprehensive shareholders or partnership agreements drafted by specialist lawyers that deal with every possible adverse scenario. This is no easy task: a decent shareholders agreement can be more than 50 pages in length. But it will save you trouble down the track.
A fourth learning has been that intellectual property is a highly undervalued asset. Vigilantly protecting your IP through trademarks and patents can be an exceptionally important source of competitive advantage and commercial leverage. Again, you need sound counsel. Here I would avoid lawyers and start with an experienced patent attorney, which are usually cheap.
My penultimate observation was that human ingenuity can usually overcome even the most intractable problems. I cannot count the number of times I used to say to myself "we’re cactus” only to sit in a room with a bright bunch of guys and come up with durable solutions. There are intelligent and executable answers to almost all commercial issues. Yet most people are intrinsically problem-orientated and find the search for solutions innately challenging. My message: be positive and condition yourself to always focus on identifying answers.
My final lesson was not to let mediocrity pollute a high-performance personality. We all have different endowments of commitment, skill, patience, empathy and intuition. When I started out I used to torture myself about personal conflicts. Over time I have learned to, first, maniacally divorce my emotions and sense-of-self from all commercial decision-making, and, second, to recognise that most people are uncomfortable with this approach.
If you look at anyone who has accomplished something significant in private enterprise – and I don't mean migrating inexorably up a major bank hierarchy – you will find that they have had to overcome countless personal conflicts in the process. They say the softest thing about Frank Lowy is his teeth.
The key to the best decision-making is surprisingly tautological: you need to select the best option irrespective of what the consensus view may be. When making any decision, you will inevitably have to conflict with some section of the participants involved in the process. Few decisions make everybody happy. Those that do are almost always sub-optimal. And many of the best decisions will upset the majority.
To my mind, progress is about breaking down the barriers erected by institutional inertia. And when you smash down walls, you often break noses. Don't be afraid to do so.
Christopher Joye is a leading financial economist and a director of Yellow Brick Road Funds Management and Rismark. The author may have an economic interest in any of the items discussed in this article.
This article first appeared on Property Observer on May 31. Republished with permission.