Outer suburbs wedded to value

Housing trends offer bargains to selective buyers.

Summary: An arrangement where parents rent a house to their adult children will become a semi-permanent part of the family finances. The parents gain substantial tax benefits and the children get rental accommodation, usually below market price. Although house prices have risen strongly, Lazard believes a downturn is inevitable, which would also mean lower profits for bank stocks.

Key take-out: Australia is over exposed to the housing sector. That overexposure will blow up if any key factors behind the housing boom are knocked over, such as population growth, tax incentives for investors, low interest rates, Chinese investment, abundant lending and restricted supply.

Key beneficiaries: General investors, property investors. Category: Residential property investment, bank stocks.

My wife and I recently attended a wedding celebration and amidst all the nice things that happen at weddings I got a preview of the future structure of family relationships and in turn that led to a fresh assessment on the current values of property and bank shares. That is not bad for one wedding. 

The couple had been living together for some years in the outer suburbs and were renting a house that was owned by one of the parents and the arrangement was part of a negative geared exercise where everybody benefited. In the weeks that followed their wedding I began talking to a lot of my colleagues and found that a great many of them have bought investment houses or apartments and were renting them to their children and in some cases grandchildren. 

Where the children are working in the city and need to live relatively close to their work there is really not much chance of the children ever owning a dwelling without a huge mortgage – the prices are too high. This investment-family rent arrangement will become a semi-permanent part of the family finances. Of course if there are two or three children it may mean that the parents might need a couple of investment properties but in many cases at least one child ends up working overseas. 

Here we have a very fundamental change in the structure of our society where the parents are the house providers but gain substantial tax benefits via lower tax and capital gains by these arrangements and the children get rental accommodation usually lower than the market. And with that comes stability of tenancy. On the parents’ death presumably they will inherit the house but the family whose wedding I attended lives in the outer suburbs where the situation is very different. 

If you can manage the commute into the city or better still work in the outer suburbs you have a totally different housing outlook. In the area where this couple plan to live they can buy a reasonable three bedroom house for $400,000 to $500,000 and it will have a little garden as well. And so they can “fly the nest” and buy their own house – a choice not so easily available to those nearer to the city. 

But should our couple abandon the “family” rented house and buy their own dwelling? House prices in Australia have risen to levels that are as high as any in the world because of a number of factors – higher population, historically low interest rates, incentives for banks to lend on housing instead of business, the influx of Chinese and Asian capital and tax incentives for investment housing. A recent report from PRD Nationwide said the average first home buyer loan is $550,000. It also pointed out that in Sydney just 10 per cent of homes in greater Sydney were cheaper than this average loan number. In Melbourne the figure was a slightly healthier 25 per cent.

These forces have provided the demand and at the same time in many areas of the country we have restricted the supply via councils and planning requirements. That particularly applies to Sydney so there is no surprise that Sydney is where the price explosion is taking place. In the outer suburbs the market is kept lower because there is supply and there is no Chinese buying. 

Should my wedding couple buy a house in the outer suburbs? Given the abundance of supply it is unlikely to skyrocket in price but there is a real lifestyle advantage in owning your own dwelling. It is yours and you get a feeling of security that enables you to make longer term plans. This has been a linchpin of the Australian society which we are now losing. My recommendation to this couple is buy your own house because unlike inner city living, the price is affordable and the lifestyle benefits are worthwhile. 

But we should not underestimate the hazards. And this was highlighted to me when the Lazard Investment Group revealed they had been underweight with bank stocks over the last year. They believed the banking sector was headed towards a significant downturn because Australian dwellings have been overpriced. The price-earnings ratio of an investment in a dwelling is about 40 times net earnings which is way above stock market levels. And banks’ profits depend on high leveraged loans to the housing sector. 

Lazard believes that a downturn in the housing market is inevitable and with that downturn would come much lower profits for bank stocks. They got their timing wrong and banks and house prices surged in price. But Lazard believes that the combination of bank shares and large investments in dwellings makes Australia over exposed to the housing sector. And there is no doubt they are right. 

But that overexposure to dwellings will only blow up in their face if any of these key factors behind the housing boom are knocked over – population growth, tax incentives for investors, low interest rates, Chinese investment, abundance in bank lending and restrictions on supply. To that you can add any significant rise in unemployment will also transform the housing market.

The Abbott Government does not appear to have any willingness to change the housing incentives. Banks will be almost certainly required to put more capital behind housing loans but can’t really afford to curb the supply of capital because they can’t afford to see a slump in housing because it would reduce their profits. The Chinese are harder to predict but the lower Australian dollar is lowering the price of our dwellings. I don’t think we will see major boosts to the supply in Sydney but Melbourne has an avalanche of apartments in the planning which is likely to affect prices in the medium term. But the outer suburban wedding couple have good employment and I think they are going to go out and buy a house and not worry about the risks. They have my blessing.