Summary: Many Australians believe property appreciates at around 7% per year on average over the long term and doubles in price approximately every 10 years. Unfortunately, the reality - as of 2016 - is very different and not just for units (as opposed to detached houses) or property in areas with obvious economic downturns.
Firstly, you need to factor in long term changes in inflation. Real (after inflation) growth rates are obviously lower, but how much lower? High nominal growth rates during past periods of high inflation can easily mislead and will not be sustainable during periods of very low inflation - like now.
Secondly, you need to understand compound returns properly, and that a real average growth rate of even 4% is hard to maintain over the long run - the curve becomes very steep. This is true for wealth-generating assets like shares in a company. It is even more the case for unproductive assets like housing.
Thirdly, you need to appreciate that many of the major drivers for property price growth in the last 30 years can't continue, they were once-off boosts. These include: the shift to buying based on two incomes, a shift to lower household sizes, much easier access to mortgage finance, elevated overseas migration rates, favourable tax changes, and, recently, a big reduction in mortgage rates.
Finally, you need to remember that property goes through major booms and busts; it is far from a stable, capital-protected asset. The more Price-to-Rent ratios exceed 20 when buying, the greater the risk that a future downturn will cause major losses. In a long-term lower growth environment, future downturns may also be very prolonged. Hoping to ride them out till the next boom is not advisable.
In this post, I will collate relevant articles and examples explaining short-term and long-term property price growth rates. I will also expose the fiction perpertrated by Australian financial and real estate companies who assert that average nominal growth rates expected in 2016 are 5 to 8% (implying real growth rates of 3 to 6%).
Details:
1. In 2016, what do Australia's major financial and real estate firms claim the expected average nominal growth rate of property is?
As of 2016, the major banks - Westpac, ANZ, NAB and the Commonwealth Bank - and other financial services and real estate firms still claim the expected average nominal growth rate is 5 to 8%.
Importantly, this figure is used in their relevant property calculators - Rent vs Buy and Property Investing - to determine the gains from price appreciation over the long term (up to 30 years from 2016).
I'd argue that all of these large corporations, with access to economists and expert research, should know that, in a long-term low inflation environment, nominal growth rates of 5 to 8% are unjustified and fraudulent. These fictional growth rates are used in order to keep mortgage debt going up as this is essential to their profits.
CoreLogic RP Data
This amounts to a growth rate of about 10% a year.
> CoreLogic: property values have chalked up 52 continuous months of price growth
Although combined capital city home values haven’t doubled over the past decade, the previous decade was quite a different story. Between January 1996 and January 2006 combined capital city home values increased by 151.7% with house values up 159.6% and unit values 110.1% higher."
> CoreLogic - Property prices double every decade?
> CoreLogic - How many suburbs have seen median prices double over the past decade?
Also see:
> NAB Property Insights
> Your Investment Property Mag - Building A Nest Egg Through Capital Growth
> Your Investment Property Mag - Why Melbourne’s Properties Will Keep On Rising
2. Other recent estimates of the expected average nominal growth rate of property
RBA
"Over the past 30 years, Australian housing prices have increased on average by 7.25% per year, However, these averages mask three distinct phases:
- During the 1980s, annual housing price inflation was high, at nearly 10 per cent on average,
but so too was general price inflation. In real terms, housing price inflation during the 1980s was relatively low, at 1.4 per cent per annum compared with 4.5 per cent during the period from 1990 to the mid 2000s, and 2.5 per cent over the past decade
- The 1990s until the mid 2000s were marked by quite high housing price inflation, of 7.2 per cent per annum, on average, in nominal terms.
- Annual nominal housing price inflation over the past decade was lower than either of these periods, at a little over 5 per cent on average."
Stockspot
"Property appreciation: 3.5% to 7.5% per annum range with 5.5% as base case. The average appreciation rate since 1955 was 5.5% so we have looked 2% either side to account for the potential for a weak or strong property market."
See: > Rent or Buy? We do the sums
Your Mortgage
> How long does it take for your property to double in value?
Rice Warner
"2016 survey expectations were direct property annual return of 6.6%."
3. What does a 5-8% average nominal growth rate in property look like when applied to specific houses over the long run?
I have taken a recent Oct 2016 sale in Preston for the example: 50 Austral Avenue, Preston as it has a lengthy sold price history and it also looks very favourable for long-term property price growth rates.
Based on 50 Austral Avenue selling for 30% more than the median 4 bedroom price, I have raised the estimated rent by 30% to $676/week ($2,929/month).
With a 20% deposit and 4% interest rate over 30 years, the mortgage repayments will be $5,212/month:
This leaves $2,283/month in savings for the renter to invest.
Using Westpac's default estimates of ongoing ownership costs and default assumptions (home appreciation 5%, investment returns 4%, rental increases 4%, inflation 2.5%) produces the following estimate of the difference in wealth after 30 years. The property is supposedly worth $5.4 million and an owner is over $2.3 million ahead of a renter:
Does $5.4 million sound reasonable for this property after 30 years?
What about if we change the average nominal price growth to 7% instead of 5%? Leaving all other variables the same, you can see what a difference this makes to the steepness of the curve and long-term outcome. After 30 years the property is now worth $9.82 million!
Does $9.82 million sound possible for this property after 30 years?
Let's see what the mortgage would look like for the buyer of this property after 30 years. Even assuming an interest rate of only 4%,
- The 20% deposit they'd need is: $1,964,601
- The loan amount is: $7,858,406
- The total interest payable is $5,647,797
- The monthly repayment is $37,517
- The total loan the buyer will need to pay back is: $13.5 million plus the $1.96 million deposit plus upfront costs of 5% (~$200,000). That's about $15.7 million all up.
This example ought to put into perspective the long run impact of the compound growth rate. From 2016 on, real (after inflation) average growth rates for property over 3% are impossible in the long run.
Note: Westpac has removed the Rent vs Buy calculator from their website. It was perfectly functional and accurate given the data you put in. However, as I've noted in this post, the default assumptions used by lenders - like Westpac's home appreciation rate being 5% - are the real problem. I'm unsurprised Australia's major banks are retreating from some of their misleading assumptions. But it's interesting that Westpac chose not to make its default assumptions more conservative (which leaves an evidence trail) and instead deleted the calculator entirely.
See: > Westpac Calculator Tools
4. How big a difference does the property price growth rate make to whether you make or lose money in the long run from owning property versus renting?
There are many factors that affect whether you come out ahead financially from buying property - whether it's to live in or as an investment.
These include the price you pay, how long you own it for, buying and selling costs, your mortgage rate, the rate of return on your money if invested instead, local government rates, maintenance, depreciation, the inflation rate, and, if renting, your rental costs and the rate they increase.
However, by far the biggest factor is the property price growth rate. This can readily be seen on any Rent vs Buy calculator by leaving all other factors the same and adjusting the property price growth rate to see what difference it makes.
If we change just one variable in our prior example - the home appreciation rate from 5% to 2.5% - the result is radically different. The value of the property after 30 years is less than half at $2.42 million and the renter is now $653,000 ahead.
Below is my estimate of a more realistic scenario for 50 Austral Avenue, Preston. The higher ongoing costs are conservative based on my calculations here: Understand the full costs of home ownership and property investing. Also, selling costs have yet to be added.
Inflation rate: 2.5% (fixed by calculator)
Loan interest rate: 4%
Home appreciation 2.5% (in line with inflation)
Investment returns 4.5% (more realistic over long run given 2.5% inflation)
Rental increases 2.5% (in line with inflation)
Council rates: $2,700
Maintenance costs: $4,000
Other ongoing costs: $4,000
In this scenario, the owner's property goes nowhere in real terms (after inflation) but the owner loses money due to the ongoing ownership costs and lost opportunity cost of investing their savings. The renter benefits from low comparative rental costs with increases limited by the fact that disposable incomes won't support high rental inflation. And they just invest the savings at a 4.5% average return.
The renter ends up ahead by around $1.4 million after 30 years. More importantly, their risk of large losses is zero. If the buyer is forced to sell early or at a time when house prices are in a downturn, they will lose between $50,000 and $300,000.
Of course, a renter doesn't have to rent forever. When they have accumulated a lot of cash, property is going through a downturn (Price to Rent ratios are around 20 rather than much higher), and their circumstances are suited to ownership, they can always buy.
Further Info:
ABC News
> Why Gen Y should hold off buying a home
The Guardian
> Why millennials should stick to renting and ignore advice to buy a home
My Investment Decision
> Annual property growth rate
Independent Australia
> Australia's housing bubble and the road to private serfdom
RBA
> Long-run Trends in Housing Price Growth - Reserve Bank of Australia (pdf)
CoreLogic
> News and research
Property Update
> Do property values really double every 7 to 10 years?
Macrobusiness
> The history of Australian property values
Who Crashed The Economy
> House Asset Prices
> Australia overstating property price growth as apartment crash looms
AMP
> Rent vs buy calculator
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