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Sep 05, 2011

The future for the Australian residential property market.

By Bill Zheng, October 2011

Bill Zheng is the founder of the Investors Direct Financial Group, which is headquartered in Melbourne with an office in Sydney. The company comprises 5 divisions: 1) Investor Education 2) Property Advisory 3) Financial Planning 4) Mortgage Solutions and 5) Property Management. Bill was educated in China, Australia & USA and is fluent in both English and Chinese. His tertiary education includes Civil Engineering at South China University of Technology, Computer Science at RMIT, MBA at Monash University, Finance at the Securities Institute of Australia and numerous investment related courses in Australia, China, Hong Kong & USA. After a long corporate career spanning positions in Australia, Hong Kong, China, USA, Canada & Northern Europe, Bill left PricewaterhouseCoopers Melbourne in 2000 to found Investors Direct, initially as a mortgage broking business solely servicing property investors. In 2005, Bill became the highest ranked mortgage broker in Victoria during the first ever national survey of mortgage brokers, before then becoming a mentor to many of the MPA Top 100 mortgage brokers in Australia. He holds an Australian Credit Licence (No. 402950). Bill soon became known for his unconventional views on property and finance. He not only personally executed numerous property strategies himself but also actively educated tens of thousands of property investors across Australia. Bill was given the honour of being the Chief Judge for the inaugural Australian Property Investor of the Year Awards in 2008. With his practical knowledge and hands-on experience in real estate investment and finance, Bill has been invited to appear on property shows on TV and radio in Australia. He regularly writes for a variety of property investment magazines, newspapers and online investment portals and is one of the most sought after presenters on property and finance in Australia and South East Asia.

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The future for the Australian residential property market.

By Bill Zheng, October 2011

I would like to make a prediction by the end of this article, that is the complete opposite of what a lot of people believe. Im very happy by the way, to put my prediction in writing so that you can hold me accountable to it in the future when it comes true! First, lets consider what determines property price movements. From my experience:

Property price movements in the short-term (within 1-3 years) are usually determined by human emotion (also known as human insanity ).

Property price movements in the medium-long term (3-10 years or more) are more likely to be beyond human insanity, hence they are more predictable and controllable.

Is human insanity something we can predict? Some of the most intelligent people have been put to the test and still failed miserably. Economists have the unfortunate job of predicting human insanity, hence they earn the reputation of "having successfully predicted 9 out of the last 5 recessions". So whats the difference between human intelligence and human insanity? There is a limit to human intelligence . What therefore does determine property price movements over the medium to long term? In my opinion, amongst many other things, property prices are predominantly determined by two factors: 1. The money supply of a nation. 2. The wealth of a nation. Let me explain.

A nations money supply.

Lets use a bit of an extreme example to make a simple demonstration.

Imagine theres this little island country called Australia, a few thousand years ago, there were only 10 houses (probably called sheds back then ), and there was no money being used at that time.

The chief of the island decides to issue some money called Australian Dollars for circulation. For the sake of simplicity, he decides that the money issued can only be used to buy properties and nothing else.

The Island initially issues only $10, so each house is therefore priced at $1 each. (Amount of money available divided by number of houses.)

One year later, the island decides to increase the money supply to a total of $100 still with the same usage restrictions (can only be used to buy houses). Without any improvement to the

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properties, each house is now priced at $10 each. ($100 divided by 10 houses, equals $10 each.) You can see now how property prices can go up just by increasing the money supply of a nation. We dont even need to discuss the supply and demand situation as these only influence short term price adjustments. If we look at the median property price in Melbourne and Sydney:

In the 1920s, property was priced at around 30; In the 1960s, property was priced at around AUD$10,00; In the 2010s, property was priced at around AUD$600,000.

Now we all know that the median priced properties are not better than those from 90 years ago when you compare their land size, location and quality of the building. But the price tag just keeps going up and up with no end in sight. This is the power of money supply increase. (Have a look at the diagram below to see how Australia has been increasing its Money Supply at around 9% a year compounding non-stop, and how it coincidentally aligns with the property prices increase over the same period.)

(Data source for Australian Broad Money Supply: Economagic.com)

A nations true wealth lies in property.

Ever noticed how regardless of which particular industry caused a nation to prosper at any given time, the wealth of that nation always ends up sitting in its residential properties? It has been estimated that around 70% of an industrial nations wealth exists within its residential properties. You can test this yourself, by looking around at 10 of your friends to see where their wealth is. You will quickly discover that the majority of their wealth is in their home, regardless of what line of work they do. So while every 20-30 years you will see new industries come and go, in cycles of boom and bust, but
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the wealth left behind those industries tends to stay in residential properties. If we take a look at some of the nations over the past 100 years, well see that each has had some incredible industries at different times that have tremendously increased the wealth of those nations. For example:

The automotive industry, steel industry and IT industry each brought America enormous wealth during their individual eras. But where has most of the wealth ended up? In their residential properties.

The great manufacturing industry of China, the oil industries of Dubai and Saudi Arabia and the electronics industry of Japan, all these industries have come and gone, but the wealth they created remains behind in their residential properties.

Back in 2006, I had the chance to work with a multi-billion dollar international hedge fund to finance a AUD$1.5billion residential property development project. The managing director of this fund happened to be the head of the Asian Pacific division of one of worlds largest investment banks. His rationale for investing around AUD$200Million into this residential development project is too simple to believe, at least for people who dont handle multi-billion dollars every day. During the trip to make his final decision to invest into the project, he said to me that it is always safe to invest, not speculate, in residential properties in a country which is becoming wealthier, regardless of which industry was predominantly responsible for creating that wealth. The reason is that the majority of the extra wealth is always going to end up sitting in residential properties anyway, with no exceptions. Its just a matter of time. Naturally the question to ask yourself is, will Australia become wealthier or poorer over the next 10-20 years? Now with the decline of the US & European economies, we are now firmly in the Asian Century as our Prime Minister recently put it. Australia is unusually well positioned to benefit from the growth of Asia, which represents 50% of the worlds population. Let us take a look at what Australia has in terms of resources*:

The worlds largest resources of brown coal, lead, nickel, uranium, zinc & silver; The worlds 2nd largest resources of iron ore, bauxite, copper & gold; The worlds 3rd largest resource of industrial diamonds & lithium; The worlds 4th largest resource of manganese ore; The worlds 5th largest resource of black coal.

(*Source: Geoscience Australia)

You can see that Australia is by far the world's richest country in natural resources per person with an unstoppable demand coming from 50% of the world's population over the next 20 years alone. According to investment firm Credit Suisse the median wealth of Australians is the highest in the world already, its Global Wealth Report shows the typical Australian adult is worth nearly four times the amount of an American. In fact the research reveals that half of all adults in Australia have a net worth above $216,000. Sadly most people living in Australia do not see that. Like the saying that "fish discover water last" we can't see what we are in because we are surrounded by it. Please let me give everyone a different perspective so you can see the impact on Australian property prices.
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In 1988 I came to Australia from China. At that time there were almost 1 billion farmers in China and it wasnt doing very much business with Australia. It is now 2011 and China has 102 cities with an urban population of 5 million people or more. While Australia has none (Sydney has only 4.5 million people). China has become heavily dependent on Australias resources. The massive urbanisation process going on in China, which is continuing to move an incredible 400 million people into cities, is creating the demand for an extraordinary amount of resources such as steel and coal just to house all these people. Should you have difficulty visualising what all this means to Australias wealth, imagine moving Australias entire population of 20 million people into a nearby fairly undeveloped country, say Papua New Guinea. Just to enable all these people to live a decent lifestyle would require building millions of new properties and supplying energy to these 20 million newly arrived residents. Then imagine doing the whole process 20 times over within the next few decades. Imagine you happened to own a business that had the mandate to rebuild the entire Australian nation from scratch 20 times over within a couple of decades, and your business has been selected as the largest supplier of resources needed for the task, how do you think this business would do financially? Some people worried about the Chinese economy slowing down could hurt Australia, but really if they slows down by 10% (i.e. a serious recession), instead of building Australia 20 times over, they are now only doing it 18 times, what difference does it make? Australia still couldn't keep up with that demand anyway. Now remember, the above Chinese scenario doesn't include the demand coming from other heavily populated countries such as India, Indonesia and Japan. For example, India is currently in the process of building over 300 shopping centres the size of Australia's largest shopping centre - Chadstone Shopping Centre, it so heavily relies on Australia's resources too. BHP Billiton recently predicted Australia's resources industry will need an extra 170,000 workers in the next five years alone, not to mention jobs needed to be created in other industries to keep these workers functioning. Australia is not called the Lucky Country for no reason.

Cut through the noise.

Unfortunately many Australian property investors have been distracted recently by the events in US & Europe. Amidst all this noise, many have forgotten the fact that Australia was one of the few developed countries that didnt go into a recession during the GFC, and still retains the highest credit rating for its government and major banks. Let us look at some facts to compare Australia to the rest of the world. If you look at the US Governments budget* for this year you can understand why their credit rating was recently downgraded:

U.S. Tax revenue: $2,170,000,000,000 Federal Budget: $3,820,000,000,000 New debt: $ 1,650,000,000,000 National debt: $14,271,000,000,000 Recent budget cut: $ 38,500,000,000

(*Source US government budget papers)

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Now to make their situation easier to understand, lets remove 8 zeros and pretend it's a household budget:

Annual family income: $21,700 Money the family spent: $38,200 New debt on the credit card: $16,500 Outstanding balance on the credit card: $142,710 Total budget cuts: $385

Let us now compare that to the Australian economy*:

Annual family income: $29,840 Money the family spent: $34,610 New debt on the credit card: $4,770 Outstanding balance on the credit card: $8,460 Total budget cuts: $2,200

(*Source: www.budget.gov.au)

A lot of people believe that the decline of US property prices over recent years was due to the global financial crisis. I see them more as symptoms rather than the cause, as residential property prices over the longer term tend to reflect the wealth of a nation. Of course, the key underlying cause of the US property price decline is that they are becoming poorer as a nation due to their heavy indebtedness which was mainly caused by a long period of overconsumption, a lack of highly competitive industries in recent times, and a few very expensive wars. When people ask me why Australias property prices didnt drop like US after the GFC, here is my view on this:

On the surface, it looks like our banking system is more prudent to avoid properties being over supplied, as Australian banks wont lend you money to develop new properties until you have pre-sold most of them, whereas you can get finance to build 200 new homes in US without knowing who is going to buy them.

Below the surface, it is mainly because Australia is getting wealthier as a nation, and US (& many European countries) are getting poorer due to their heavy indebtedness; To make matter worse, US (& many European countries) are in denial of such situation and trying to use more debt to solve their debt problems. Do you think using more cocaine is the solution for a cocaine addict?

It is very important for property investors to see the new trend where Australia has now permanently departed from the general decline of wealth in the rest of the developed world, and the performance of property in other developed countries bears very little relevance to Australian property performance.

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In Conclusion

I very firmly believe Australian residential properties are on the verge of a major bull run over the next 20 years, because of 3 major reasons:

The Australian dollar, as a relatively small currency in size, is at the mercy of the rest of the worlds money supply, and the rest of the world has been on a money supply increase path for the last 100 years. With no mechanism to stop printing more money around the world, Australias money supply will have to continually increase, hence the price tag on everything will continue to go up, including residential properties;

Our country will continue to grow wealthier over the next few decades and property prices will rise to match the wealth created through this process;

With Australia now being more aligned with the Asian region which is where the majority of growth will continue to come from, the negative impacts of US & Europe will soon become less and less relevant.

And now my prediction! The next 20 years will be a golden era for Australian residential property investors, regardless of what will happen in the short term. As always I recommend all our clients to follow good money management principles and put more money into residential properties as early as it is safe for them to do so within their own circumstances. On a practical level, every Australian property investor should take into consideration the impact that the baby-boomers impending retirement will have on property prices and follow the banks lead of where the next income generating group will be residing, then park your money where they do!

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