Real Estate Investing Thoughts from Australia: Affordability Index, Five Structural Disruptors to Property Prices
During my winter vacations to Australia, I have read many of Dymphna Boholt’s posts. Dymphna is one Australia’s leading REI educators and is a prolific writer. She writes a weekly blog and hosts REI training seminars throughout Australia in addition to her own personal investing ventures. You can view her blogs at “http://iloverealestate.tv/”
This past winter, she wrote a series of blogs dealing with the unaffordability of Australia housing. In the first post, she describes one calculation for measuring affordability / unaffordability. In the second, she identifies what she terms five structural disruptors that caused massive increases to house prices.
These posts will be summarized below.
Dymphna identifies the single biggest hurdle to home ownership as the down payment. Most times, these people can afford the monthly payment and qualify for the mortgage amount. So the DP becomes the choke point on affordability. The measure of affordability is, “How much of the family income is required to stump up for the down payment?”
The affordability calculation is the ratio of the average amount required divided by average annual salary, expressed as a percentage. The mathematical formula would look like:
Annual Salary X Affordability Index = Down Payment
Using high school algebra, the calculation to determine Affordability Index is:
Affordability Index = DP required / Annual Salary X 100%
Median house price for City XYZ in 2016 was $300,000; 20% DP is $60,000
Annual Family Income (Salary) = $75,000
Affordability Index (AI) = $60,000 / $75,000 X 100% = 80%
80% of the family’s annual income is needed for the DP.
This number does not mean much in isolation but when compared to other years or to other areas, it provides a picture of how houses are more / less affordable from year to year, or from area to area.
Suppose the median house price in the City XYZ in 2011 was $240,000 and the annual family income that year was $65,000.
20% DP = $48,000
Affordability index in 2011 = $48,000 / $65,000 X 100% = 74%
In this example, houses became less affordable during the 5 year interval as a greater portion of their annual salary was required to meet DP requirements.
- Link to post: “Property Affordability: BS or Reality? My take on it… [Part 1]”
Five Structural Disruptors
Australia has some of the most expensive and least affordable property in the world. The two largest cities – Sydney and Melbourne – are frequently ranked in the top five of least affordable cities. Even smaller cities such as Tweed Heads and Brunswick Heads have a large percentage of homes exceeding $1,000,000 AUD.
Pricing is a balance between supply and demand, but other factors that disrupted the demand side are to blame for the massive property increases. Dymphna refers to these as structural disruptors.
Disruptor 1: Easy Credit
Consumers have never had such easy access to credit as now. Low interest rates and easy qualifying have encouraged more to become property owners than ever before.
Disruptor 2: Negatively Geared Investors
Australian tax laws changed a few years back. The first changes allowed investors to claim annual operating losses against income from other sources. The second change required only 50% of capital gain to be included as income in the year of the sale of the property. Investors were influenced to use tax advantages to buy investment properties to use 100% operating losses to minimize current tax obligations with the anticipation of a larger capital gain that would only be taxed at 50% of the gain. Newbie investors flooded the market, out numbering professional investors 2:1, armed with the confidence that it didn’t matter what they paid, the tax write-offs would justify the prices and operating losses.
Disruptor 3: Population Growth
As population rises in an area, the demand side increases resulting in more competition for properties. In Australia, as in other western countries, higher population is due to increased migration and immigration to cities, not increased birth rates.
Disruptor 4: First Home-Owner Grants
FHOG have been around Australia for many years but more recently, the means-testing was removed. The result is that more buyers are pushing prices higher.
Disruptor 5: Foreign Investors
Add to internal factors pushing prices upwards, foreign investors are adding even more pressure to the housing market. These investors are cash buyers and will pay premium prices which adds to the already pent up pressure on affordability.
Dymphna finishes by adding that these disruptors created the perfect storm for property and price rises were inevitable. Once she saw the tsunami of cash coming, she ensured the wave was going to crash over her.
- Link to post “http://iloverealestate.tv/property-affordability-how-did-house-prices-get-so-expensive/”
Parallels to Canada
An interesting way of determining affordability, it has some validity. Are houses more expensive today? When I bought my first house in 1978, the median house price in the College Heights neighbourhood in Prince George was $45,000 which required a 20% DP of $9,000. Median household family income was about $20,000. Affordability index = 9 / 20 X 100% = 45%.
Today, that same house would sell for $260,000. A 20% DP would require $52,000. Median family income in Prince George today is about $60,000. Affordability index = 52 / 60 X 100% = 87%. So houses have become less affordable since the time I started owning property.
My disclaimer – I know what prices in College Heights were then and what they are now. I don’t know what the family incomes were then or are now. I estimated those based on what the average sawmill worker earns in a year – then and now. It is also noted that CMHC financing is now available and houses can be purchased as little as 5% DP – which as Dymphna noted – makes the DP more affordable but also pushes prices higher.
Disruptor 1: Easy Credit
No question about it, credit is much easier today. Interest rates are at historic lows, not quite Japan standards low, but still 3% and less is available. Even recent adjustments to financing have not raised the rates. What remains to be seen is the effect of raising the rates and there is some pressure to raise them. Most anticipate that raising the rates will slow down the house buying due to higher costs of mortgages which in turn will cause some lowering of prices. This is a “wait and see” scenario.
Disruptor 2: Negatively Geared Investors
The tax implications of operating losses and capital gains between Australia and Canada are identical at this point. Individuals can use operating losses (when expenses are greater than gross income) to reduce their income from other sources such as employment income. Likewise, the capital gains (when the property sells for more than purchase price) inclusion rate is 50% meaning that only 50% of capital gains on a property is included as income in that tax year. A capital loss is treated differently, the loss CANNOT be subtracted from income – check with a tax expert for correct information.
The other point here, I don’t think as many investors buyers here purchase property for tax purposes. There are less amateur investors making that mistake. My experience is that most investors look for positive cash flow from the very beginning.
Disruptor 3: Population Growth
No question, increased population means more demand and that demand results in higher prices. In Kamloops, people are attracted to jobs in new industries and businesses opening, expansions to the university, hospital and existing industries.
The opposite is also true, population shrinkage results in lower prices. The 1980’s were not kind to Kamloops in this regard. Mt. Lolo radar base closed and 400 jobs were lost or transferred out. BC Tel relocated their corporate headquarters to Kelowna and 275 jobs moved out. Tranquille Farm was closed and 625 government jobs were terminated or transferred. Consequently, house prices dropped 20%+ from 1981 to 1985.
Another place we see shrinkage is in the smaller outlying communities such as Clearwater, and Cache Creek. There has been no growth to existing jobs so as students graduate, fewer jobs are around for them and they leave the area looking for opportunities elsewhere. House prices in these communities are stagnant.
Disruptor 4: First Home-Owner Grants
Like Australia, governments here at both the federal level and the provincial level have at various times have offered grants and incentives for young people to buy their first home. As Dymphna noted, these grants made it easier for young people to buy their first home, but then developers raised the prices of their developments.
Disruptor 5: Foreign Investors
This is a contentious issue in both Australia and Canada. Australia has legislated the Foreign Investors Review Board and has put restrictions on the types of purchases foreign investors can make. Their goal is to keep existing housing inventory affordable to Australian nationals. Foreign investors, including those from Canada and the U.K., may only purchase new builds with few exceptions.
In Canada, we don’t have the same regulatory barriers to foreign buyers. Consequently, many Vancouver homes have been purchased by foreigners which has forced prices up. There is one example of a Chinese buyer purchasing three adjacent houses on Cambie Street. Cambie is generally considered the westside of Vancouver, the more desireable side. The three houses had a market value of $1.1 to $1.3 million each at the time of purchase. The buyer paid $3M each for the properties. This type of predatory buying has raised the ire of many Vancouverites.
In my travels around the world, it has become apparent that concerns about affordability, transportation, and urban sprawl are not unique to North America. Examining the approaches that other countries employ can give us as investors insight into different opportunities here.
Specifically here in Kamloops, we are experiencing a migration of greater Vancouver people. Some are cashing out home equity and moving for lifestyle, others are looking for more affordable housing. In ddition, students are arriving in the thousands to pursue educational opportunities. Increased population results in greater demand and in turn, increased rents and increased house prices. And this provides opportunities for investors.
“Owning Up” – Confessions of a Real Estate Investor
Japan Real Estate, Parallels to Canada
My son’s experience in buying a house in Japan is described and explanations of the developer’s opportunities for building in a distant city are examined. From there, parallels with the Canadian and local market are examined. The post ends by identifying opportunities for investors based on two major issues.
Japan is a densely populated country, the population is 130 million and its land mass is about ⅓ of BC of which only 27% is habitable due to terrain. Land prices in the urban areas are amongst the priciest in the world and as a result, most of the housing is in condo towers. Single family homes are built on small plots of land with minimal setbacks.
Another issue in Japan is transportation. Given the density and land prices, personal vehicles are an indulgence. Innovations to parking include turntables to turn cars around at tight turns, and lifts to stack cars in parking towers. These innovations add to the cost of keeping a car. In light of parking expenses, many people prefer to use public transit. Japanese trains and subways are very efficient at moving large numbers in a timely manner.
As in Canada, preferred locations command premium prices. These preferred locations, like Canada, are those close to shopping, hospitals, schools and transportation.
I recently visited my son who lives in Japan and was pleasantly surprised to learn that he was buying a house. In discussing his purchase, I learned about the similarities and differences between here and there. His home is in Nagoya, Japan’s third most populous urban area; best known as Toyota’s corporate headquarters.
He purchased the house from a developer and the purchase was conditional on bank financing. The house itself is about 1000 s.f. with has three bedrooms and two bathrooms. The purchase price is $378,000 CAD. All of this is not dissimilar to Canada.
The bank financing is being arranged through a broker. His initial offer from one bank was for 0.545% interest and the amortization period is 35 years. My son held out for a better rate and got it! The interest rate will be 0.525%. Ever since the Japanese bubble burst in the late 1980’s when it was briefly the world’s largest economy, that country has been stuck in what has been referred to as “stagflation” for the past twenty plus years. Recent attempts by the government have included super low interest rates to stimulate their economy.
Building Lot Considerations
As Canadian cities struggle with increased density, officials should look at Japanese cities. The developer purchased a single lot of approx. 2000 s.f., or about 45 feet along each side. This was then subdivided into three lots, two aligned north-south will face the wider street and one aligned east-west will front onto the narrow street along the side.
Honda CR-V in front of lot to be subdivided into three.
Narrow access road to be widened.
My son’s lot is about 700 s.f., and his house is 1000 s.f. How does this work? Easy, the house will be three stories above grade. The upper two floors will be 400 s.f. and the ground level will be 200 s.f. This will allow for a parking spot for a vehicle. Under Nagoya city bylaws, the building footprint can be 90% of the land area and total build-out can be 140%. The developer was granted a variation on the minimum setbacks; instead of 50 cm, the new-build houses can have a 30 cm setback with each other.
My son purchased the back lot fronting onto the narrow road seen in the photo. This road was surveyed and built in the 1930’s, possibly earlier. It is only two meters wide and at least four homes use this road for access. The other concession made by the city was to allow an easement to widen the road; 60 cm was taken from those two lots so that my son can more easily access his parking area.
The developer is based in Tokyo, about a 5 hour drive from Nagoya. They have already built, or in the process of building over 20 houses, and are looking to build more.
One has to ask, “Why Nagoya?”
If the land prices in Nagoya seem expensive – $378,000 for a house on a 700 s.f. lot – Tokyo is even more so. And there is every indication that Tokyo prices will explode in the future; the catalyst – the 2020 Olympics. Every western city that has hosted the Olympics has seen massive increases of property values – think of Vancouver post-2010.
And how will that impact Nagoya given its distance from Tokyo?
Nagoya is on the verge of becoming a bedroom community to Tokyo. You ask, “How can that be? People can’t drive 5 hours each way every day and fit in a full work day.” But most commuters in Japan don’t drive.
Most commuters take public transportation. Their train and subway systems are among the best in the world. And the jewel in the crown is the Shinkansen, the bullet train. It is a mag-lev train that travels at 330 kph and has a smooth, quiet ride. Everyone has an assigned seat, so no standees; the seats are spacious – better than flying premium economy; and free wifi internet is available. There is even a food and beverage cart service.
The Shinkansen currently takes 1 hour 30 minutes to go from Nagoya Central Station to Tokyo Central Station. Still most wouldn’t consider daily commutes of 1.5 hours plus time to get from home to station and station to work.
The second catalyst – the next generation of Shinkansen will be operational shortly after 2020. The new Shinkansen trains will cut the travel time to less than an hour, now commuting becomes a viable alternative to living in Tokyo.
The next generation Shinkansen has been announced and work is progressing. Investors and developers and getting into Nagoya ahead of the projected opening as higher prices are anticipated.
Parallels to Canada
Like Japan, Canadian cities struggle with density and affordability, urban sprawl and traffic. Even in Kamloops where I live, these issues exist. While Japan represents an extreme example, there are lessons that translate to the Canadian reality for investors.
As cities around BC look at housing issues – inventory, affordability, etc… increased density is becoming the preferred option. Permitting secondary suites and laneway homes meets several goals:
- housing inventory increased,
- more affordable housing choices for both owners and renters
- increased tax revenue without massive infrastructure investments
- more viable for families to stay, keep schools open and communities vibrant
Impact of Unaffordable Housing and The Effect of Improving Transit
We have watched the Vancouver market where city prices have forced many to move to the ‘burbs – Richmond, Coquitlam, Surrey and beyond. It is very recognizable in the Metro Vancouver area where neighbourhoods near major transit routes command premium prices. And when expansions to rapid transit system are announced, developers are quick to construct housing adjacent to future stations.
Some have even moved to Sechelt and Nanaimo. They have cashed in equity and purchased in lower priced areas. Now, not only are buses are involved in the commute but also ferries. The Sechelt ferry is 50 minute ride whereas the Nanaimo ferry takes 1 hour 30 minutes. Imagine if there was a service that cut the ferry times in half and how that would impact the housing markets in those areas.
Opportunities for Investors
- Increasing Density – Investors can look for underutilized properties in the city centre that can be purchased at a discount. Forced appreciation and increased revenue can be realized by adding a secondary suite.
- Identifying Preferred Locations – Preferred locations are not just those located in the city centre, they can actually be further out. These locations are preferred for their access to transportation routes – close to highways or adjacent to public transit. Some cities will have direct buses running to the local university, and some universities provide bus passes to the students – housing near bus stops with direct routes will be desireable for student accommodations.
As an investor, many opportunities for rental properties can be found near the city core. But locations outside the city can also present equally good opportunities. Don’t be overly restrictive in your property searches.
Next – thoughts from Australia.