High Demand for Rentals, But Property Prices Flat: Why?

I think I might know the answer and it comes in two parts.

Part A:

One of the puzzlements about the current housing market is that house prices are slowly edging downwards even though there is huge demand for rentals. In a ‘normal’ market this overload demand for rental properties would push up the price of houses, units, and apartments because investors can get more rental return. So why isn’t this the case now?

An article today on News.com put some light on this for me.

SellingHomeThe people selling their houses—because they can no longer afford the mortgage—are the very same people looking to rent. They are prepared to take a 10 percent or more loss on the purchase price of their houses against the pain of continuing to service their $3,665.00 per month average mortgage (based on a house costing $580,000 two years ago with a 5 percent deposit over 30 years at 7 percent) of which about $5,500 is coming off the capital cost per year in the first two years.

So in two years they have paid out $88,000 dollars on a mortgage for a house that will have fallen roughly $50,000 in value (depending on the location) and on which they will be lucky to have paid $11,000 off the principle. In two years they have lost $50,000 off the house plus $77,000 in mortgage payments (i.e., $88,000 less the $11,000 they have actually paid off the principal). That is a total of $127,000 gone in two years!

I am pretty sure I would be thinking very hard about selling in such a case. By paying out $44,000 a year on the mortgage a working couple would be basically burning one person’s entire average wage after tax plus basic living costs; and if they are not at least earning the average wage of around $65,000 (about $30 per hour) then these numbers work out even worse.

SellingHome2According to the item, which is linked to the image above and at left, Australia has the most unaffordable housing in the Western world, and has the second most unaffordable housing in the entire world.

According to the News.com article the cost of a median house in Australia is six times the average salary. According to the data I posted on my site here it is more like 7.2 times the average salary (it is in Melbourne anyway). Whereas the “international standard” indicates that the accepted ratio is three times which is where it used to be in Australia from 1965 to 1987.

Most banks now have sliding interest rates depending on how much of a deposit you have. If you have 30 percent deposit (which would be about $175,000 for the average house) then you get the lower ‘safe’ home buyer rate which is currently in the region of 6.5 to 6.8 percent. But if you only have the base 5 percent deposit (which would be about $30,000) then you will likely pay the premium rate which is typically between 7.5 and 8.0 percent; unless you can get someone (like your parents) to sign up as unconditional guarantors and they have the assets to cover 130 percent of the value of the loan.

Part B:

So. You have all these ‘average’ home owners who purchased their properties in the last two, three, or four years bailing out and taking the loss. According to the News.com item recent home owners have bailed out at the rate of one in five (or 20 percent) over the last few years.

Then you have the investors.

Historically when the property market is in the doldrums the share market is doing well and vice versa. When the share market is flat or heading south the property market is usually doing well. So smart investors move their funds around depending where the good money is being made.

But here and now we have a unique situation. Investors who bet on the stock market will have lost about 30 percent of their stake money and they can’t risk taking it out or the loss become a real loss (as opposed to a paper loss). And investors that bet on real estate in the last two to three years are not that happy either. Especially if they went in at the normally safe top end of the property market where property price falls of 30 and 40 percent have occurred.

Investors have been burnt and they are still very unsure about whether the housing market has bottomed or not. In fact the general wisdom appears to be that it could be some way off hitting bottom yet—possibly as far as five years and maybe more. So smart investors, who are the people who generally buy properties to rent, are only interested in really good bargains. They don’t want to buy something now and have it lose capital value over the next five or so years.

This drive for ‘really good bargains’ is keeping heavy downwards pressure on house prices. Even investors buying to rent and leverage the tax deductible ‘loss’ of loan repayments after rent don’t want a property that is losing value or is likely to lose too much value.

Conclusion:

So you have this ‘perfect storm’ unique situation that has never occurred before in Australia where the average house is way out of reach of the average first home buyer by a huge factor. On top of this investors have lost big on the stock market which has hurt their cash reserves and, worse still, robbed them of their confidence. They are now very reluctant to buy into property because of the current toxic situation both in relation to the 7.2 ‘average wage:average house cost’ ratio plus the ongoing general worldwide economic uncertainty.

Hence, house prices are remaining flat, and are even edging down—even though the demand for rental properties is intense.

I have absolutely no idea what happens next but something is going to have to give. I guess those very smart people that do know what is going to happen (assuming they exist) will most likely make a lot of money somehow when whatever is going to happen happens; but I have no idea about the what, where, or how.

I should point out that I am not an economist. I have not done a single unit of economics in any of my studies at any time. This is simply how I am fitting the pieces together. These are basically just my random gatherings on the subject.

BarryMark

[499th posting]