Property Observer: most read articles

My piece on the Aussie housing bubble is the most read article on Property Observer.

Take a read here.

China data extends US stock records

It's a day for records.

The data out of China sees the S&P 500 in the US continue to break records up to 1,682.50 and the Dow ticked up 20 points or so to 15,484.

The S&P 500 has now closed up for 9 consecutive trades as investors continue to be buoyed be stimulus.

Spillard (again) ends in Kevenge

So, Labor has another leadership spill (again) and Australia will get another Prime Minister (again).

Well, kind of, we'll be reverting back to Kevin Rudd (again), for now at least.

It's all a bit deja vu.

This is only a politics blog to the extent that politics impacts the economy, and I think that, regardless of whether the Coalition or Labor get voted back in in the coming few months, it will be a challenging period ahead.

I doubt there will be many immediate game-changing shifts in economic policy. 

Both parties have pledged to steer clear of reform on the negative gearing tax rules, for example. Will we see any major shifts on the Carbon Tax or the MRRT? 

Whether or not Rudd returning the favour on Julia Gillard by stabbing her in the back will be enough to save Labor in the forthcoming election is highly doubtful.

The bookies certainly don't seem to think so with Labor priced at odds of $5.00 as compared to Abbott's Coalition quoted at $1.15.

It's all very well changing leaders on the basis that politics is "about personality", but is Australia really going to re-elect a party which can/t seem to get its own house in order?

It was only a matter of three months ago that after Rudd's most recent failure to challenge for the leadership that he said he "was a man of his word" and he would "never" partake in a leadership spill.

Sure, we have short memories but not that short.

Rudd's election campaign will doubtless be run along the lines of portraying Labor as the "proven" or known quantity which has steered Australia away from recession through a challenging period. Abbott will be portrayed as the "risky unknown quantity" (not without some reason, it must be said).

In Rudd's own words, talking of Labor's tiresome leadership squabbles and internal wranglings: "All this now has to stop".

Well, yep, I guess it will - in two or three months when the whole debacle will finally be ended by an election and a leadership contest which we're actually allowed to vote in.

---

Too easy a win for Queensland in Origin II at Suncorp stadium - sends the Aussie dollar back up to 92.9 cents...

;-)

Market psychology (Sydney property booming)

Auction boom

The Sydney property market once again recorded an "extraordinary" 81.3% auction clearance rate on Saturday at a median sale price of some $835,000 according to Australian Property Monitors. One auction clearance result at such an elevated level may or may not represent an anomaly, but that's now four consecutive weekends where the rate has exceeded the so-called 'boomtime levels' delineated by the 80% barrier. 

Meanwhile futures markets are pricing in another interest rate cut to just 2.50% as greater than a 9 in 10 likelihood for Tuesday. Indeed, cash rate futures markets imply that we may see rates as low as 2.50% right through until 2015, although that outcome is naturally dependent upon the success or otherwise of stimulatory monetary policy managing to resurrect other key sectors of the economy.

I've predicted on this blog for the last 18 months that the Sydney property market will be the prime beneficiary of the overriding weakness of many of Australia's other property markets. 

Weak property market recoveries

RP Data shows that prices in Adelaide have waned badly in the last quarter are now lower than they were 12 months ago, despite generational lows in interest rates. Prices have also fallen slightly year-on-year in Hobart. Brisbane has fared no better than Adelaide over the past half-decade with median prices below levels seen in 2008, and many regional markets have been in a steady decline for several years now. 

The same data provider reported back in May this year that house prices in real terms (i.e. when adjusted for inflation) were in the region of 10-20% lower than at their peak across every capital city.

Any lingering doubt that strong price growth would follow increased activity in the hot sectors of the Sydney market (inner west, lower north shore, city and east) has been eliminated. This week has seen properties in my neck of the woods (Pyrmont, the inner west, city and east) selling at astonishing prices, with full asking prices often being met and auction results comfortably clearing reserves.

In fact, ask market participants and they will tell you that in favoured suburbs and market sectors price growth over the past 12 months has been comfortably higher than the reported median gains. Sydney's median dwelling price now sits comfortably above its previous all-time peak, but the apartment market actually broke through to record highs way back in May 2012. 

RP Data has reported that it is the broad middle-priced market which is racing ahead, likely due to the exaggerated levels of investor activity.

Why markets cycle

There are a number of common explanations of why markets move in cycles:

-It's been said that monetary policy, particularly the tightening of interest rates, has been effective in the past at stifling undesirable levels price growth;

-Governing bodies have been blamed at times for becoming addicted to the 'feelgood factor' or 'wealth effect' associated with rising dwelling prices; and

-Construction activity can increase rapidly during a house price boom (and be quelled during times of falling prices) leading to a temporary oversupply (or undersupply) thus exaggerating market downturns (and upturns).

The most compelling factor, in my opinion, however, is the human psychology element. Not only does each new generation see an influx of new market participants who have never experienced a housing bust, humans are emotional creatures: we tend to extrapolate the present into the future in an irrational manner. 

Perhaps unconsciously, we tend to believe that when times are good they will always remain so, and when times are hard we fear they will never improve. We find it harder than we should to bet against the crowd ("...what if everyone else is right and I'm wrong?") and, most damningly of all, we cannot abide the idea of others profiting when we do not.

It was frequently observed back in the 1930s by George Orwell and others that while unemployment was frequently a devastating or humiliating prospect for millions, the impact was sometimes lessened where every household in the street was enduring the same experience. It seems to be human nature that our happiness and level of contentment is impacted by the successes or tribulations of our immediate peers.

FOMO rallies

The FOMO rally or the 'fear of missing out' is the human psychology most evident during a market price boom: prices which have been rising solidly can suddenly accelerate as the herd mentality kicks in. Soros noted in his Theory of Reflexivity that expectations of future price growth can lead to a positive feedback loop and further, perhaps even stronger, price gains.

This phenomenon is more typically associated with pure investment asset classes such as in the equities markets, and yet increasingly residential property is being treated by many as an investment asset as well as being seen as a place for shelter, particularly in the face of unnerving share market volatility.

The underlying thought processes are not dissimilar to those involved when I played the UK National Lottery when I left school as a teenager. 

Of the 49 lads and one lass in the factory I worked in, 48 of them were signed into a Lotto syndicate. I never really thought we had much chance of winning (the odds of an individual ticket taking out the jackpot prize were an outlandish 14 million to one). 

Moreover, I simply couldn't abide the thought of turning up on another freezing winter Monday morning, only to discover that 48 chortling ex-machinists had retired to sun themselves and drink cold cans of Red Stripe by the pool in Barbados (thereby leaving me with the tedious task of grinding tools for 10 hours a day).

Classic human psychology: even at the likely risk of losing, I wasn't prepared to risk missing out where there was a chance of others gaining significantly.

It's the fear of missing out which is now driving Sydney's property markets way past previous peaks. Even those who have previously not shown a remote interest in real estate as an asset class reluctantly begin to consider clambering aboard the bandwagon.

Sydney's market

I'll admit I didn't rate the description of the Sydney's property market experiencing a "mini-cycle" through the financial crisis and beyond. After all, prices can only really go in three directions - they can go up, down or track sideways. While mini-cycles may always appear to be taking place, the true nature of a cycle only really becomes clear as it recedes in the rear-view mirror. 

And yet, at the distance of a few years, it does appear that Sydney's market responded rapidly to stimulatory policies with a burst of activity through 2009 and 2010, before quickly levelling off.

In fact, it was a compressed version of a textbook market cycle. First there were the predictions of a 40% market crash. Then, commentary subtly shifted towards "prices falling in real terms". And finally, with conflicting market data sporadically suggesting possible strong price growth, it was concluded by bearish commentators that "we should judge on the ABS data". 

And as at June 2010, so we did, when the ABS showed detached dwellings in Sydney as having jumped by 21.4% in 12 months.

History repeats

And here we are again: rinse and repeat. Since 2010, there have been countless Sydney housing bust predictions, but to date, they could hardly have been more wrong. As the market bottomed out with moderate falls through to around May 2012, the predictions once again gradually shifted towards "price falls in real terms", and finally news articles are now surfacing by the week belatedly predicting new record market highs.

RP Data shows that Sydney dwelling prices have increased since their trough by around 10% in nominal terms. Due to the high levels of leverage involved in residential property, this has resulted in an increase in equity on a median priced dwelling of more than $60,000. That's a troubling figure which the average Sydneysider might take half a working lifetime to save in today's consumer-focused world.

On closer examination, RP Data's oft-maligned Daily Home Value Index now shows Sydney's solid median dwelling price gains as having accelerated rapidly of late, increasing by 5.32% in less than 60 days.

Source: RP Data

Traditionally, this is the shortest phase of the market cycle as the crowd joins the party late and quickly pushes prices to previously unthinkable levels - the fear of missing out for many simply becomes too great, despite the associated risk of losing.

It's easy enough to sit out of the market when all the talk is of a "huge, market-wide crash" or "an inevitable housing bust", and even moderate gains don't tend to create too much fuss. When homebuyers begin to talk about their house having "gone up by 10%", this can become mildly worrying.

But what really grates is when the smug, highly-leveraged property speculator with half a dozen investment units to his name starts to crow confidently about how he is seeing accelerating 25-30% gains right across his entire portfolio since 2009, while savings account and term deposits look set to continue delivering woeful yields.

Remember, this property market recovery has largely been an investor-led rather than a homebuyer story, and this is particularly the case in Sydney. Housing finance data shows that around half of housing finance activity in the city is related to investors. 

Wary of high transaction costs, and armed with their trusty 'buy-and-hold' mindset, a proliferation of investors discourages frequent turnover of stock, clogging up the middle-priced and medium-density sector of the market, thereby potentially exacerbating any potential shortage of appropriate dwellings in desirable locations.

Of course, investment risk increases together with prevailing market prices. The entry price is a key input when calculating the absolute returns on any property investment - entry price and investment risk cannot be decoupled. Thus the market is de-risked when prices are lower, but correspondingly becomes riskier as prices increase. 

Throw into the mix lagging construction of appropriate and well-located dwellings together with a city population increasing at ~60,000 persons per annum, and  I expect to see a further interest rate cut send Sydney's property markets into a relatively short-lived but nevertheless rampant speculation phase. 

This phase of the cycle must necessarily be short for price growth surely cannot continue at such a furious pace for too long, but new entrants are now being lured into the market at ever-higher prices.

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RBA's chart pack shows uneven property market recovery

The RBA chart pack clearly shows the strongest gains to be in Sydney and Perth over the past 12 months.

While Brisbane prices fell from their peak there are at least some signs of life in that market.

Adelaide median prices and the regional Australian property markets have shown no median price growth for around four years. 

In the case of most regional markets, as I noted yesterday, I expect gains to remain weak. 

Of course, regional investors will doubtless say I'm wrong - but the charts continue to tell their own story.

---

Aussie dollar is crumbling...it touched 94.4 cents earlier in the trade. Stay tuned for US payrolls tomorrow...

The accelerating Australian population boom

It's a bit of a mystery to me why people are so keen to try to dismiss population growth as a key factor which underpins our major capital city property markets.

I mean, just take a look at today's numbers from the ABS:

Source: ABS

In the year to December 2012, the population of Australia increased by 394,200 people or 1.8%, which is way ahead of the long-term average of 1.4%.

Of course, population growth does not occur smoothly across the states. 

In some states such as South Australia (+15,600), ACT (+8,600), Northern Territory (+4,200) and Tasmania (+400), the absolute growth numbers continue to be quite small. I don't expect that to change too much.

On the other hand, take a look at what is happening in the states which house the major capital cities.

The population of WA is absolutely booming by 3.5% in the year to December 2012 or 83,000 people, so it's little wonder that the Perth property market is flying.

And in Queensland (+92,500), Victoria (+99,500) and New South Wales (+90,400) the population growth continues apace.

People continue to head largely to the capital cities, and so it's little coincidence that over the past 12 months prices in Sydney (+4.61%) and Perth are smoking along (+7.8%). Growth in Melbourne has been a little more subdued (+2.12%) but then, why wouldn't it be? Melbourne has, after all, experienced a quite phenomenal boom in prices since 2007.

It's small wonder that we struggle to keep up with accommodation and infrastructure needs with population growth figures such as these reported today.

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UK growth confirmed at 0.6% in Q2

As forecast for Q2. From the Pommie Guardian:

"Britain's recovery picked up pace in the second quarter, official figures have confirmed, with GDP expanding by 0.6%.

The 0.6% quarterly rate of growth was twice the pace of the first three months of 2013, and exactly as predicted by economists, after signs of a pickup in retail sales and strong readings in business surveys.

"The economy is coming out of the shadows, with a doubling in its quarterly growth rate from 0.3% in Q1 to 0.6% in Q2. The recovery is not quite on dry land yet, but at least it is a step in the right direction," said David Brown, of consultancy New View Economics."

The result follows growth of 0.3% in Q1, while house prices in the south-east of the UK also look set for lift-off recording new highs recently. 

An economic recovery is underway in Britain, which will raise questions as to whether the Bank of England needs to fire up further monetary stimulus next month.

Meanwhile, surveys from Germany show that growth is expected there too

Forget the doom and gloom - the storm clouds are lifting for 2014.

---

RP Data records property price growth yet again for Australia, making it 7 consecutive weeks of gains.

Sydney prices have already obliterated previous peaks and are up by 9.2% since their trough.

The worst performing capital city is easily Adelaide. In fact, Adelaide is the only capital city to see prices fall in 2013. 

AUD touches 91.58 cents

Its lowest level since September 2010.

Amazing falls given that on April 10 the Aussie dollar was buying 105.4 US cents.

It's been a long, long time coming for those of us short the Aussie dollar, but at last it has eased back somewhere close to a fair value. 

Will it drop yet further? Plenty forecasting further falls....

Owner occupied housing finance +1.8% in May

The value of owner occupied dwelling commitments increased for the 4th consecutive month in May (+1.8% seasonally adjusted).

The number of owner occupied commitments also continues to surge upwards (+2.6%) in May to 49,636, and is up for the 7th month in a row. The trend is up very strongly over the last couple of years.



Source: ABS

And the value of total dwelling commitments continues to surge (+2.0%) as it has been doing over the past year:

Source: ABS

Investor commitments are up a massive 24% over the year to date and are rapidly approaching all-time highs. 

This global trend towards real estate as an investment asset class is one I have discussed plenty and in part explains why I believe that inner and middle ring suburbs of the four major capital cities are likely to fare significantly better than other areas.

I've also been suggesting for months that first homebuyer commitments will gradually recover as those on the sidelines increasingly do not expect prices to fall, and they were up for the 5th month in a row, recording a 17% jump in the month of May. 

However, some caution should be exercised on this figure, as the 17% increase is still on a fairly low base and the result is likely distorted by grants and may soften in July once the grant rules are shifted in Victoria, Tassie and the ACT.

There are a lot of theories as to whether these strong figures across the board will or will not continue to move up at such a strong pace.

I'll analyse this in more detail tomorrow, but for now it's fair to say that yet another strong result means that those forecasting a housing bust will have to put the champagne on ice for a long while yet.

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Retail sales on the road to nowhere...

A weak result for the month of June, with retail sales failing to show growth for the month of the quarter on a seasonally adjusted basis.

Although there are whispers that July and August may show a better result, weak retail sales in June missed expectations and should temper optimism about the GDP result for June.

Aussie dollar sank to a new low of 88.49 cents earlier, the weakening of the currency continuing to be great news.

Shares were flat. 

Stand by for an interest rate cut.

Source: ABS

Not so super...

A brighter day ahead for stocks in Australia.

It needs to be! Markets are doing their level best to undue all of their good work of the past 12 months.

It was all fairly predictable really. As soon as those articles starting appearing saying "best year for superannuation in years..." the kiss of death was well and truly applied.

Here's the ASX200 one month chart:

Source: ASX

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SQM's take on falling prices...

Not sure why people don't use SQM's vendor sentiment index more, it's an enlightening resource which shows the uneven nature of the housing market recovery.

It shows asking prices across the cities for the past 12 months:

Houses

-Sydney +5.4%

-Melbourne -1.1%

-Perth +6.1%

-Darwin +8.0%

-Adelaide +0.2%

-Brisbane -0.7%

-Canberra -4.6%

-Hobart -2.6%

Units

-Sydney +4.9%

-Melbourne -0.6%

-Perth +7.9%

-Darwin +13.9%

-Adelaide +0.2%

-Brisbane -0.7%

-Canberra -5.1%

-Hobart +9.6%

So Sydney, Perth and Darwin seem to have led the way over the last 12 months. 

As we might have expected after the recent boom years, sentiment in Melbourne appears to have softened. 

Brisbane and Adelaide don't appear to have gotten going yet, and Canberra and Hobart look to be weak.

This seems to make more sense to me than prices sprinting ahead in Q1 and then falling. If anything gains were likely weak in Q1 and are now picking up.

Very handy resource-- Bravo SQM.

Source: SQM

US jobless claims drop to 5.5 year low

From Reuters:

"The number of Americans filing new claims for unemployment benefits fell unexpectedly last week, touching a 5-1/2 year low, suggesting a steadily improving labor market.

Initial claims for state unemployment benefits dropped 19,000 to a seasonally adjusted 326,000, the lowest level since January 2008, the Labor Department said on Thursday."

A volatile series but promising news nonetheless. More important will be the July employment report on Friday, which economists expect to show an unemployment rate dropping a notch to 7.5%.

Reuters again:

The government's closely monitored report is expected to show nonfarm payrolls increased 184,000 last month after rising 195,000 in June, according to a Reuters survey of economists."

Dow Futures are up by more than 100 points in response to the news while investors try to second-guess ongoing stimulus plans.

RBA retains easing bias; stocks rocket 2.63%

It just goes to show how wrong technical analysts often get it. It's all very well looking at a chart, but you have to look at fundamentals too. The RBA left interest rates on hold today at 2.75% as expected, but its Statement on Monetary Policy suggested that it retains an easing bias, which buoyed stocks:

"Globally, financial conditions remain very accommodative. However, a reassessment by the market of the outlook for monetary policy in the United States has seen a noticeable rise in sovereign bond yields from exceptionally low levels. Volatility in financial markets has increased and there has been some widening of credit spreads.

In Australia, the recent national accounts confirmed that the economy has been growing a bit below trend over the recent period. This is expected to continue in the near term as the economy adjusts to lower levels of mining investment. The unemployment rate has edged higher over the past year and growth in labour costs has moderated. Inflation has been consistent with the medium-term target and is expected to remain so over the next one to two years, notwithstanding the effects of the recent depreciation of the exchange rate.

The easing in monetary policy over the past 18 months has supported interest-sensitive spending and asset values and further effects can be expected over time. The pace of borrowing has remained relatively subdued, though recently there are signs of increased demand for finance by households.

The Australian dollar has depreciated by around 10 per cent since early April, although it remains at a high level. It is possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy.

At today's meeting the Board judged that the easier financial conditions now in place will contribute to a strengthening of growth over time, consistent with achieving the inflation target. It decided that the stance of monetary policy remained appropriate for the time being. The Board also judged that the inflation outlook, as currently assessed, may provide some scope for further easing, should that be required to support demand."

Share markets latched on to the potential for another cut and jumped 2.63%, and so markets have bounced quite considerably since the "suckers rally".

Source: ASX

Could one of Australia's main lenders fail? (and what would happen if they did?)

The Big Four

Australia's four major banks were named this week as being the most profitable in the whole world...for the third year in a row! Big bank profits appear likely to come it at well in excess of a combined $25 billion, and probably some way higher than that.

Why? It's partly because the Australian banks have wider interest margins than most, and lower equivalent costs. 

It's also because of a lack of competition worthy of the name. After a number of smaller lenders went to the wall during the global financial crisis, the 'big four' banks (Commonwealth, Westpac, ANZ, National Australia Bank) control a massive 83% of the mortgage market in Australia. 

Last year, as cuts in the cash rate were relentlessly delivered by the Reserve Bank of Australia (RBA), the major lenders consistently failed to pass on the full cuts to borrowers citing 'higher funding costs". It's laughable really, given the profits which will now again be reported, but the truth is that the banks get away with it because of the "feeble competition". It's an oligopoly.

Sure, there's talk of introducing more competition, and perhaps Macquarie will step in to become a fifth major player, but it all feels rather half-hearted given the monstrous profits which have once again been generated.

Some are more equal than others

Under Corporations Law, you might be forgiving for thinking that all companies are created equal. In theory, maybe businesses are in many ways equal, but in reality some are far more equal than others. If a retail company becomes insolvent and goes under it would be sad news for the owners and the employees, but the sun would likely come up tomorrow and the world would continue as before. 

There are some industries which the government might elect to support, such as car manufacturing. And then there are some businesses without who out entire financial system would implode: namely, the banks.

Without the banks to transfer money between borrowers and lenders, for want of a better word, we'd be well and truly stuffed. How would we even survive on a day-to-day basis with no cash cards, credit cards,  internet banking, ATMs? Undeveloped countries manage to run cash economies reasonably enough, but for the Australia of today, we'd be faced with almost unthinkable turmoil.

What do the banks DO?

At the simplest level, banks make their colossal profits through charging a higher rate of interest on their loans than they pay out on the money we bank as deposits.

If you've ever tried to buy a property with a deposit of less than 20% of the purchase price (an 'LVR' of more than 80%) you'll be aware that the bank can charge you a higher rate of interest as well as hit you up for Lenders Mortgage Insurance (LMI) as compensation for the higher perceived risk.

Investment banks also generate profits from issuing financial advice or from engaging in transactional activities such as capital raisings or takeovers.

Of course, under the modern system of banking, banks are not required to hold enough money to pay all of its depositors. It's known as fractional reserve banking. If we simultaneously all demanded our cash, the banks would not have the funds available to pay us, so much rests on our collective confidence in the institutions. Sometimes governments therefore choose to guarantee deposits up to a certain level in order to shore up confidence.

In fact, where I am today - in England - we saw a modern version of an old-fashioned 'run on the bank' in 2007 after rumours spread of the Northern Rock bank being in financial strife. The result was that the Bank of England had to step in as the 'lender of last resort' to provide emergency funding. The UK Treasury ultimately intervened and nationalised the bank.

Last resort

And that is the key point. 

There is simply no way Australia could allow one of its major lenders to fail because the fallout would be catastrophic beyond belief. For this reason the banks receive what is known as an implicit guarantee from the government.

The paradox of an implicit guarantee is that it can cause the largest banks to become larger still. They are seen as more creditworthy which can attract more business, and the very act of becoming larger reassures banks that they will become 'too big to fail'. An implicit guarantee could therefore the theory be seen to encourage reckless management.

However, banks will quite rightly be subject to increased regulation in the form of BASEL III and stress testing. 

What would happen if a major bank failed?

Overall, it is unlikely but certainly possible that with massive exposure to residential property one of our major banks could fall into difficulties. Take a look at the typical capital structure of a bank's balance sheet - you will notice that the net asset positions are surprisingly low given the vast loan balances on the books. 

However, a bank collapse would have the most diabolical and far-reaching consequences for the Australian economy. 

What would happen? Well, consumer confidence would instantly evaporate, the money supply would be annihilated as the insolvent or failed bank ceased lending funds to instead shore up their reserves...and we would likely end up in a deflationary economy with disastrous outcomes for the entire country.

So, it is for all these reasons that hell would probably freeze over before one of our major lenders would be allowed to fail. In business and economics, some are indeed created more equal than others.

---

A bit of talk of 'Ruddmentum' in the press - on a two party preferred basis Labor might have gained as much as five points in the polls! I'm not sure how thorough the polls were, though. Business leaders, who hate uncertainty, will push for an early election to be called.

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UK house prices up to highest in 3 years

No surprise at all that the combination of a growing dwelling shortage in the south-east of England and the Government Help-to-Buy scheme is pumping the UK housing market back up.

Bloomie:

"U.K. house prices rose last month to the highest in almost three years as measures by the Bank of England and the government stimulated property demand.

Home values increased 0.6 percent from the previous month to an average 167,984 pounds ($256,100), the highest since August 2010, the mortgage unit of Lloyds Banking Group Plc said in a statement in London today. From a year earlier, prices rose 4.1 percent.

The property market is showing signs of strengthening after the BOE’s Funding for Lending Scheme helped to lower borrowing costs and the government set up a program to help people buy homes. The central bank said yesterday that demand for mortgages rose “significantly” in the second quarter.

“Improved confidence in both the housing market and the economy, combined with a shortage of properties available for sale, appear to be pushing up house prices, said Martin Ellis, housing economist at Halifax. Still, ‘‘subdued economic background and weak income growth are expected to remain significant constraints on housing demand.’’

Taylor Wimpey Plc (TW/), the U.K’s second-largest homebuilder by volume, said today that more than 1,000 customers reserved homes using Help to Buy and a further 232 are seeking approval. It also said that first-half operating profit margin in the U.K. was more than 13 percent, up from 11.2 percent a year earlier.

In the three months through June, house prices rose 2.1 percent from the previous quarter, according to Halifax. From a year earlier, values were 3.7 percent higher, also the biggest increase since August 2010."

The nature of growth

Greetings from bright but rather brisk England where I've been hanging out for the past week. Busy as ever, I've been taking in a bit of culture, being the history buff that I am. 

In the last week, I've visited the ruins of the 6th century fort of Bolingbroke Castle, which was once one of the most important sites in Britain, being the birthplace of Henry IV. Today, it's essentially a mound of earth and a pile of stones in the countryside, but tremendously interesting nonetheless!

This morning I also visited the magnificent Kings College in Cambridge which was founded by Henry VI in 1441, and the restoration of which - a bit like the unending painting of the Sydney Harbour Bridge - seems to be an ongoing, 365-day-a-year job.

And, just in case all that wasn't tiring enough, I've also been spending some time with my three nieces.

Not having children of my own, I forget just how darned noisy and energetic kids can be, and I'm also amazed at how they seemingly eat round the clock: breakfast at 7am, sausage sandwiches by 9am, morning snacks by 10.30..."Well, they're growing kids, y'know..." - and it's true enough, they definitely are growing!

Physical growth and price appreciation

So, what have I missed in the world of Aussie real estate this week? Prices are on the move in some cities, it seems, with data provider indices showing some "growth".

A couple of commentators have again highlighted the risks inherent in mining towns, noting the possibility of land being released. I wholeheartedly agree with this assessment, although I note that this risk extends to many regional towns in general: land being available for release introduces a risk of very weak real long-term price appreciation.

Over here in the chilly south-east of England, it's very noticeable how so many former greenfield sites have been developed on the fringes of provincial towns and the smaller satellite cities in recent years. New property developments are sprouting up all over the place in fringe suburbs, with the UK Government and Bank of England pushing things along with its 'Help to Buy' scheme and ZIRP respectively.

While UK median prices have shown a very moderate uptick (this can happen when new builds come online), in many areas outside London the prices of existing properties remain way below where they were in 2007.

Remember that the physical growth of a town or city does not necessarily equate to price growth in existing properties, and this is especially the case where new land is being released.

In London, the dynamic is markedly different. Not only is there a massive, growing population and almost no prime land available for release, investors from Britain and overseas who were spooked by share market crashes during and after the financial crisis are simply throwing money at the property market, pushing prices up to unheard of levels, way ahead of their previous peaks.

"Room to grow"?

Some commentators say that investors should buy in the cheapest quartile of the market where properties have "more room to grow". 

But properties do not "grow", unless of course you are investing in building them to make them bigger. No. Instead, properties, just, well...kind of sit there.

Plants grow. Trees grow (though, as the saying goes, trees don't grow to the sky). My nieces grow. 

But properties do not grow.

And besides, why on earth should each successive generation pay more for property than its immediate predecessor? Particularly now that the deregulation of lending standards and products is well in the past and interest rates have fallen to as close to the 'zero bound' as they hopefully ever will be in Australia. 

If you want investments to grow - like my nieces - they need to be fed. You need to re-invest in them.

If you want a term deposit to grow, re-invest the interest.

How do companies grow? Because companies tend to only pay out a small portion of their net earnings as dividends and they retain sufficient capital to re-invest in the business. 

This is why value investors and Buffett-types seek businesses with strong and growing owner earnings (reported earnings with depreciation and amortisation added back, less capital expenditure for plant and equipment) - they want companies which can be self-perpetuating and are able to re-invest in their own futures.

If you want to grow your own share portfolio, re-invest your dividends via a dividend re-investment plan (DRP).

But, I'm afraid to say, properties do not "grow", especially if you take the approach recommended by some pundits of not maintaining properties to a reasonable standard.

In fact, if you don't re-invest in a property regularly through paying for repairs and maintenance (as the chaps do at Kings College in Cambridge nigh on continually) then eventually the property will fall down and you will be left with a pile of rubble and some earth (such as exists at Bolingbroke Castle in rural Lincolnshire).

Price growth

It's common to talk of "market value" or "intrinsic value" in the world of real estate. 

But what is market value? It's really only what another individual or entity will pay for the title at a given point in time.

Imputed rents don't make for a great measure of 'fair value' in residential property for they take little account of the emotional factors impacting homebuyers. In property, price is perhaps a far more appropriate word to use than value.

All things being equal, the price of a property should only move in line with inflation: as the currency becomes gradually worth less over time, the price of property should slowly tick up accordingly, but no faster than inflation.

A property in strong demand might potentially move rather in tandem with the growth in household incomes over time, with the effective speed limit for price growth being the ability of the populace to service mortgage repayments.

So how does an investor source price growth which outperforms inflation over the long term? Ultimately, unless you are a skilled renovator (and, let's face it, most property investors definitely aren't) there's only one way that it is possible to do this, by finding a property which:

(1) is in an area with a strongly increasing population, with real wages appreciation and booming demand;

(2) is in an area where there is little or no land available for development or release and thus supply does not keep pace; and

(3) where investors are pushing up prices through seeking returns on their capital.

This discounts most regional markets and fringe suburbs where land is available for release, demand is very low and price-to-income ratios remain subdued.

The markets which are fitting the criteria for price growth at present are Perth, Sydney and Darwin and prices are increasing accordingly.

Investors tend to prefer capital cities and the combination of land-locked suburbs and growing populations tend to be a happy one for investors and an unhappy one for homebuyers, pushing the price of the prime-location land ever higher. 

SQM's asking prices show multi-speed property recovery

Nice tool this from SQM Research, which allows you to view movements in asking prices by postcode.

Asking prices for houses in Sydney (+7.3%) and Perth (+7.4%) have moved up strongly over the past 12 months. Darwin also has seen asking prices well up.

In other cities, asking prices have not responded to record low interest rates in the same way.

Source: SQM

RBA to hold rates tomorrow

So, it will be an interesting Board Meeting for Australia's Reserve Bank tomorrow with plenty of weak data for the Board to mull over, but on balance the cash rate will probably be left on hold at 2.75%.

The ASX 30 Day Interbank Cash Rate Futures June 2013 contract last traded at 97.285 which (being a lot closer to 97.25 than 97.50) indicates only a small 16% expectation of an interest rate decrease to 2.50% tomorrow.

Or you can get $1.04 for rates on hold and $8.00 for a 25bps cut if the bookies are more your thing.

However, the yield curve remains inverted and the implies that the RBA will cut again by September/October to a new record low cash rate of 2.50%.

Plenty of data to flow in before then which may well make their mind up sooner - will have to wait and see...

Source: ASX

Some thoughts on investment strategy

Stocks up yet again in the US overnight. We've heard nothing but doom and gloom from some quarters for the past half decade and yet all you needed to do to generate returns of well over 100% since 2009 was to hold the Dow Jones index, a price-weighted index of 30 blue chip industrials.

Warren Buffett once said that being out of the market introduces a different risk to being in the market, and over the history of stock markets, it has indeed been a costly one. Here's the Dow 5 year chart, courtesy of Bloomie:

Source: Bloomberg

A huge deal was made at the time about the blips in the chart, such as the corrections caused by the US debt ceiling crisis and the European debt crises, yet over time corrections tend to take on a decreased significance as share index values run higher.

The stock market recovery has not been as pronounced in Australia, but you would have done very well had you focussed on the industrials and financials, as opposed to resources.

Indeed, over the decades in Australia, profit-making industrials have tended to outperform resources stocks and listed property trusts, tending to be more self-perpetuating businesses which pay strong dividends, while mining companies re-invest capital in further projects and have often paid weaker dividends in downturns.

Property trusts (once known as LPTs, now as A-REITS) have paid out high dividend ratios but demonstrated weak capital growth, sometimes diluting values through capital raisings for new projects.

Resources stocks have had a poor run since the onset of the global financial crisis. The 5 year chart of Rio Tinto (RIO) is an example of this under-performance, until its recent upturn which was buoyed by a bounce in the iron ore spot price.



Source: ASX

Generic advice

There is a worrying trend towards generic advice being issued from a wide range of sources on the internet. Each person has different financial goals, needs and risk tolerance levels, so generic advice is often misleading and could result in capital loss.

Even more worryingly, an awful lot of generic advice is dished out about investing (or very often not investing for whatever reason) by people who have never built an investment portfolio of their own.

Free advice is usually worth what you pay for it, as the old saying goes.

Ben Graham once said that if you have an amount available to invest regularly, then the only sensible investment strategy is to write yourself a contract committing to buying shares in good times and in bad on a regular basis.

This strategy is even more straightforward today because instead of having to buy a cross-section of the index to diversify your specific investment risk, you can simply invest regularly in a diversified product (such as an ETF or, my preferred option, an Australian LIC with heavy exposure to industrial stocks) which mirrors the balance of investments and risk profile you require.

My wife's index fund has just entered its 17th year of existence; that's nearly 200 consecutive months of share market acquisitions. This investment approach offers great peace of mind and requires very little skill other than discipline - you don't need to fret about how the market is performing on a day-to-day basis (if you are doing so, this maybe an indication that you have adopted the wrong investment strategy).

If the market falls, your money will just buy more stocks. And if it rises, your net worth increases and you buy fewer shares while the market is high. In the meantime, you can enjoy the growing dividend streams.

The only calibrating this investment approach might need is to learn to buy more heavily when the market suffers a major correction, such as it did through the financial crisis.

Most developed world economies are not like Japan and do not fall into a long spiral of deflation. Indeed, even in Japan, lessons have now been learned and stimulatory monetary policy has seen stock valuations surge by an astonishing 74% in the past year.

Property

Investment strategy in Australian property is a different beast for most average investors.

Statistics show that most Aussies do not ever invest in more than a handful of properties and therefore are unlikely to benefit from the averaging approach which so benefits share market investors.

The leverage involved can also mean that even when only buying a small number of property investments, the balance of a portfolio can be skewed towards this asset class, increasing the portfolio's risk.

Further, yields are so low on residential investment property that the asset class only becomes worthwhile for most if the investor can source reasonable capital growth. Cash flows can be reasonable on some commercial property types, but mostly this is not the case on residential stock.

For these twin reasons, it is important to invest only in areas where the population is forecast to increase for decades to come and there is little land available for release.

Commentators will continue to give the impression that they can forecast short-term market movements, despite the not-so-secret truth that they can't.

When you are granted a mortgage, the lender tends to give you a handy hint as to the appropriate time horizon for limiting risk in property investment in the terms of the loan: banks are comfortable that real estate is of an acceptable risk over 25 years.

Historically, this has been true, but investors would be wise to exercise care when selecting property investments and stick to those which suit their own risk profile.

---

CPI (inflation data) today, which will determine whether interest rates are cut again in August.