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Ben Kingsley Blog post by Ben Kingsley

Why Do So Many Academics and Economists Get Residential Property So Wrong?

You have to admire those who spend their days trying to improve ours – that’s the pursuit of so many academics and economists all around the world.  They are trying to solve problems and predict outcomes, which makes their work very challenging and also highly rewarding, one would guess, when they do get something right.

Knowing these people have great intellects, stating a brash headlines like the one for this article won’t be winning me any friends down at the alumni.  However, I feel it’s an important article to write because of what I’ve observed and read about over the years on the subject of property from professionals with perceived credibility, which is that their commentary on property especially the high value of property, has and continues to be wide off the mark.

Let me share with you a couple of examples. My favourite ‘Nay saying’ Property gloom and doom Australian Economist is Steven Keen. Since the GFC he has been predicting a 40% drop in Australian property values (Oct 2008), dating back to stories on 4 Corners on the ABC and 60 Minutes. It was pre GFC and at the start of the GFC that he continued to make predictions about property values in Australia following those in America. We all know that in hindsight, he was wrong and he has continued to push his property bubble message, yet since that time in many areas property prices have in fact gone up as much as 40%.  That’s a prediction that was up to 80% out in terms of property values.

If anyone had been listening to this economist and decided to get out of their property, whether it be their owner occupier home or their investment property/ies, they would have made a MASSIVE mistake and their wealth base would have been severely dented.

Keen’s theory on why property prices would fall is based on the debt level theory he has been advocating for many years.  In simple terms he argues that prices will fall because on-mass people can’t afford the debt levels.  He further reiterated his claim on Business Today in 2011, regarding a 40% decline in values of property, he argued our debt ratios were the highest they had ever been and they were unsustainable at these levels. Interestingly, since 2011 our debt levels have decreased, but prices held their ground. Now in late 2013, we are seeing price increases occurring again, which does not align with Keen’s theory (I’ll outline later in this article where Steve got it wrong).

The other example is the very well respected The Economist magazine, which each year publishes a list of countries where they believe the house prices are over-valued.  Earlier this year Australia was ranked fourth in term of overvalued property prices. They believe that our property prices are 24% overvalued as a measure of average personal disposable income and 44% against rents as a measure of property value.

How The Economist determines this statistic is twofold – one is prices to disposable income as a means of measuring affordability (Steve Keen likes this one too) and for the record we as a business measure this as well, but we measure it on a micro level and don’t care for it too much on a macro level.

The second is a price-to rent-ratio, which takes the long term average rental yields and measures the value difference this way.  The argument is, the lower the rental yields is the lower the property value when measured against the longer term average.  This type of valuation method is really an income capitalisation approach. In this case, using the annual rental income and dividing it by the relevant rental yield you can extrapolate value estimate.  Often this type of valuation method is used in Commercial real estate.

 

So why do these smart people get residential real estate wrong?

Firstly, there is no such thing as the ‘average’ Australian house, so trying to deliver a macro reading on a market place where there are over 9.1 million dwellings with an extra 2000 – 2500 new ones coming on line each week is challenging in itself.

Secondly, incomes vary significantly in each state and city to city, for example, Western Australian has the highest average household incomes, followed by the ACT, yet the largest city where there are more higher paid jobs are Sydney and Melbourne.  Stating an Australian average income is also fraught with danger and will lead to misguidance in terms of making statements and predictions about the value of ‘any’ market one study.  This is where Steve and the Economist get it so wrong. They are taking too broad an approach to measure and hence if their ‘average’ statistics include people on welfare and pensions and people in the bush who primarily live off their own land and derive very low incomes, it will all influence the ‘average’ calculations they put into their models to make these short sighted and ill-informed determinations.

The final area where the academics and economists struggle to understand the residential property market is in determining the ‘emotional’ value within the purchase decision.  Property might be an essential need for shelter, however for 70% of the population it means much more than just that.  For some it means status, for others it’s all about the liveability of the area or it could be the best opportunity for their kids’ education. All these considerations do result in there being tens of thousands of small ‘marketplaces’ where competition (demand) is strong and supply for could be limited, which ultimately leads to further value growth.

Sure there will be areas and properties that simply don’t make the grade and will suffer and see very little price growth in the coming years, and my observations are that these number of areas will be on the increase, because as I acknowledged earlier, the measure of income and affordability is an essential ingredient in the mix, but there will be many areas and properties across Australia that truly outperform the market consistently and for the long term. For academics, to solve this problem and understand this to be the truth, they need to move from macro assessment to micro assessment and start studying human nature – both from a ‘behaviour’ and ‘interest’ perspective, and then they will understand the true science of understanding residential property and its value.

 

Remember, knowledge is important if you act on it.

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