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A friend, Dominic Stevens, who is CEO of the annuity provider Challenger, shot me a chart of Australian house prices compared with US house prices over the long term. This particular chart seemed to suggest that there was an enormous difference in the growth rates. Dom asked me whether it was right. 
So we took up the challenge of answering his question. In Australia, all home sales data is collected by state government land titles or valuer-generals’ offices. However, none of these agencies make comprehensive sales data available before about 1975. We therefore view any indices purporting to rely on data before the 1970s as quite suspect, and certainly a very poor representation of the national market. It also turns out that reliable US house price data starts in about the mid-1970s too. 
The two most respected indices in the US, produced by S&amp;P Case-Shiller and the FHFA, begin their benchmarks in 1987 and 1975 respectively. Robert Shiller has tried to construct a longer-term house price series but relies on a “five-city” median price proxy between 1934 and 1952, and presumably poorer data before that. It is hard to fathom how one could legitimately argue that a sample taken from five US cities is somehow a decent representation of 50 to 100 cities spread across the US. 
For Australia, we used RP Data’s information to construct a comparable “all regions” median price index (i.e., as broad as possible) based on the criterion that we needed at least 12,000 dwelling sales per quarter. This begins in 1975, and by the end of that year we are including nearly 20,000 sales per quarter. (For the technical boffins, we use a simple median price index because it includes the maximum amount of data. A hedonic index would not be possible because we don’t have sufficient property attribute information in the 1970s and a repeat-sales index excludes too many observations for our liking.) 
The results of our analysis over this 36-year period are shown in the chart below. The first interesting insight is that Australian house prices grew no faster than <country-region><place>US</place></country-region> house prices right up until the late 1980s. And even during the next one and a half to two decades, the growth rates were similar. It is only the recent financial markets’ crisis and ensuing recession that has caused a noticeable disconnect.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust4.jpg"><img src="/images/stories/joyeaugust4thumb.jpg"></a>
Over the 32-year period stretching between 1975 and 2007 (i.e., just before the GFC), the inflation-adjusted compound annual capital growth rate for Australian dwelling prices was 2.6%. In contrast, the inflation-adjusted compound annual capital growth rate for US dwellings was 1.7%. (Again, for the boffins, our analysis of all alterations and additions data collected by the ABS implies that you should probably knock about 0.5% to 0.6% per annum off the CAGR to account for capital improvements to homes when using median prices.) 
That is, there was only a 0.9% per annum differential in the real house price growth rates realised in Australia and the US in the three-plus decades before the US sub-prime crisis materialised (of course, cumulatively this gives rise to a material divide in house price levels). 
Since 2007, or the advent of the GFC, the differences between the two countries have widened considerably given the strongly divergent economic circumstances. 
The US had its worst recession since the 1930s Depression, with the unemployment rate surging to 9.2%. <country-region><place>Australia</place></country-region>, in contrast, suffered only one quarter of negative GDP growth and today has an unemployment rate of 4.9%. Within the housing market, US mortgage default rates are more than 11 times higher than Australian equivalents (8% compared with 0.7%) notwithstanding our far steeper interest rates. 
The effects of the crisis, and the 15% to 30% peak-to-trough fall in US dwelling values, led the US market’s real CAGR to fall from 1.7% to just 0.5%. Since default rates and the unemployment rate only ticked up mildly, <country-region><place>Australia</place></country-region>’s real CAGR has remained relatively stable at 2.5%. 
One question is whether the long-run differences between the two markets have been driven by per capita incomes. We find that real per capita national incomes have been nearly identical over the last 36 years. 
There has, however, been a substantial disparity in inflation rates, with consumer prices in <country-region>Australia</country-region> growing at about a 1.2% per annum higher pace than the <country-region><place>US</place></country-region>. This may be related to the fact that the RBA has a substantially higher inflation target than the Federal Reserve. 
In addition to the underlying economics, a range of institutional, regulatory and tax factors have likely conspired to cause divergent outcomes. 
For example, US home owners get the benefit of tax-deductible mortgage interest payments, whereas Australians do not. This has led US borrowers to use more leverage, and hold it against their homes for longer (resulting in higher and more volatile default rates). 
Australians, in comparison, typically pay down their mortgage debt quickly (because it is expensive) over a 15-year period, well in advance of the normal loan’s 25-year term. 
In the <country-region>US</country-region>, households also pay capital gains tax above a certain threshold, whereas Australians (and those living in <country-region>Canada</country-region>, the <country-region>UK</country-region>, <country-region>New Zealand</country-region>, <country-region>France</country-region> and <country-region><place>Germany</place></country-region>) do not. 
Finally, <country-region>Australia</country-region> has a much denser urban structure, with 61% of our population residing in urban areas with more than 750,000 people, whereas the <place><country-region>US</country-region></place> is far more decentralised, with a comparable rate of just 47%. 
As always, the devil is in the detail!
Christopher Joye is a leading financial economist and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="https://www.rismark.com.au/" title="Rismark International" target="_blank">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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chrisjoye-JYhJsTrNRC

US and Aussie house markets disconnected but still similar

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The Reserve Bank has decided to keep rates on hold for the time being, but next month's meeting could bring an interest rate hike. That would mean the headline variable mortgage rate in Australia would advance from 7.8% to 8.05%. The official “discounted” rate would also rise by 0.25 percentage points from 7.05% to 7.3%. 
This would place home loan rates at about 0.1 percentage points above their historical average since 1993, which is 7.7%. Accordingly, nobody could seriously argue that rates are unreasonably high – recall mortgage rates hit 9.6% in August 2008 – given that private wages growth is running strongly at a 4.1% per annum rate (including bonuses), disposable household incomes have risen by more than 8% over the last year, and the unemployment rate is near all-time lows at 4.9%. 
Nevertheless, higher rates would mean more repayments for the 90% or so borrowers with variable-rate loans. On the other hand, an increase in the RBA’s cash rate usually means that households who are net savers benefit from better returns on their cash investments as compensation for higher inflation. 
Banks are always looking to improve margins, and it would not surprise me to see them pass on, say, the full 0.25 percentage point RBA increase to their mortgagors (if and when rates do rise), but only give savers a slimmer increase.
In this way, the banks can widen the “spread” or “net interest margin” between the rates at which they borrow from depositors and the much higher – net 2.5 percentage points on average – rates they charge home loan and business borrowers. 
If the RBA does not hike today, savers can consider themselves hard done by, while borrowers will have received a puzzling reprieve. One would be left concluding that Australia’s central bank has developed an unusual tolerance for high core inflation, which is running about 40% above the RBA’s official 2.5% per annum target.
The “consensus” view is, in fact, that the RBA will not touch rates today. In a survey of 25 economists by Bloomberg, 21 projected that rates would remain on hold. As another guide, the financial markets are only pricing in a circa 15% probability of a hike. So, all things being equal, one would have reasonable grounds for thinking that the RBA will not step up to the plate, as it has threatened to do so many times this year. If they once again defer the decision to deal with inflation this month, most economists think we will get a hike before the year is out. 
What does that mean for <country-region><place>Australia</place></country-region>’s housing market? Ri<personname>sma</personname>rk forecasts imply that with one to two more rate hikes we will get no capital growth, or some <personname>sma</personname>ll price declines, over the ensuing year. If for some reason the RBA does not raise rates at all, we are projecting inflation-like growth in dwelling values (see two charts below) combined with attractive rental returns.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust21.jpg"><img src="/images/stories/joyeaugust21thumb.jpg"></a>
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust22.jpg"><img src="/images/stories/joyeaugust22thumb.jpg"></a>
As we had expected, the latest RP Data-Ri<personname>sma</personname>rk house price data suggests that Australia’s housing market was finding a base before today’s RBA board meeting. In the month of June, we found that national dwelling values were basically flat (-0.2%). Over the 12 months to end June, Australian home values had retraced by a very modest 2%. 
The chart below shows the year-on-year capital growth returns (excluding rents) for both the combined capital cities index and our “rest of state”, or regional areas, benchmark. The final numbers to the right are the year-to-date results.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust23.jpg"><img src="/images/stories/joyeaugust23thumb.jpg"></a>
While dwelling values have tapered by a <personname>sma</personname>ll margin, both raw rents and rental yields (i.e., rents expressed as a share of the property’s value) have been expanding quickly. According to the ABS, the dollar value of rents rose at a 4.4% annualised pace in the second quarter, which is well above the overall rate of underlying inflation. The combination of rising rents and softening prices has helped yields to improve, as is illustrated by my next chart. Gross yields for apartments now look to be piercing the 5% threshold.
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeaugust24.jpg"><img src="/images/stories/joyeaugust24thumb.jpg"></a>
If you are a household with a lot of mortgage debt, fingers crossed that the RBA decides to ignore its official inflation-targeting responsibilities next month. If, on the other hand, you have prudently accumulated large net cash savings, here’s to hoping it does its job!
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Savers and borrowers both have their fingers crossed

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Yesterday’s inflation data heralds good and bad news for Australian households.


It almost certainly means interest rates are heading higher. Probably at least two more hikes – or half a percentage point in total – are left in the current monetary policy cycle. We may be spared too many more by the strong currency and the fact that the economy’s sensitivity to interest rate changes is much greater than it was in decades past.

While that’s undeniably disappointing news for borrowers, they should remember that even with two more hikes, the “market” (or discounted) mortgage rate in Australia will only be 7.6%. In January 1990 it was over 15%.

And although it is cold comfort for those with big loans, higher interest rates will be terrific news for net savers and Australia’s growing class of retirees, who should be heavily invested in cash-like securities. It means that these folks should be able to generate near-risk free cash or “enhanced cash” returns of 7% to 8% per annum. That’s easy, safe money.

On the flip side of the coin, further increases to the RBA’s target cash rate mean that we are likely to see a little more softening in house prices before the central bank starts cutting costs again. 

It means that the rental market will continue to tighten beyond its already very firm levels with vacancy rates at all-time lows. Perversely, it means that <place w:st="on"><country-region w:st="on">Australia</country-region></place>’s inflation rate will be propelled higher by robust rental growth as investment in housing supply stagnates. Indeed, we could see gross rental yields heading north of 5% in the apartment sector. 

And, unfortunately, it means that Australia’s mortgage default rate, which stands at an internationally very low 0.7% today, will probably edge up further.

The good news is that potential buyers and investors are going to be presented with more favourable valuation prospects. 

The dynamic whereby disposable household incomes in Australia rise solidly while house prices flat-line or decline modestly, which has held for the last year or so, will be reinforced. 

As I have argued countless times before, this is not a bad thing. Asset prices cannot always appreciate. Investment is not a one-way bet. Prices will typically fluctuate through the cycle. 

In fact, <a target="_blank" title="The home buyers' losers club" href="https://www.propertyobserver.com.au/trends/economy/the-home-buyers-losers-club-joye/2011072650914">as I showed recently</a>, one in 10 Australian property investors lose money when they trade their homes, and that is before accounting for transaction costs. On average, they do well: excluding rents, the compound annual capital growth rate over the past 10, 20 and 30 years has been 7 to 8%. Including rents, that number is considerably higher.

When you buy a home, you are, on average, making a seven- to eight-year commitment. So you need to consider what your total post-tax returns will be over this period. 

A conservative guide is that asset prices will track disposable incomes through the cycle. Historically, disposable incomes have expanded at a 6% per annum pace in <place w:st="on"><country-region w:st="on">Australia</country-region></place>. Going forward, a more realistic guide is probably around 4% to 5% per annum. 

If you can generate this kind of capital growth (CGT-free if you are an owner-occupier) in concert with net rental yields of 3 to 4% per annum, you are doing fine. Of course, this is an average outcome. Some will do better, others worse. That’s called risk.

As part of a broader portfolio, housing is a good “diversifier” because its returns tend to be uncorrelated with – or move in a different direction to – most other investment classes.

My own reckoning is that patient folks opportunistically investing in housing over the next one to two years are probably going to get the best prices, and valuation fundamentals, that they will have had access to in a long time. 

The demand-and-supply fundamentals underpinning Australia’s housing market are already quite attractive. They are only going to get better over the next 12 months. The one fly in the ointment is interest rates. When the RBA comes to cut them, affordability in this country is likely to be the best we have seen in over a decade, which will help to fuel a very strong recovery (and encourage people to allocate scarce capital to improving supply).

In the heated debate about interest rates, people seem to forget that 90% of Australians have variable rate debt. As we saw during the GFC, it is much easier to cut interest rates, and bequeath instant cash-flow relief to all those households paying off loans, than it is to chase the inflation tiger by the tail.

Trust me, you want our RBA to be vigilant in attacking inflation. You don’t want it to get too far “behind the curve”, which yesterday’s data confirms it is. 

If the RBA has to respond belatedly to an entrenched inflation problem the likes of which it struggled with in the decades prior to the 1990s, you will be slugged with much more challenging conditions. You will be dealing with the bad old days of double-digit interest rates.

And in the event the RBA does get its monetary policy settings wrong (i.e., overcooks the interest rate egg), it will not hesitate to correct the mistake and grant instant relief to everybody with a loan.

So what actually happened yesterday? As I have predicted for more than a year, Australia officially has an inflation problem. 

Underlying or core inflation has been running at more than a 3.5% per annum pace over the last six months. That is one percentage point above the RBA's implied 2.5% per annum target, which just happens to be the highest inflation target in the developed world. (Remember, inflation is a tax on your savings.)
 
<hr class="system-pagebreak">
 
August or September now loom as very likely for the first RBA cash rate increase. And I reckon we will get another one before the year is out, following which the RBA will probably sit on its heels and watch and wait.

What makes yesterday’s inflation numbers so much worse – we already knew that the cost of living indices were running at an annual pace of circa 4% – is that the June quarter was supposed to be a softer outcome, one where we got statistical payback for the incredibly high first-quarter numbers. 

All the economists were canvassing downside risks to their projections for core inflation of around 0.7%. And many economists argued that the first quarter numbers had potentially been dragged up by the floods, even though core inflation is meant to strip out the impact of unusually strong price rises. 

Recall also that throughout the last six months we have had huge currency appreciation (both in US dollar and trade-weighted terms), which, we were told, should have been deflationary. Indeed, the currency appreciation in the last quarter was much stronger (more than three times as much) as the appreciation in the first quarter.

Finally, we have had non-stop war stories about the “retail recession” and how there is massive, across-the-board retail discounting.

Guess what? They were all wrong. 

In the first quarter, average core inflation was 0.85%. In the second quarter, average core inflation was 0.9% (taking the average of the trimmed mean and the weighted median). 

And this is before Australia starts digesting an unprecedented increase in private investment via the commodity price boom and urbanisation of Chindia. 

It is before Australia starts importing more inflation from China, where wages and prices are sky-rocketing care of a pegged currency and inflationary US monetary policy. 

It is with the benefit of a near-100% appreciation in the currency from the 60US¢ lows touched in late 2008 and early 2009.

Glenn Stevens told our parliamentarians at the start of 2011 that the RBA had a history of getting "behind the curve" with respect to inflation, which has averaged an unacceptably high 3% per annum over the last decade. 

Stevens told MPs that the RBA had to learn from its mistakes and that if you waited to remove all risk to your forecasts – if you waited to eliminate all uncertainty (as many have argued they should) – it would be too late. The inflation genie would be out of the bottle, so to speak.

Well, underlying inflation in Australia has been running 40% above the RBA's 2.5% per annum target for the last half year. The RBA is now well and truly behind the interest rate curve. It has not touched rates since November 2010, and rate changes today take around another two years to have their full effect.

The inflation doves have been quite sensationally blown out of the sky. Rates are heading higher. Soon.
Christopher Joye is a leading financial economist and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="https://www.rismark.com.au/" title="Rismark International" target="_blank">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Australia has an inflation problem, and higher interest rates are the only way to fix it

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What’s the chance of losing money when you buy a home? Or, put another way, what percentage of all people who buy and sell suffer losses before accounting for costs? As simple as these questions may sound, they are not easy to answer. There are only a handful of organisations with the data and capabilities required to run this type of analysis. 
Addressing this question is also important if you want to better understand individual property level risk, which is something that I have written about for years. In <a href="https://www.propertyobserver.com.au/observers/not-as-safe-as-bricks-and-mortar/2011071150768">this column</a>, I showed that the volatility of a home is akin to that of the sharemarket, and three to five times riskier than a broad-based house price index. 
Commencing our analysis in 1990, Rismark’s team of PhDs collected 3.7 million purchase and sale pair transactions pertaining to the same home. We call these “repeat sales”. In total, there were 7.3 million transactions. Of course, there are going to be many people who bought homes during this period but who have yet to sell. They are, by definition, excluded. 
The team then calculated the buy-and-hold annual compound capital return (excluding imputed or explicit rents). These are, to be sure, gross returns and do not account for the many transaction costs associated with holding a home. They also do not control for alterations and additions (viz., renovations), which are undertaken to offset the physical depreciation of the asset, or simply to improve it. 
Several years ago we took the ABS’s alterations and additions data and tried to estimate its impact on annual capital growth. The number we arrived at was about 0.55% per annum, which has been confirmed by other analysts. 
The results of the first cut of our research are illustrated in the chart below. The median capital return to property owners since 1990 has been 7.8% per year.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejuly261.gif"><img src="/images/stories/joyejuly261thumb.gif"></a>
This is interesting for a couple of reasons.
First, it is exactly the same compound annual growth rate we get when we look at RP Data-Rismark’s hedonic house price index over the last 10 years, which is a completely different methodology.
Secondly, it just happens to accord with the return we get if we calculate the compound annual growth rate attributable to a very simple “median” house price index over the last 28 years. 
Observe in the chart above that the distribution of buy-and-hold returns looks to be right skewed: more people are realising high returns relative to very low returns. 
In particular, 9.3% of all home owners traded their property for a loss (note that these are pure capital returns, and ignore the rental income that you would have got along the way). This is also gross of all transaction costs, so you can be sure that the net number is higher. Ipso facto, about 90% of owners realise positive gross capital returns on their homes before accounting for rents and costs. 
The next diagram breaks out this analysis by capital city so that we can get a feel for relative performance over the last two decades. And the results are fascinating. Perth and Adelaide are the two best-performing cities, generating compound annual capital growth rates of 10.3% and 9.5%, respectively. The worst performer was <city><place>Sydney</place></city>, which has yielded about 1% per annum less than the national average of 7.8% per annum.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejuly262.gif"><img src="/images/stories/joyejuly262thumb.gif"></a>
Two other things to think about. 
First, these returns reflect the change in the capital value of a home over time. What they do not tell us is what the home owner’s actual equity, or geared return, would have been. We can comfortably assume that the equity returns are far higher (likewise the losses for the one in 10 folks who get unlucky). 
Second, as discussed, this analysis excluded gross rents, which are currently around 4% to 5% per annum. It also ignores all transaction costs, which sum to around 1% to 2% per annum for the average home owner who stays in a property for seven to eight years. 
In closing, what are reasonable growth expectations going forward? A simple benchmark is national disposable incomes. If we take the ABS National Disposable Income estimates, and divide by the number of households to control for population growth, we get a useful per household growth estimate.
Based on this measure, Australian disposable incomes per household have risen by 4.9% per annum since 1993, which is about 25% higher than wages growth. The differential could be attributable to the advent of multiple-income households, the tendency for marginal tax rates to decline, stimulatory government subsidies, such as middle-class welfare, and as a result of the better portfolio diversification households are getting via superannuation.  
Looking ahead, one might reason that disposable income growth will be a bit lower. This in turn implies that house price growth might be less than the circa 7% to 8% annual rate that it has compounded at over the last three decades.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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The home buyers' losers club

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There is mounting evidence to suggest that <country-region><place>Australia</place></country-region>’s housing market rests at a critical juncture. The first two charts below show the evolution of Australian dwelling values since 2000 and 2006, respectively. You can clearly see the latest innovation in the housing cycle, wherein overall Australian home values (blue line) have tapered by a modest 2.3%. The question on everyone’s lips is: what lies in wait?
Before I address this, it is interesting to inspect the charts more carefully. Observe, in particular, how Sydney dwelling values have massively underperformed the rest of the Australian market over the last 11 years or so (black line, first chart). It is also fascinating to note that even though the Perth and Brisbane housing markets have suffered 7.5% and 5.9% declines in the past year, they have actually been our two best-performing conurbations over the past 11 years.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune211.jpg"><img src="/images/stories/joyejune211thumb.jpg"></a>
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune212.jpg"><img src="/images/stories/joyejune212thumb.jpg"></a>
In my opinion, the near-term destiny of Australia’s housing market very much depends on next week’s second-quarter inflation numbers. If inflation is low, the RBA will likely be on the sidelines for the rest of the year. It can argue that it was vindicated for not responding to the very high first-quarter results, and will in any event be downgrading its economic growth forecasts for 2011, which were always on the high side.
Talk in the media will galvanise more firmly around rate cuts. Consumers will start to scale back their still extraordinarily hawkish interest rate views (see chart below), with 84% anticipating rate hikes. Given the average Australian thinks he will be hit by two or more rate hikes in the next 12 months, it is no surprise that underlying economic conditions have been so soft.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune213.jpg"><img src="/images/stories/joyejune213thumb.jpg"></a>
In this low-inflation scenario with no future hikes and the prospect of cuts, our forecasting models predict that Australia’s housing market has the ability to start grinding out very modest capital growth, which, of course, should be complemented by healthy rental returns (see next chart).
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune214.jpg"><img src="/images/stories/joyejune214thumb.jpg"></a>
In the less favourable alternative, where inflation next week is reported high – at, say, 0.8% for the quarter or more – it saddens me to say that our beloved central bank will be very much on the interest rate warpath. That means the likelihood of a rate hike, or hikes, before the year is out. And the half-nelson that the RBA currently has <country-region><place>Australia</place></country-region>’s housing market in will only tighten. 
These crossroads are best illustrated by the divergence of beliefs between economists and the financial markets. The following chart shows ANZ’s interest rate forecasts contrasted against the futures market’s expectations. Whereas the futures market is predicting rate cuts, ANZ thinks we will get hikes.
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyejune215.jpg"><img src="/images/stories/joyejune215thumb.jpg"></a>
Who is right? We cannot tell at this point. It all depends on inflation. So, if you are looking to buy but have not found a place yet, you should be hoping for a high inflation outcome, which will inevitably result in persistent, interest rate-induced pressure on prices. If, on the other hand, you are looking to sell, you should be praying for a low number next week.
Christopher Joye is a leading financial economist and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice. You can follow Christopher on twitter at <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" href="https://twitter.com/#!/cjoye" title="Follow Christopher Joye" target="_blank">@cjoye</a> or read his blog.
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It all comes down to inflation

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When thinking about investing and life in general, I try to conceive of so-called “non-linearities”’. These are situations where the world suddenly veers off our “central case”, or most probable course.
This is why I find someone like Dr Steve Keen interesting. While Keen has arguably been wrong about a lot of the things he has sensationally forecast, he is effective at painting extreme pictures. Every so often, one of these unexpected events can materialise as our “central case” among the millions of possible paths life can take.
The “Great Recession”, as it is known in the northern hemisphere, or “North Atlantic crisis”, as RBA officials incorrectly call it (recall they cut interest rates to 40-year lows while Aussie government debt exploded!), or the “GFC”, as it is uniquely referred to Down Under, is a graphic illustration of a non-linearity.
And, to Keen’s credit (pun intended), he was right about the hazards that leverage can embed in a financial system.
With that cue, it is instructive to think through the possibility of the Aussie dollar advancing to levels much higher than most currently anticipate — say to US$1.25 or US$1.50. 
This would have serious ramifications for <country-region><place>Australia</place></country-region>’s housing market. In particular, it would crush demand among foreign buyers while also curtailing income and growth in both the export industry, which would be rendered less competitive, and in businesses that compete against imports, which would be dramatically cheaper. 
The one positive of a super-high currency is that it could alleviate the need for future interest rate hikes, and even compel the RBA to cut rates. 
As long-time readers will recall, my own central case has involved a global inflationary cycle as sovereign states seek to inflate their way out of public debt crises, which, it is too rarely noted, were originally private debt problems. Combined with the incredible surge in private investment to capitalise on the “Chindia” induced commodity price boom, this explains why I have been an inflation “hawk” (about 60% of Australian inflation is actually explained by global inflation). 
Another key element of my central case has been a deterioration in the US government's creditworthiness, and a rise in US yields to reflect (a) higher US inflation tolerated by authorities happy to see the fixed-value of US nominal debt decline, and (b) the higher probabilities of US government default. 
Thus far this story has played out nicely, much to the frustration of folks like Nobel Prize-winning US economist Paul Krugman, who would have us believe that US inflation is not, in fact, a credible concern. This does not sit comfortably with the latest data released on Friday, which showed core inflation in the US running at a 2.9% annualised pace over the past three months, which is way above the Fed’s target of less than 2%. (And so much for the pundits who canvassed “deflation” in the US last year.) 
Many respected economists are now openly talking about the merits of a bout of “surprise” US inflation. The trouble is that this would not be a surprise to anyone, and would likely translate into higher long-term inflation expectations, which can then feed back into prices. The real risk is that the current public debt crisis undoes three decades of hard work by central banks to secure so-called “price stability” (or low and relatively predictable inflation). 
I have previously assumed that the rise in <country-region><place>US</place></country-region> government bond yields forces an appreciation of the US dollar since global exchange rates are ordinarily determined by interest rate differentials. This is a contingency that RBA board member Professor Warwick McKibbins also believes is very <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1828363">possible</a>.* 
If the <country-region><place>US</place></country-region> currency rises, the Aussie dollar spot mechanically declines. This means we start importing more inflation on top of any domestically generated price pressures (especially since key trading partners like <country-region><place>China</place></country-region> have US dollar pegs). And higher inflation means higher interest rates. 
One potential shortcoming in my story (and McKibbin’s scenario-analysis), which I have been seeking to highlight of late, is a non-linearity. This is probably best called the “Global War for the Preservation of Capital”. 
More specifically, my base case does not account for the relationship between a deterioration in the US government’s creditworthiness and the value of the US dollar as an international store of wealth – that is, the greenback’s historical role as the international “reserve currency”. 
This non-linearity could produce a seemingly unexpected outcome: soaring <country-region>US</country-region> bond yields coupled with a static or declining (rather than rising) <country-region><place>US</place></country-region> exchange rate. 
Another thread of logic that lends weight to this possibility is the fact that a depreciation in the US dollar improves the international competitiveness of US exports, and thus provides short-term assistance to its economic recovery and the political imperative of reducing the <country-region><place>US</place></country-region>’s 9.2% unemployment rate. 
There is little doubt that much of the motive behind the US’s current program of “quantitative easing” has been a deliberate attempt to put downward pressure on the greenback to help US exporters who have for years laboured to compete against the artificially depressed prices of Chinese products (given the value of the Chinese currency has been held down via its US dollar peg). 
We are already seeing parts of this new story play out, which explains the otherwise bizarre behaviour of the Aussie dollar, which used to be a world growth/commodity proxy (and normally suffers badly during market ructions). 
Today foreign governments, and their agents, central banks, are desperately diversifying out of the old “safe haven” currencies (with the exception of the auspiciously austere Swiss) in recognition of an emerging new world order dominated by Asian economies. So they are selling the US dollar, the British sterling, and the Japanese yen. 
These historical stores of wealth are being destabilised by competitive currency devaluations (resulting from US, UK, and Japanese central banks doing almost anything to keep official interest rates ultra-low) in the name of inflating their way out of the twin evils of difficult-to-pay back sovereign debts and post-GFC economic stagnation. 
Investors are also beginning to realise that the present fiscal challenges are a veritable “pimple on the arse of an elephant” when juxtaposed against the future pension crises that could be eventually triggered by the ageing of Western (and Japanese) populations. 
In the race to preserve wealth in a world in which governments are either defaulting on their debts or debasing them through currency depreciations and inflation, the Australian and Swiss exchange rates stand out as two islands of economic, fiscal, social and political rectitude (despite what local partisans might have us believe). 
In addition to having negligible net government debt, high interest rates (and hence attractive yields to holders of government bonds) and the providence of possessing an extraordinary bounty of natural resources that just happen to be in high demand (these points are actually related), Australia’s trade relationships, unlike the Swiss and, say, Canadians, are relatively insulated from the US and European woes. 
In economic terms, we are a resolutely Asian nation, albeit with the legal and political stability of an Anglospherean Western democracy. Our four biggest trading partners are, after all, <country-region>China</country-region>, <country-region>Japan</country-region>, <country-region>South Korea</country-region> and <country-region><place>India</place></country-region>. 
Sure, this is a globalised economy, with deep interdependencies. Yet Australia’s developing country partners, China and India, will almost certainly keep on urbanising and industrialising even with stasis in the US and Europe. 
 
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The shifting of the currency sands I have described above is confirmed by discussions with leading investment bankers, who report immense demand for Australian government bonds almost irrespective of their price. 
That is, buyers don’t really care if Aussie bond prices fall in value a bit in the event that the RBA nudges rates higher to subdue inflation because they are earning strong and secure (from a credit perspective) underlying yields. And most of these buyers are foreign governments that will likely hold the bonds to maturity, and are therefore indifferent to fluctuations in price. 
The demand for Aussie government debt has caused a tremendous increase in its price and thus a decline in its implied yield (the two are inversely related), which at around 4.3% today is well below the RBA’s target cash rate of 4.75% (see chart).
<a href="/images/stories/joyejuly191.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joyejuly191thumb.gif"></a>
Normally this “price action” would portend disaster for the local economy. The likes of Westpac’s Bill Evans evidently thinks so. Yet I would venture that it is perhaps more a reflection of the global war for the preservation of capital.
One constraint on the ability to obtain Aussie dollar exposures is that there is only a <personname>sma</personname>ll stock of government debt – about $197 billion worth. This means that the currency could face unprecedented demand combined with limited supply, which could collectively conspire to propel its price to previously unimaginable highs.
The risk of this event is highlighted by the vastly asymmetric responses of the Aussie dollar to the 2010 and 2011 sovereign crises. Last year the Aussie battler plummeted from 93 US cents to 80 cents (see chart), which is what typically happens when financial markets are in turmoil. In contrast, the Aussie dollar has hardly budged during the graver 2011 episode.
<a href="/images/stories/joyejuly191.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joyejuly191thumb.gif"></a>
There is a further nuance here that could make central bank purchases of Aussie dollars a <personname>sma</personname>rt trade. If the currency keeps on appreciating, the exchange rate could end up doing much of the inflation-fighting work for the RBA.
Crucially, this means that the holders of Aussie government bonds (more than 75% are foreign investors) would minimise any capital losses inflicted by an inflation-induced rise in market yields (which would reduce the price of their bonds) while benefiting from an increase in the capital value of those assets on their balance-sheets via the soaring Aussie dollar.
Forecasting is a difficult trade to ply given the complexities of the world in which we live. It is more useful to think of the future as a distribution of potential paths. For example, imagine the world as having a “‘base case” bookended by “upside” and “downside” scenarios. When trying to sketch the contours of any downside event, it pays to twist your mind to visualise non-linearities.
History has a tendency of surprising us by overshooting both good and bad expectations.
*A crucial assumption made in McKibbin’s analysis is that “the main financier of global public debt (namely <country-region>China</country-region>) to the major borrower (namely the <country-region><place>United States</place></country-region>) [does not lose] its appetite to continue lending on the same basis as before.” One objective of this article was to test that assumption.
Christopher Joye is a leading financial economist, and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Rismark International" href="https://www.rismarkinternational.com/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Shifting currency sands could trigger unexpected consequences for Australia

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One of the main obstacles people have in understanding the dynamics of Australia’s $3.5 trillion housing market is what I like to refer to as an “anchoring bias”.
Since 70% of households own the homes in which they live, they tend to think they are experts on the subject. But, as I noted in my<a href="https://www.propertyobserver.com.au/observers/not-as-safe-as-bricks-and-mortar/2011071150768"> previous column</a>, an individual home, with all of its idiosyncrasies, is actually a very poor proxy, or representation of, Australia’s overall housing market.
Perhaps the strongest anchoring bias one finds is in the luxury market. Most newspapers and real estate publications tend to focus their reporting on high-end property sales. There are good reasons for this: reading about multimillion-dollar homes is fascinating. It sells newspapers and attracts eyeballs.
But how relevant is the $1-million-plus market to the average Australian? And could it be the case that all of the financial services executives and corporate titans who live in higher-end suburbs, and who exercise so much power and influence over “consensus thinking”, are most adversely affected by anchoring bias?
I consistently find that the more well paid somebody is, the more bearish they seem to be on housing, especially during downturns. For example, during the GFC, countless top executives would relay stories about how Australian house prices plummeted in the 1991 recession, and predicted the same would likely happen again.
Yet when we went back and looked at every available house price index, we found that Australian house prices hardly budged in 1991 despite the fact that unemployment peaked at around 11%. According to the ABS house price index, home values actually rose on average over the period January 1990 through December 1992, albeit at a very slow pace. Of course, within the national index there was a great deal of cross-sectional variation.
As was the case during the GFC (when average prices only declined by 3-4% peak-to-trough), by far the worst affected suburbs back in 1991 were the luxury markets. In places like Toorak, Point Piper, Mornington Peninsula and Palm Beach, prices indeed fell by 10-20%. And while this was doubtless a painful experience for the “big end of town”, it had no bearing on the average Australian family.
In psychology, anchoring denotes the tendency of people to rely far too heavily on small pieces of non-representative information when making decisions or estimating probabilities. In 2002, Daniel Kahneman was awarded the Nobel Prize in economics for his work (with the late Amos Tversky) documenting that anchoring biases and other behavioural dysfunctions interfere with objective human decision-making.
These frailties in our judgment have, for instance, been shown to exacerbate the protracted booms and busts in share prices that we have observed over the past 30 years.
When it comes to house prices, purported experts tend to make the mistake of extrapolating from their individual circumstances and using this information as a credible proxy for the wider market. More specifically, I would contend that the luxury market is afforded far too much weight in experts’ assessments of wider conditions. So how important is it?
In the chart below I have dissected out the price distribution of all home sales in Australia over the past year. Recall that the median dwelling price across Australia is $420,000 (including both capital city and regional areas).
<img src="/images/stories/joyejuly14-1-cropped.png"> 
Unsurprisingly, about 65% of all sales in Australia are for homes worth less than $500,000. If we widen the price band to between $0 and $700,000, we capture 83% of all sales.
 
In contrast, only 6.4% sales were for homes worth more than $1 million. That is, the $1 million-plus market is irrelevant to over 93% of households. If we boost the granularity of our analysis and concentrate on the $2 million-plus market, we find that it accounts for only 1.1% of all sales (ie: meaningless to 98% of people).
 
The next question is whether the luxury segment performs differently to the broader market. In the chart below I am have illustrated the year-on-year capital growth rates realised by the bottom 20% of suburbs (ranked by price), the middle 60% of suburbs, and top 20% of suburbs in Sydney. The results are similar across Australia.
 <img src="/images/stories/joyjuly14-2-cropped.png">
What should be clear is that the most expensive homes are significantly more volatile (or risky) than the remaining 80% of dwellings. During the good times they experience much faster house price appreciation, while in the downturns they perform by far the worst.
This probably helps explain why the talking-heads who frequently live in these areas are prone to the most pessimistic exclamations on Australian house prices. That is, they forget that their $1 million-plus home is a poor guide to overall conditions.
Christopher Joye is a leading financial economist, and works with <a href="https://www.rismarkinternational.com/" title="Rismark International" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Troubled prestige prices don’t signal woes for suburbia

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Since 2003 I've argued that many academics, economists, commentators and consumers confuse two fundamentally different concepts: the risk observable in a broad-based house price “index” and the probability of loss (or risk) faced by individual homeowners. This is a profoundly relevant issue for us all. 
The popular notion of bricks and mortar being a safe investment for owner-occupiers is at least partly based on the observed volatility, or risk, associated with regional house price indices.
The problem here is that a house price index proxies for literally millions of homes worth billions or trillions of dollars. An index is, therefore, an incredibly well-diversified portfolio.
In contrast, an individual homeowner is making an economic commitment to one highly idiosyncratic asset. 
You are buying one home, on one street, facing one direction, with all of its manifest peculiarities. This is, by definition, a poorly diversified investment with a much larger prospect of loss. 
A similar analogy can be found when comparing the risk of a micro-cap listed on the ASX with the fluctuations observed in the ASX All Ordinaries index, which captures every company listed on the exchange.
The micro-cap’s volatility will be much greater than the variations observed in the index. This is why your average super fund's portfolio invests in the index, and not micro-caps. 
Diversification is meant to be the one “free lunch” in economics. It’s the one time you really can walk along the street and pick up 100-dollar bills.
Since the circa 7-8 million property owners out there do not get the benefit of a national portfolio comprising millions of assets, understanding and managing individual asset-level risk (ie: your own home) is of great importance.
Regrettably, there is very little research on the economic hazards faced by single family homeowners. Rismark's team has, however, spent a lot of time thinking about this subject. 
Applying one methodology developed by professor William Goetzman, a leading financial economist at Yale, we found that the total risk of an individual home is about 15-20% per annum depending on the holding horizon. If we take a seven to eight-year ownership period, the individual property volatility is about 15% per annum. The chart below illustrates the results of this research based on all purchases and sales of Australian homes between 1990 and 2009. 
<img src="/images/stories/joyegraph1-cropped.png">
 Based on this analysis, owning a home outright is slightly less risky than owning every company listed on the ASX, which has exhibited historical volatility of nearly 20% per annum over the past 30 years. The next diagram shows a simulation of the risk profile of an individual home compared with capital city and national house price indices between 2004 and 2009. For the purposes of this analysis, the team used RP Data-Rismark's Hedonic Home Value Index. Importantly, we have also assumed that the individual property owner, which is represented by the red dotted line, has no mortgage debt. You can see that the value of the individual asset varies strikingly through time, compared with the capital city and national indices. 
<img src="/images/stories/joy-new-graph-cropped.png">
To highlight these differences further, here are approximations of the expected return ‘distributions’ attributable to both a national portfolio of housing and a single family home. 
<img src="/images/stories/joyegraph3-cropped.png">
 Observe how the individual property’s return distribution, which is proxied by the blue bars, has far 'fatter' tails and a lower peak. This tells us that the prospect of realising positive or negative capital growth outcomes is much higher than a nationally diversified portfolio, which is represented by the comparatively narrow red distribution. The latter demonstrates that the dispersion in the range of possible outcomes is very tightly wound around the average, or expected, capital growth rate. 
This is just one way of saying that a national housing portfolio has exceptionally low risk of just 3-4% per annum. If you had this holding, the value of your investment would have fallen only 2.5% in 2008. If, on the other hand, you had a single, million-dollar-plus property in Sydney or Melbourne, it probably fell by about by 10 to 15%.
The final chart illustrates the monthly returns attributable to a simulated Australian home between 2004 and 2009. Critically, we have created both 'geared' and 'ungeared' capital growth profiles. The blue line denotes the value changes associated with a homeowner with 70% mortgage debt. The red line represents a homeowner with no debt (they own the property outright). The impact of leverage is vivid: it amplifies the probability of loss, with the blue line dipping far below the zero% (ie, no change in value) axis with disturbing regularity.
<img src="/images/stories/joyegraph4-cropped.png"> So, what is the message from all of this? Over and above simple portfolio diversification, one take-away is that households have a profound (latent) desire to deleverage their balance sheets. This is an obvious statement today – but it was not something that many folks focused on back in 2003, when I first made it.
The only way to reduce debt is by boosting equity. This brings us to an economic puzzle: equity markets for housing finance don’t exist. While listed and unlisted companies raise debt and equity every day of the week, homeowners are stuck with debt. So, whereas a company with 90% gearing would be punished by the market for being excessively risky, we happily allow first-time buyers to leverage up to the tune of 95% against far riskier underlying assets.
The principal value of equity finance, as opposed to debt, is that the equity provider wears the risk of loss alongside you.
When times get tough, equity costs you nothing. In comparison, you always have to service your debt. Equity only has a positive cost when things go well, and you can afford to pay. This is precisely why financial markets and regulators like to see companies with more equity and less debt. 
The Bank of England's Andy Haldane recently arrived at this conclusion: policymakers need to revisit the housing finance paradigm and promote the design of smarter instruments that help households better mitigate their risks. Of course, real change is an awfully difficult thing to implement.
Christopher Joye is a leading financial economist, and works with <a style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;" target="_blank" title="Rismark International" href="https://www.rismarkinternational.com/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Residential: not as safe as bricks and mortar

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In one corner we have journalists at The Economist newspaper, who in a recent survey make the extraordinary claim that Australian house prices are overvalued by 55% using their preferred benchmark. In the other corner we have a crowd of the most respected economic minds in Australia, including the Reserve Bank of Australia, the Commonwealth Treasury, almost all market economists, and leading house price index providers, such as RP Data and Rismark.
This latter cohort essentially contends that The Economist does not know what it is talking about. They argue that Australian house prices are not materially overvalued, and there is no reason to believe that they must suffer precipitous price falls in order to obtain some more desirable valuation benchmark.
This group has also produced vast reams of analysis showing that robust demand and supply-side fundamentals underpin Australian housing valuations while dwelling-price-to-income ratios remain unexceptional by international standards. In fact, recent research by Rismark has demonstrated that house price growth in Australia’s capital cities and our regional areas has not kept pace with disposable household income growth since the end of the last cycle in 2003.
It was only a few months ago in The Economist’s backyard, the city of London, that RBA Governor, Glenn Stevens, was tossed a question about whether he was worried about Australian housing valuations. In the past – most notably in 2002 and 2003 – the central bank has not hesitated to express reservations. Yet Stevens responded:
“Well, let’s establish a few facts… For the past year or two, house prices haven’t done anything much at all… We continue to see arrears rates on mortgages very low by global standards ...We don’t have a gearing up going on now… I don’t think we have huge rises going on... that’s probably not top of my list of worries…
“The other thing I’ll say is that it’s quite often quoted very high ratios of price to income for Australia, but if you get the broadest measures, a country-wide price and a country-wide measure of income, the ratio it about 4 ½ and it hasn’t moved much either way for 10 years. And that is higher than it used to be, but it’s actually not exceptional by a global standard as far as I can see.”
While the typically conservative RBA thinks Australia’s housing market is sitting pretty, The Economist’s survey suggests it is massively overvalued. In order to decipher who is right or wrong here, one has to dive into the detail.
The Economist arrives at its 56% estimate by taking the ratio of median house prices to median rents, and then comparing current levels with their “long-run average”. There are many technical problems with this approach. One obvious issue is that we do not observe rents for more than two-thirds of the entire housing stock, which is ‘owner-occupied’. So The Economist is actually comparing the yields on rental properties with the prices of owner-occupied homes. Imputed owner-occupied rents are likely to be different to those deriving from investment properties given the far greater control rights associated with the former.
But this is a trivial error in the scheme of things. There is a much deeper problem with The Economist’s logic, which both the RBA and we here at Rismark have repeatedly highlighted. Let me explain.
Anyone can compare the current observed values of a range of economic indicators, such as interest rates or inflation, with their ‘long-term’ averages. But we need to ask ourselves whether this is an informative exercise, or potentially misleading.
For example, applying The Economist’s way of thinking to Australian interest rates would lead one to conclude that current rates are much too low. Indeed, the analysis implies that Australian government bonds are massively overvalued since today's 10-year yields of 5.5% more than a third lower than the 30-year average of 9%.
Yet the body that sets interest rates – the RBA – has repeatedly told us that present-day lending rates are, in fact, “a little higher” than their long-term averages. So what is going on?
As an alternative, let’s examine inflation. Today the RBA believes that the acceptable rate of consumer price inflation is around 2.5 per cent per annum. Yet the 30-year average rate is 4.2% per annum. Does this mean that the RBA should substantially revise up its inflation target? Of course not.
These variables were not selected by chance. The truth is that the crux of this debate hinges on how inflation, interest rates, household debt, and house prices have varied over the last three decades.
In its survey, The Economist takes median house prices and median rents over the last circa 30 years – which is the longest horizon over which these data are publicly available – and calculates a long-term ‘average’ ratio, which it assumes to be the ‘correct’ benchmark. It then compares current house prices and rents to this 30-year benchmark. If current ratios are above (below) this 30-year average, The Economist claimshey are over- (under-) valued.
The Economist does not question whether the old housing ratios might be nonsensical to today’s home owners as a result of: (a) fundamental changes in the structure of the economy wrought by the fact that interest rates over the past 15 years have, on average, been 43% lower than interest rates in the 15 years that preceded that period (see first chart below); (b) the fact that average inflation since the middle of the 1990s has been 55% lower than inflation in the 15 years prior (see second chart); or (c) the fact that the rise of two-income households and the female participation rate in concert with a near halving in the nominal cost of debt might have triggered a once-off upward increase in household purchasing power, and hence housing valuations.
<img src="/images/stories/graph-1---kate1.gif">
<img src="/images/stories/graph-2---kate1.gif">
Now we have tried to replicate The Economist’s analysis using the longest publicly available time-series of median houses prices and median rents in Australia, which one can purchase from the Real Estate Institute of Australia. This covers the period June 1982 through to December 2010.
If we adopt The Economist’s method, we conclude that the current ratio of median Australian house prices to median rents is about 38.7% above its 28-year average. We do not know how The Economist gets its 56% estimate, but ours is in the same general ballpark.
Interestingly, we can get a 56% number if we look at inflation over this exact same period. Australia’s current inflation rate of 2.7% would have to rise by 56% to agree with its long-term average of 4.2% since June 1982. But, of course, nobody in their right mind would claim that this makes any sense. It is just that The Economist uses this logic when it analyses housing.
One can undertake a similar exercise with interest rates. The headline mortgage rate today is 7.8%. The average headline rate since June 1982 is 9.9%. Does this then mean that Australian mortgage rates are currently way too low? Applying The Economist’s method, Aussie home loan rates should rise by 27% in order to correspond with this historical benchmark.
As we mentioned earlier, imposing that logic on the Australian government bond market would imply that it is in the throes of an enormous bubble since yields are more than a third lower than their 30-year average.
To really understand what is going on here one needs to examine the time path of three economic variables: inflation; interest rates; and rental yields.
As you can see from the chart above, Australian inflation has steadily declined from its high and volatile double digit levels in the 1980s to sit within the RBA's 2 to 3% per annum target band during most of the past two decades. This has allowed the central bank to in turn reduce interest rates.
In the RBA’s view, the long-term reduction in inflation has mainly been a function of the early 1990s recession and its adoption of what is known as an ‘inflation target’. The RBA’s 2 to 3% target was first taken up in about 1993, and more formally enshrined in an agreement between the RBA and the Treasurer in 1996.
Between 1982 and 1995, mortgage rates in Australia averaged 12.8%. Since the start of 1996, they have averaged 7.3% (or 43% less). The RBA considers today’s mortgage rate of 7.8% to be slightly “above” its historical average because the RBA believes that the history that is relevant to today starts with the application of the inflation targeting approach to monetary policy in the early 1990s. Yet we don’t hear The Economist claiming that Australian mortgage rates are too low. (In fact, Australian mortgage rates are today amongst the highest in the developed world.)
The RBA has regularly argued that the structural decline in inflation, and the resultant downward shift in nominal interest rates, in turn drove a once-off upward shift in household’s borrowing (and purchasing) power. This has been reflected in the once-off jump in household debt levels, which basically occurred between 1996 and 2003. This marked rise in household borrowing power also boosted their purchasing power and hence the value of readily leveraged assets, such as houses.
In the following chart, we track the change in Australian mortgage rates and rental yields since 1982. The message is clear: the secular decline in nominal interest rates has propagated a corresponding fall in yields.
<img src="/images/stories/graph-3-kate1.gif">
Our final chart tells the same story by comparing Australia’s dwelling price-to-disposable household income ratio (bottom line) with Australia’s rent-to-dwelling price ratio (top line) over the last two decades. Observe how these ratios look like mirror images of each other. The common driver has been inflation and interest rates.
The RBA believes that as interest rates started to stabilise at their new, much lower levels in the late 1990s, and households got comfortable with the idea that both rates and inflation were unlikely to jump back to the double digit levels of the 1980s, there was a consequential upward increase in the valuation 'level' of housing assets. This had been fully priced by the early 2000s, which is why the two ratios track sideways thereafter.
To be clear, the RBA's ability to get inflation under control (and thus cut the long-term level of nominal interest rates) caused increases in the household debt-to-income, household debt-to-GDP, house price-to-income, and house price-to-rent ratios. In the jargon, these were 'level effects' rather than 'growth effects'. This means that the very rapid double digit credit growth of the 1990s and early 2000s will not be repeated anytime soon.
<img src="/images/stories/graph-4-kate1.gif">
Unless you believe that we are going to get double digit inflation and 17% mortgage rates, which most observers think are near impossibilities, the housing market benchmarks of the 1980s are irrelevant to home owners in the second decade of the 2000s. The same principle applies to The Economist’s analysis.
It would, of course, be wonderful if our ever-changing, multi-dimensional world could be judged by crude long-term ratios that blissfully ignore all sorts of key facts. Unfortunately, that's just a recipe for confusing further an issue that already has many confused.
Looking ahead, it is highly likely that Australian house prices will track household earnings in what PIMCO's Bill Gross has aptly described as the 'New Normal'.
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Australian house prices to track household earnings

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The Aussie housing market remains a tale of two superficially conflicting dynamics. On the one hand, prices are continuing to slip, albeit at a relatively benign rate. On the other hand, very low rental vacancy rates are fuelling impressive growth in rental returns. Total returns are, therefore, likely to be in positive territory, which compares well with other asset classes, such as shares.
This morning we get the latest RP Data-Rismark house price index results, which are the benchmark that economists and the RBA watch most closely.
Drawing on more than 110,000 home sales nationally in 2011, the RP Data-Rismark Home Value Index for Australia’s capital cities declined by 0.3% (seasonally adjusted) in the month of May (or by -0.5% in raw terms). The flash April estimate was revised down slightly from -0.3% to -0.4%.
Capital city home values have now fallen for the last five consecutive months, with by far the worst seasonally adjusted result coming in the month of January (-1.2%), which accounts for 45% of the 2011 decline.
The softening in Australian home values is delivering a valuation dividend, with Australia’s dwelling price-to-disposable income ratio falling to 4.2 times (see chart), which is its lowest level since June 2003, according to Rismark’s analysis.
 
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RP Data-Rismark’s Index shows that gross Australian yields have now touched the 5% threshold. The best rental yields can be found in <city>Darwin</city> (5.7%), <city>Canberra</city> (5.4%), <city>Brisbane</city> (5.2%) and <city><place>Sydney</place></city> (5.2%). The worst yields are in <city>Melbourne</city> (4.2%), <city>Adelaide</city> (4.6%) and <city><place>Perth</place></city> (4.9%).
 
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Over the three months to May 2011 dwelling values in Australia’s capital cities have retraced by 1.2% on a seasonally adjusted basis. In raw terms, dwelling values have fallen by 1.3%. The quarterly rate of decline has, however, moderated since the end of March when home values were off by 2.0%, care of a flood-affected January.
Over the 12 months to end May, Australian capital city dwelling values are now down 2.3% (seasonally adjusted). If we just look at the first five months of 2011, Australian home values have stepped back by 2.7% (seasonally adjusted). However, in raw terms, actual dwelling prices are only off 1.2% in 2011. The difference between these latter two estimates is a mostly a function of the fact that the first few months of the year are normally very strong, but this year we got hit by the floods. Accordingly, the seasonally adjusted numbers look especially bad.
Across the capital cities performance has been varied, and have run against the grain of what one might expect if focusing purely on Australia’s nascent capital expenditure boom. <city><place>Sydney</place></city> is the only market to have recorded a modest capital gain over the last year (up 1.0%). Homes in <city><place>Canberra</place></city> have also held ground (-0.1% over the year). All other capitals have slipped into the red, with some down by significant margins.
 
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The two weakest conurbations have been Perth, where dwelling values are down 7.5% year-on-year, and Brisbane, where capital growth is -5.9% over the year.
 After extraordinary capital gains in recent years, Darwin (-3.2%) and Melbourne (-2.9%) have also both experienced small corrections. Interestingly, in the last three months the laggards have again been Perth (-4.2%), Melbourne (-1.8%), and Brisbane (-1.4%).
 
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RP Data-Rismark’s Rest of State Index captures the 40% of all homes not located in the capital cities. The Rest of State areas have had smaller peak-to-trough swings in value since 2007. Over the three months to end May, Rest of State house values were down 0.9%. Year-on-year, the Rest of State markets capital growth was -1.4%.
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The national median dwelling price in capital cities is $470,000, based on sales over the three months to May. Sydney is the most expensive market, with a median dwelling price of $522,000, followed by Melbourne ($500,000). The cheapest cities remain Hobart ($315,000) and Adelaide ($382,500). In the Rest of State markets, the national median dwelling price is a far lower $325,000. Across all Australian regions, the median dwelling price is currently a very reasonable $420,000.
 
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The trend of premium markets taking the brunt of the correction has continued, with the top 20% of capital city suburbs ranked by price recording a fall of 3.9% over the 12 months to end May compared with a fall of 0.9% across the cheapest 20% of suburbs and a fall of 2.3% within the broad “middle” 60% of the market.
Demand for luxury homes has likely been sapped by a combination of Australia’s abysmal share market performance and a surging currency. The former has dampened the ability of financial services professionals to bid for high-priced homes, notwithstanding Jonathan Chancellor’s revelation yesterday that an ANZ banker bought an $8.4 million holiday <a href="https://www.propertyobserver.com.au/residential/a-rising-tide-lifts-all-luxury-yachts/2011062950650">home</a>.
The Aussie dollar’s ascendancy has made local housing much more expensive for expats located in Europe, North America and Asian countries (with US dollar currency pegs) to buy.
Financial markets are currently pricing in a decent chance of an interest rate cut over the next six to nine months. If the RBA does indeed reduce rates, this would provide substantial support to the market. However, our central case remains that rates are heading up, not down, and thus we are not looking for any capital gains in 2011 with the risk to the downside if rates do rise. That said, total returns will be boosted by very solid growth in rents.
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Note: Some of the information above derives from today’s RP Data-Rismark media release, which is available on request.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice. You can follow Christopher on twitter at <a href="https://twitter.com/#!/cjoye" title="Follow Christopher Joye" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">@cjoye</a> or read his <a href="https://christopherjoye.blogspot.com" title="Christopher Joye's blog" target="_blank" style="outline-style: none; outline-width: initial; outline-color: initial; text-decoration: underline; color: #6888b1;">blog</a>.
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Rents robust, but house prices slide slightly

Roseville is poised for a wave of new apartment development following the NSW Government's rezoning of land around Roseville Station under its Transport Oriented Development program.

The new planning controls have unlocked significant development potential within walking distance of the station, with a number of sites expected to be amalgamated and redeveloped in the coming years as developers seek to take advantage of the increased density allowances.

One of the more restrained developments in the precinct, and set among the first to be delivered having commenced well before the recent changes, is Hyecorp's Juliet. The boutique apartment project is already well under construction and remains on track to welcome residents by the end of the year, offering a markedly different proposition to many of the larger-scale developments now likely to emerge across the suburb.

[smartcode_project:default project_id=7395 project_image_fid=278194]

<a href="https://www.apartments.com.au/new-apartments/juliet-roseville-64-pacific-highway-roseville-nsw-2069">Juliet</a> will comprise just&nbsp;34 one-, two-, and three-bedroom apartments opposite Roseville Station. For Hyecorp, which has delivered projects across Sydney's Lower North Shore for more than three decades, Roseville presented a rare opportunity to address a growing gap in the market.

"<a href="https://www.apartments.com.au/developments/roseville-nsw-2069">Roseville</a> has long been one of the North Shore's most tightly held and desirable suburbs, offering a unique combination of village charm, established greenery, excellent transport connections, and proximity to some of Sydney's best schools and lifestyle amenities," Hyecorp said.

"We recognised a growing demand from local homeowners seeking to downsize without leaving the community they have built their lives around. The location presented a rare opportunity to create homes that cater specifically to that buyer profile."

[smartcode_project:default project_id=7395 project_image_fid=278196]

The six-level development has been designed by <a href="https://www.apartments.com.au/architects/pbd-architects">PBD Architects</a> as a collection of residences that feel more like homes than apartments. The brief centred generous floorplans, abundant natural light, quality finishes, and strong connections to outdoor space.

PBD Architects drew inspiration from Roseville's established garden suburb character, creating a building that sits comfortably within its surroundings rather than dominating them. The architecture incorporates natural materials, soft forms, layered landscaping, expansive balconies, and generous setbacks to strengthen the connection between residents and the suburb's leafy environment.

"The focus was on designing spacious, house-like residences for discerning owner-occupiers and downsizers who wanted to remain on the North Shore without compromising on comfort, privacy, or design," PBD said.&nbsp;

"Every apartment was to feel considered, timeless, and highly functional."

[smartcode_project:default project_id=7395 project_image_fid=278195]

Inside, residences feature engineered timber flooring, stone kitchen benchtops and splashbacks, integrated Fisher &amp; Paykel appliances, ducted air conditioning, and large outdoor entertaining areas designed to take advantage of district and treetop views.

Residents will also have access to a rooftop barbecue and lounge area, alongside practical amenities including parcel lockers, EV charging capability, bicycle storage, a dog wash bay, and a basement car wash facility.

The majority of purchasers so far have been local owner-occupiers from Roseville, Lindfield, Chatswood, Killara, and the broader Upper North Shore, many of whom are transitioning from larger family homes.

"Buyers are looking for spacious, house-like apartments that allow them to downsize without feeling like they are sacrificing comfort or functionality," Hyecorp noted.

"They value large kitchens, generous living areas, ample storage, quality finishes, secure parking, lift access, and low-maintenance living."

[smartcode_project:default project_id=7395 project_image_fid=278204]

Juliet sits directly opposite Roseville Train Station and within walking distance of Roseville Village, while Chatswood's retail and dining precinct is only minutes away. The development is also surrounded by some of Sydney's most established schools, including Roseville College, Ravenswood, Pymble Ladies' College, and Knox Grammar, as well as nearby parklands and golf courses.

Juliet is currently more than 75 per cent sold ahead of its anticipated completion in late 2026.

[smartcode_project_cta:default project_id=7395]

Joel Robinson

Juliet to sit quietly amid Roseville apartment boom

Sherpa Property Group has unveiled the third instalment of its Flourish series, securing full approval for the two-tower, $500 million Flourish Soleira development in Palm Beach.

<a href="https://www.apartments.com.au/new-apartments/flourish-soleira-1150-1154-gold-coast-highway-palm-beach-qld-4221">Flourish Soleira</a> will rise from a prominent site in the commercial heart of Palm Beach, the long-time home of Cash Converters and a range of local retailers.

The project will introduce a new retail and dining precinct at ground level, beneath 286 apartments.

[smartcode_project:default project_id=150017 project_image_fid=370959]

“We’re very committed to not only providing affordable residential offerings that are much needed in Palm Beach, but also delivering a vibrant new commercial heart that complements the extraordinary growth of the southern Gold Coast,” Sherpa Property Group founder Christie Leet said.

The development will sit under Sherpa's Flourish brand, which is aimed at providing a pathway into the beachside suburb for locals, first-home buyers and downsizers. In a move designed to assist first-home buyers entering the market, Sherpa has reserved all one and two-bedroom, one-bathroom apartments exclusively for eligible first-home buyers.

[smartcode_project:default project_id=150017 project_image_fid=370964]

“Our vision through Flourish is to create a vibrant retail and lifestyle focal point within the Palm Beach centre zone, delivering thriving communities underpinned by lifestyle-rich locations,” Leet said.

“So far, Flourish has been an incredible success, and we hope to carry this momentum as we progress the next two Flourish projects in Palm Beach.”

[smartcode_project:default project_id=150017 project_image_fid=371430]

Located across 1150-1164 Gold Coast Highway and 3 Sixth Avenue, the development will comprise two towers. The northern tower will deliver 154 apartments, while the southern tower will add a further 132 residences, helping address ongoing demand for new apartments in the tightly held coastal suburb.

Flourish Soleira will also feature the most extensive rooftop amenity offering ever delivered in Palm Beach.

The two towers will be connected by a skybridge, with residents gaining access to a rooftop recreation deck featuring a full-width swimming pool, hot and cold plunge pools, wellness spaces, a gymnasium, private dining facilities, massage treatment rooms, barbecue areas, a basketball court, golf simulator, indoor and outdoor dining spaces, sun lounges and extensive landscaping.

LPS Group is expected to start construction later this year.

Sherpa is already well advanced on construction of its debut Flourish project, Flourish Amargo, located just around the corner from Soleira. Meanwhile, Flourish Oasis, positioned opposite Amargo, recently commenced construction and has nearly sold out its collection of 47 apartments.

[smartcode_project_cta:default project_id=150017]

Sherpa unveils $500m mixed-use Palm Beach precinct, Flourish Soleira

Are mortgage holders set to get a reprieve from the RBA in 2026?

Big Four bank NAB believes so. They are now expecting the next move from the RBA to be a cut, rather than a hike, which they had pencilled in for August. They are unsure of the timing of the cut however, they note in their latest&nbsp;NAB Economics RBA Watch.

NAB Chief Economist, Dr Sally Auld, said recent data suggests the economy has lost momentum and the outlook for rates has shifted, noting that the broader economic backdrop has changed since earlier in the year.

“The next move in the cash rate is likely to be down, but the timing is uncertain," Dr Auld said.

"In February, growth was above trend, the economy was operating above capacity and there was uncertainty over the restrictiveness of rates. None of these conditions exist today,” she outlined.

Dr Auld said recent data pointed to softer momentum across the economy while acknowledging that at the same time, uncertainty remains a key feature of the outlook.

“Both Q1 GDP data and the NAB business survey suggest momentum in the economy has slowed, meaning that growth has likely peaked for the cycle. That said, we are cognisant there is still considerable uncertainty around the outlook, both with respect to activity and inflation.”

Dr Auld said inflation risks and labour market outcomes would be important to watch.

“On the prices side, we are still forecasting above target core inflation through to mid-2027. Margins will compress and weaker labour market outcomes are a risk.”

She said tighter financial conditions are expected to weigh on housing and activity.

“Tighter financial conditions will be reflected in a slowing in house price growth and housing credit growth. In summary, we have greater conviction that the next move in rates is down, but less conviction on the timing.”

Mortgage relief? NAB forecasts RBA rate cut, not hike, after softer economic conditions

A local downsizer has splashed $6.5 million on a penthouse in Perifa's Alex &amp; Willow development in Crows Nest. 
&nbsp; 
The purchaser sold their long-held family home in the area before embarking on a six-month search for the right apartment. After inspecting a range of options across the Lower North Shore, the buyer returned to <a href="https://www.apartments.com.au/new-apartments/alex-willow-crows-nest-82-90-alexander-street-crows-nest-nsw-2065">Alex &amp; Willow</a>. 
&nbsp; 
The buyer profile reflects the project’s broader purchaser mix. <a>Alex &amp; Willow</a> has attracted predominantly local downsizers looking to transition from larger homes without compromising on space or quality, alongside a smaller cohort of upsizers and investors drawn to the project’s location and design credentials. 
&nbsp; 
The milestone sale comes as the project, developed by&nbsp;<a href="https://www.apartments.com.au/developers/perifa">Perifa</a>&nbsp;and delivered by <a href="https://www.apartments.com.au/builders/versatile-made-construction">Versatile Construction</a>, both part of Versatile Group, reaches 60 per cent sold.

[smartcode_project:default project_id=6680 project_image_fid=371325] 
&nbsp; 
Eddie Mansour, Managing Partner of <a href="https://www.apartments.com.au/project-marketer/ray-white-projects">Ray White Projects</a>, said the result demonstrates not only a headline price but also depth of demand. 
&nbsp; 
“This is an exceptional outcome and a clear reflection of sustained buyer demand for premium, well-located downsizer product,” Mansour said.

“We’re seeing a consistent pattern of local homeowners selling family residences and reinvesting into high-quality apartments that allow them to remain within their community. Alex &amp; Willow has resonated strongly with this group because it offers genuine scale, thoughtful design and immediate proximity to the village.” 
&nbsp; 
The sale reflects a broader and consistent trend of local downsizers actively seeking high-quality, low-maintenance residences close to established village centres. Agents report that demand for this product type has remained resilient, particularly where developments offer a rare combination of scale, design quality and walkable amenity. 
&nbsp;&nbsp; 
Fabrizio Perilli, Managing Director of Perifa and Versatile Group, said the sale marks a defining moment for the project. 
&nbsp; 
“The penthouse sale is a strong endorsement of the quality we have delivered, alongside our partners, and the clear demand from local downsizers for premium, boutique residences in this location,” Perilli said.&nbsp; 
&nbsp; 
“Most importantly, we’re proud to see the Alex &amp; Willow community beginning to take shape. As we move closer to completion, we’re looking forward to welcoming residents and seeing the project come to life.”&nbsp;

[smartcode_project:default project_id=6680 project_image_fid=338516] 
&nbsp; 
Designed by <a href="https://www.apartments.com.au/architects/nettletontribe">Nettleton Tribe</a> with interiors by <a href="https://www.apartments.com.au/interior-designers/richards-stanisich">Richards Stanisich</a>, Alex &amp; Willow is a boutique collection of generously sized two- and three-bedroom residences in the heart of Crows Nest village.&nbsp;

Completion is slated for early 2027.

[smartcode_project_cta:default project_id=6680]

Alex & Willow, Crows Nest penthouse sells off the plan for $6.5 million

Fresh from launching the first stage of its Wollongong precinct, <a href="https://www.apartments.com.au/new-apartments/keira-place-wollongong-120-122-smith-street-wollongong-nsw-2500">Keira Place</a>, builder-developer Urban Property Group has unveiled plans for the next phase of the masterplanned community.

Now on public exhibition through the NSW Government's Housing Delivery Authority pathway is a State Significant Development Application for a further 657 homes on the prominent gateway site opposite Beaton Park.

The proposal comprises three buildings, including two build-to-sell towers rising 25 and 30 storeys, delivering 391 apartments, alongside a 12-storey co-living building with 266 residences, making it one of the largest co-living proposals currently planned in regional New South Wales.

Of the apartments proposed in the build-to-sell towers, the majority, 310, are two-bedroom dwellings. The balance comprises 44 one-bedroom apartments and 37 three-bedroom residences. Apartment sizes range from around 50 sqm for one-bedroom homes to approximately 90 sqm for three-bedroom apartments.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="19347059-1612-41a0-9c74-b86a657237f8" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%2010.02.18%E2%80%AFAM.png?VersionId=sWXnaCcA.cIC6N8YT1dg5pJ2e1V3Z6z7" />

The submission says the proposal has evolved significantly from its original Housing Delivery Authority application following extensive consultation with the State Design Review Panel and Wollongong City Council.

The final scheme has been designed to align with the emerging vision for the Flinders Street Precinct, an area identified by Council as a future high-density mixed-use neighbourhood capable of accommodating substantial housing growth close to transport, employment and community infrastructure.

According to the design report prepared by COX Architecture, the development aims to "deliver a built outcome consistent with the future character of the Wollongong CBD while responding to the site's unique constraints and opportunities."

"Our vision for the next phase of the site evolution in Wollongong is grounded in three design pillars that guide the design response: place, natural environment and celebration," COX said.

"Inspired by its surroundings and grounded in the stories of place on Wodi Wodi Country, the design proposal acknowledges the established character of its setting while creating a unique and timeless identity that sits harmoniously within it.

"The design proposal responds to its specific site conditions, acknowledging the vegetation, climate, wind conditions and solar access of the site."

The architecture responds directly to the site's position between Wollongong's urban core and its natural landscape setting.

COX identified views towards Mount Keira and the Illawarra Escarpment as defining features of the site, while the upper levels of the towers will also capture expansive views across the city and out to the Pacific Ocean.

The design team has positioned the tallest buildings closer to the rail corridor, where overshadowing impacts can be better managed while establishing a landmark built form on the northern approach into the city.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="79580d5b-500c-4ebf-9629-797146a4a694" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%209.51.59%E2%80%AFAM.png?VersionId=WbTB1EKSG.KDfsfz0F3wp1QVa2oCMGR5" />

Urban Property Group secured the 11,000 sqm Smith Street site in 2022 and has since progressed plans for the broader Keira Place precinct.

Construction recently commenced on the first stage of Keira Place, which will deliver 150 apartments across two residential buildings, including 27 affordable housing apartments and 18 specialist disability accommodation dwellings, alongside activated ground-floor retail and commercial space.

Urban Co-CEO Patrick Elias said the commencement of construction marked a significant milestone for Wollongong and reflected the developer's long-term commitment to regional cities.

"Today's groundbreaking is about turning approvals into homes and moving quickly to deliver much-needed housing in Wollongong's city centre," Elias said.

"Keira Place will provide a diverse mix of homes close to jobs, transport and services, while setting a high benchmark for quality, durability and consumer protection."

Read more:&nbsp;<a href="https://www.apartments.com.au/news/nsw/groundbreaking-marks-start-of-construction-at-keira-place-in-wollongong-cbd">Groundbreaking marks start of construction at Keira Place in Wollongong CBD</a>

&nbsp;

&nbsp;

&nbsp;

Christopher Joye

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