Commentators often refer to the price of property relative to household incomes. For example, it is estimated that property in Melbourne and Sydney now costs more than 10 times the median household income.
But is this really a meaningful measure because if it is, property cannot continue to grow at a faster rate than incomes (a point often made).
If prices continue to rise faster than income, how will property be affordable?
At the beginning of this year, I wrote about the factors that have driven property prices higher over the past four decades. I concluded that borrowing capacity together with higher incomes have increased 3.5x since 1980, whereas property prices have increased 4.5x. That is, prices have grown faster than incomes and borrowing capacity growth combined. Clearly, something else has contributed to property growth for it to be affordable for some buyers.
It is worth stating at this point that borrowing capacity is likely to be flat in the future. That is, borrowing capacity will not increase anywhere near it has over the past four decades. That will probably have an adverse effect on property price growth in many locations.
Do locations with higher incomes perform better?
Data analyst, Jeremy Sheppard has done some work on this question and found there’s a weak statistical relationship between income and capital growth rates. The thesis is that people that earn more can afford to pay more for property. Therefore, we should invest in locations that have above average household incomes. A big problem with Jeremy’s analysis is that the data may not be accurate and/or out of date (which Jeremy acknowledges), so this thesis is impossible to test.
I think the reality is that incomes do have an impact, but so do many other factors, so it is impossible to isolate the impact of income alone. Also, do you really need census data to identify the locations that wealthy people want to live in? I think those locations are pretty obvious.
What other factors may be pushing property prices higher?
Approximately, one-third of Australians own their home without a mortgage, one-third own their home with a mortgage and one-third rent. That means that approximately two-thirds of Australians’ (owner-occupier) property decisions are driven by lifestyle goals. Of course, people will draw on financial resources other than income to achieve their lifestyle goals.
Property prices can be driven higher by two factors. Firstly, an appreciation of the underlying land value (which is a function of supply and demand). Secondly, improvements on the land e.g., renovations, rebuild, etc. It is important to remember this when studying how median prices have changed over time. Houses are more expensive because, to some extent, the dwellings have been improved.
I discuss the financial resources that some people use to upgrade their homes and/or invest in property.
Investment returns
Share markets have returned circa 10% p.a. over the past 40 years. Super funds have delivered similar returns (circa 9% p.a.). Some of this ‘wealth effect’ will eventually make its way into the property market as investors use some of this wealth to upgrade, improve their home, and/or invest.
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