February 24, 2016 by Dymphna 23 Comments

Are property prices ‘crazy’?

I keep hearing people say that house prices are ‘crazy’. But relative to what?

I remember quite some time ago, could be 15 years ago I guess, I was looking at a property in the Brisbane suburb of St Lucia.

St Lucia is right next door to the Uni, and this was a decent doer-upper with a lot of potential.

I didn’t get it in the end though. It went for much more than I could afford at the time. It went for the princely sum of $330,000.

People were shocked. The street couldn’t believe it. The suburb couldn’t believe it. $330K for that little dog box?!?

As far as everyone was concerned, $330K was ‘crazy’.

In the end I’m pretty sure whoever bought it has done pretty well out of their investment.

But it’s something I hear every time prices ratchet up a level. The new reality is always ‘crazy’.

And over the last 15 years prices kept stepping up into crazier and crazier levels. And each time people would say that this was it. It’s gone too far. It’s unsustainable. It’s disconnected from reality.

It’s crazy.

But crazy is a relative concept. If I were to stand on a beach flapping my arms about, you’d have good reason to think I was crazy. If I was a seagull however, suddenly that behaviour doesn’t seem so crazy.

So it’s relative. So the question then is, if you think prices are crazy, what’s your reference point?

For most people it’s the recent past. Back in the day in St. Lucia, $330K was a high-water mark. No one had seen anything like it. And so it seemed crazy.

With the benefit of hindsight though, with a broader view of history, $330K doesn’t seem crazy at all.

But prices, like most things in the economy, are trending upwards. The economy expands, incomes grow, prices of things increase. They system we’ve got actually needs this growth.
So when things are trending upwards over time, but you’re using recent history as your reference point, you’re going to be constantly surprised by how crazy prices are getting.

Or maybe your reference point is how you think the rest of the economy works. Maybe you think that the economy is in some natural harmony, guided by immutable laws, and property is just like some rogue cancer cell, completely out of step with the broader economy.

Well, here’s a news flash for ya. It’s all nuts.

I mean, the basic building block of the economy is money. Money is to the economy what the atom is to the physical universe. And where does money come from?

We just make it up.

95% of it doesn’t physically exist. America has just gone through a period where they printed trillions of dollars and threw it into the system just to see what would happen. The short-term price of money in Australia is set by the RBA, and that just depends on what kind of mood Glenn Stevens is in.

None of it is real.

Money is a social construct, like manners. And it changes over time.

But think about that for a sec. What if I told you that the atoms of the physical universe didn’t actually exist, and we’re just social constructs open to interpretation? (May not actually be far from the truth.)

But would you expect a system with a fiction at its core to produce sane and predictable outcomes?

I wouldn’t.

But this is the one advantage that real estate has that no other asset class has. It actually exists.

I’m not going to wake up tomorrow and find that the government has devalued my property by printing more properties, or that the property I’d invested in had gone broke and was now worthless.

That stuff doesn’t happen. And so while prices might seem crazy, real estate itself is like the only island of sanity in a crazy economic system.

Little wonder that it’s worth more and more each year.

And the more crazy the broader economy gets, the more valuable property will become.

People like sanity and security and they’re willing to pay a price for it.

So if you’re saying that property prices are crazy, I’d say, show me something in this economy that isn’t.

The other reference points you might use are rents and incomes. Rental returns have been falling, as rental growth fails to keep pace with prices growth.

But that’s happening with every asset. We’re in a low-interest world. Money is cheap, so assets don’t need to deliver what they used to.

And house prices have also been growing faster than incomes. True enough. But the difference between the two is the leverage factor, and that’s been growing as interest rates fall and credit is easier to come by, through mortgage brokers and bank competition etc.

And so again, it’s different from the past, but that doesn’t make it crazy to my mind.

Anyway, it feels to me like when I hear people say prices are ‘crazy’, I’m really hearing them say they wish prices would fall back to levels they’d be comfortable with. Crazy is just another word for uncomfortable.

I can understand that wish. But I wouldn’t be banking on it.

Do you think prices are crazy?