Australian Residential Property Market – What Lies Ahead for Investors?

By the end of this article, you will discover I have made a prediction which is the exact opposite of what most people believe. You’ll also discover why I am happy to put my prediction in writing so that you can verify my claim in the future. Let’s check out what determines property price movements. From my observations:

Short-term property price movements (within 1-3 years) are usually determined by human emotion (also known as human insanity).

Medium to long-term price movements (3-10 years or more) are more likely to be beyond human insanity, hence they are more predictable and controllable.
Can we really predict human insanity? Some of the most intelligent people have been put to the test and still failed miserably. Economists have the unfortunate job of predicting human insanity, hence they earn the reputation of “having successfully predicted 9 out of the last 5 recessions”. What is the difference between human intelligence and human insanity? There is a limit to human intelligence. So what does determine property price movements over the medium to long-term? In my opinion, amongst many other things, property prices are predominantly determined by two factors:

The money supply of a nation

The wealth of a nation.

The money supply of a nation.

Let me explain. The money supply of a nation. Let’s take an extreme example to create a simple demonstration.

Let’s say on this little island country called Australia, a few thousand years ago, there were only 10 houses (probably called sheds back then), and there was no money being used at that time.

The island chief decides to issue some money called Australian Dollars for circulation. For the sake of simplicity, he decides that the money issued can only be used to buy properties and nothing else.

The island initially issues only $10, so each house is therefore priced at $1 each. (Amount of money available divided by number of houses.)

A year later, the island decides to increase the money supply to a total of $100 still with the same usage restrictions (can only be used to buy houses). Without any improvement to the properties, each house is now priced at $10 each. ($100 divided by 10 houses, equals $10 each.)
Now you can see how property prices can go up just by increasing the money supply of a nation. We don’t even need to discuss the supply and demand situation as these only influence short-term price adjustments.If we look at the median property price in Melbourne and Sydney:

In the 1920s, property was priced at around 30;

In the 1960s, property was priced at around AUD$10,00;

In the 2010s, property was priced at around AUD$600,000.
You know that the median priced properties are not better than those from 90 years ago when you compare their land size, location and quality of the building. But the price tag just keeps going up and up with no end in sight. This is the power of money supply increase. If you look at a graph of Australian Money Supply vs Property Prices you will see how Australia has been increasing its Money Supply at around 9% a year compounding non-stop, and how it “coincidentally” aligns with the property prices increase over the same period.)

The wealth of a nation.

Have you ever noticed that regardless of which particular industry caused a nation to prosper at any given time, the wealth of that nation always ends up sitting in its residential properties? It has been estimated that around 70% of an industrial nation’s wealth exists within its residential properties. You can test this yourself, by looking around at 10 of your friends to see where their wealth is. You will quickly discover that the majority of their wealth is in their home, regardless of what line of work they do. In other words, every 20-30 years you will see new industries come and go, in cycles of boom and bust, but the wealth left behind those industries tends to stay in residential properties. Let’s take a look at some of the nations over the past 100 years. Each has had some incredible industries at different times that have tremendously increased the wealth of those nations. For example:

The automobile industry, steel industry and IT industry each brought America enormous wealth during their individual eras. But where has most of the wealth ended up? In their residential properties.

The manufacturing industry of China, the oil industries of Dubai and Saudi Arabia and the electronics industry of Japan, all these industries have come and gone, but the wealth they created remains behind in their residential properties.
In 2006, I had the chance to work with a multi-billion dollar international hedge fund to finance a AUD$1.5billion residential property development project. The managing director of this fund happened to be the head of the Asian Pacific division of one of world’s largest investment banks. His rationale for investing around AUD$200Million into this residential development project is too simple to believe, at least for people who don’t handle multi-billion dollars every day. On the trip to make his final decision to invest into the project, he said to me that it is always safe to invest, not speculate, in residential properties in a country which is becoming wealthier, regardless of which industry was predominantly responsible for creating that wealth. The reason is that the majority of the extra wealth is always going to end up sitting in residential properties anyway, with no exceptions. It’s just a matter of time. So the question to ask yourself is, will Australia become wealthier or poorer over the next 10-20 years? With the decline of the US and European economies, we are now firmly in the “Asian Century” as our Prime Minister recently put it. Australia is unusually well positioned to benefit from the growth of Asia, which represents 50% of the world’s population. Let’s look at what Australia has in terms of resources:

The world’s largest resources of brown coal, lead, nickel, uranium, zinc and silver;

The world’s 2nd largest resources of iron ore, bauxite, copper and gold;

The world’s 3rd largest resource of industrial diamonds and lithium;

The world’s 4th largest resource of manganese ore;

The world’s 5th largest resource of black coal.
(Source: Geoscience Australia)

Australia is by far the world’s richest country in natural resources per person with an unstoppable demand coming from 50% of the world’s population over the next 20 years alone. According to investment firm Credit Suisse the median wealth of Australians is the highest in the world already, its Global Wealth Report shows the typical Australian adult is worth nearly four times the amount of an American. In fact the research reveals that half of all adults in Australia have a net worth above $216,000. Unfortunately most people living in Australia do not see that. Like the saying that “fish discover water last” we can’t see what we are in because we are surrounded by it. Let me give everyone a different perspective so you can see the impact on Australian property prices. I came to Australia from China in 1988. At that time there were almost 1 billion farmers in China and it wasn’t doing very much business with Australia. Now it is 2011 and China has 102 cities with an urban population of 5 million people or more. While Australia has none (Sydney has only 4.5 million people). China has become heavily dependent on Australia’s resources. China’s massive urbanisation process, which is continuing to move an incredible 400 million people into cities, is creating the demand for an extraordinary amount of resources such as steel and coal just to house all these people. If you have difficulty visualising what all this means to Australia’s wealth, imagine moving Australia’s entire population of 20 million people into a nearby fairly undeveloped country, say Papua New Guinea. Just to enable all these people to live a decent lifestyle would require building millions of new properties and supplying energy to these 20 million newly arrived residents. Then imagine doing the whole process 20 times over within the next few decades. If you happened to own a business that had the mandate to rebuild the entire Australian nation from scratch 20 times over within a couple of decades, and your business has been selected as the largest supplier of resources needed for the task, how do you think this business would do financially? Some people worried about the Chinese economy slowing down could hurt Australia, but really if they slows down by 10% (i.e. a serious recession), instead of building Australia 20 times over, they are now only doing it 18 times, what difference does it make? Australia still couldn’t keep up with that demand anyway. The above Chinese scenario doesn’t include the demand coming from other heavily populated countries such as India, Indonesia and Japan. For example, India is currently in the process of building over 300 shopping centres the size of Australia’s largest shopping centre – Chadstone Shopping Centre, it so heavily relies on Australia’s resources too. Recently BHP Billiton has predicted Australia’s resources industry will need an extra 170,000 workers in the next five years alone, not to mention jobs needed to be created in other industries to keep these workers functioning. Australia is not called the Lucky Country for no reason.

Cutting through the noise.

Many Australian property investors have been distracted recently by the events in US and Europe. Amidst all this noise, many have forgotten the fact that Australia was one of the few developed countries that didn’t go into a recession during the global financial crisis, and still retains the highest credit rating for its government and major banks. Let’s look at some facts to compare Australia to the rest of the world. When you look at the US Government’s budget for this year you can understand why their credit rating was recently downgraded:

U.S. Tax revenue: $2,170,000,000,000

Federal Budget: $3,820,000,000,000

New debt: $ 1,650,000,000,000

National debt: $14,271,000,000,000

Recent budget cut: $ 38,500,000,000
(Source US government budget papers)To make their situation easier to understand, let’s remove 8 zeros and pretend it’s a household budget:

Annual family income: $21,700

Money the family spent: $38,200

New debt on the credit card: $16,500

Outstanding balance on the credit card: $142,710

Total budget cuts: $385
Now let’s compare that to the Australian economy:

Annual family income: $29,840

Money the family spent: $34,610

New debt on the credit card: $4,770

Outstanding balance on the credit card: $8,460

Total budget cuts: $2,200
(Source: )

Many people believe that the decline of US property prices over recent years was due to the global financial crisis. I see them more as symptoms rather than the cause, as residential property prices over the longer term tend to reflect the wealth of a nation. The underlying cause of the US property price decline is that they are becoming poorer as a nation due to their heavy indebtedness which was mainly caused by a long period of over-consumption, a lack of highly competitive industries in recent times, and a few very expensive wars. People ask me why Australia’s property prices didn’t drop like US after the global financial crisis, here is my view on this:

On the surface, it looks like our banking system is more prudent to avoid properties being over supplied, as Australian banks won’t lend you money to develop new properties until you have pre-sold most of them, whereas you can get finance to build 200 new homes in US without knowing who is going to buy them.

Below the surface, it is mainly because Australia is getting wealthier as a nation, and US (and many European countries) are getting poorer due to their heavy indebtedness; To make matter worse, US (and many European countries) are in denial of such situation and trying to use more debt to solve their debt problems. Do you think using more cocaine is the solution for a cocaine addict?
So it is important for property investors to see the new trend where Australia has now permanently departed from the general decline of wealth in the rest of the developed world, and the performance of property in other developed countries bears very little relevance to Australian property performance.

In Summary

I believe Australian residential properties are

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The Differences Between Commercial and Residential Property Investment

When you invest in residential property you are essentially dealing with people. When the rent is late, you have to deal with a person – the tenant. If you feel the property is not being looked after properly, you will have to deal with people who may have a different opinion from you.

With commercial property, you are essentially dealing with contracts. If the rent is not paid on time, then the contract (lease agreement) stipulates a series of remedies that the landlord can take. If the property is not kept up to a certain standard, then the contract may stipulate that you can send in a commercial cleaner and send the bill to the tenant.

Generally, governments around the world have countless rules governing the renting of property to residential tenants, which override anything that you may put in your rental agreement. For example, in the UK, if a tenant is behind in their rent, you cannot just evict them. There are all sort of protections in place so that the tenants will not be exploited. You have to allow them to fall behind in rent for at least 30 days before you can start eviction proceedings.

With commercial property, what is in the lease contract is generally what goes. Many commercial leases have a clause in them that stipulates that if the rent if late by more than a week, then penalty interest will be applied to the amount of rent outstanding. If the tenant still has not paid the rent a certain period of time thereafter, then you have the right not only to change the locks and take your premises back, but also to seize all the tenant’s fittings, furniture and equipment on the premises, and to sell them to recover the rent owing. Your rights as a commercial landlord are far stronger than those as a residential landlord.

With commercial property, the tenants usually derive their income at your premises. Therefore they have a vested interest in keeping your property in good condition. With residential tenants, there is not the same drive to maintain your property, let alone improve it. With my commercial property, I spent thousands of pounds changing the business from a men’s hairdressers (which it had been for the previous 30 years) – into a real estate business. In fact, for the first couple of years, we often had men coming to the property and looking inside expecting to have their haircut.

With a commercial lease, the tenants often paint their premises every couple of years so that it will be attractive to customers. In fact, in a commercial property, the tenant is responsible for whatever maintenance repairs occur. So if there is a plumbing problem in a commercial property, it is up to the tenant to bring in his own plumber and to be responsible for whatever bills are presented to him. In a residential property, the tenant is entitled to call the landlord or the management company – they are compelled by law to fix whatever repairs are necessary.

Another fundamental difference between residential and commercial property concerns the typical length of the lease. With residential properties it can be on a month-to-month basis, but is rarely longer than one year. Commercial properties, on the other hand, are generally leased for many years at a time. From the tenant’s perspective, it gives their company or business the security of the same premises to work out of. Banks like long-term leases as well: the longer and stronger the lease, the more willing they are to lend money on the property.

In some countries a tenant cannot rent the premises with a lease that is under 5 years. There is an upside to this and a downside to this. The upside is that his business is secure in that location for at least 5 years. He cannot be asked to move. The downside is that if times are bad, he might be able to pay his rent and he has no wiggle room to get out of that lease. So in the end he possibly could lose everything. He could lose whatever deposits he has put down, he could lose his furnishings, his equipment. He could theoretically lose the essence of his business.

So far, you can see there are a lot of advantages of commercial properties over residential ones.

To summarise the main categories of commercial property:

1. Retail: shops or any building where passing trade or the general public are invited
2. Office: commonly found with retail or alone, and often above the retail areas on the ground floor
3. Industrial: places where things are manufactured or services provided – but not necessarily where the general public are walking past.

Commercial property is much more specialised than residential and it may be more difficult to find a tenant in the area of specialisation catered to by your building.

Typically banks will lend you up to 80% of the value of the property on a residential investment. However, with commercial property usually the maximum is about 60%.

The biggest advantage of residential property over commercial comes when your property is empty. If you have a house where the tenants have just left, if you have bought it in a good location and the market is reasonably active, then you should be able to find tenants quite quickly. Generally even in a slow market, the only reason why a residential property sits empty for a long time is because of the rental price. If you drop your rent by 10% or more, you will usually get a tenant. However, this downturn economy has vastly affected both residential and commercial properties. Workers who have been made redundant find that they cannot pay the rent. Many commercial properties are suffering because their tenants have been forced out of business.

With residential property, if your tenant has been laid off or fired, it may take you months to be able to evict him let alone find another tenant. In a commercial property, you are entitled to keep his deposits, fittings, equipment and furnishings, but that still doesn’t give you an income for that property. And right now there are many commercial properties that are going bankrupt. So my best advice is that in this downturn economy, that while there may be numerous opportunities for investment, be aware that there are just as many situations where you could lose a great deal of money.

Let’s look at commercial property that has been empty for 3 months or 3 years, then the problem may not be because the rent is too high. Even if you were to slash it in half you still may not find a tenant.

The reason for this is simple. Just about any residential property on the market has all that is required for someone to live in it. However, when it comes to commercial property, the requirements vary hugely from tenant to tenant. For example, when a dog food cannery becomes vacant, it may not be simply a matter of reducing the rent to find a tenant. No matter how much you drop the rent, no photographer looking for a studio is likely to settle for the dog food cannery. No shoe shop that relies on passing foot trade will want the top floor in an office tower, no matter how good the view or how reasonable the rental.

To summarise the differences between residential and commercial property:

Tenants have little interest in maintaining or improving your property
Leases tend to be short
Tenants contact the landlord for minor problems
Governments tend to legislate to protect tenants rights
Banks lend up to 80% of the value
If the property is empty, it is usually easy to find a new tenant
You deal with people

Tenants have a strong vested interest in the upkeep of your property
Leases tend to be long
Tenants tend to fix minor problems
Governments tend to leave you alone
Banks will lend only 50-60%
The appraised value when tenanted may be 2 or 3 times the value when empty
If the property is empty, it may be difficult to find a new tenant
You deal with contracts, not people

If you were coming to me for property investment advice and you didn’t know which would be better for you: to buy a house or to buy a piece of commercial property. The first thing I would say to you is: research, research, research commercial property. Find out everything you possibly can about being a landlord, about tenancy agreements, about your areas of responsibility, the tenant’s areas of responsibility, and when you have spoken to a number of commercial property landlords, and gotten to understand the business really really well, then I would look for a group of investors who would go in on a building with you.

I would also look for a syndicate – you would be just a small part of that syndicate. Your financial obligation would be very small in comparison if you had just gone into it yourself or with one or two other people. A syndicate usually implies a large group of investors. The upside is that you don’t have to have much of a cash outlay if you invest with a syndicate. The downside is that you don’t make as much money if you invest with a syndicate. But your risks are greatly reduced, which is why people have a tendency to look for syndicates. When you have a syndicate investing in residential property, a lot has been written about landlords – that the la

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