Chapter 05 – What to say to clients? Is there a bubble about to burst?

Historically, Dover’s advice has been for clients to own as much home as the bank will let them, as soon as they can, and then pay off the loan as fast as they can.

Clients who followed this advice have done well so far.

But, as of November 2015, we are having some second thoughts. The rapid rise in home prices raises questions about the sustainability of those prices. By definition, things cannot remain unaffordable. Some – including ASIC – suggest there is a bubble and it’s going to burst. Interest rate rises are likely to be the trigger, particularly if unemployment grows and mortgage stress sets in.

Rose Powell, a journalist with the Sydney Morning Herald, summarized the concerns in her article on 1 July 2015 captioned House prices in a bubble- but what will make them pop?

Others who see a bursting bubble include the RBA, well known property advocates and academic economists. The field is surveyed and summarized by Larissa Ham in an article published in the New Daily on 16 August 2015 which can be read here: How to deal with the threat of a housing bubble.

The OECD is perhaps the most revered body warning of a possible price collapse: The OECD has warned Australia’s housing market could collapse.

We confess to second thoughts, and these thoughts are expressed here, in a YouTube presentation developed by our Responsible Manager, Terry McMaster, for Australian Doctor magazine: Is There a Grand Design

The next ten years

We are not sure what will happen to home prices over the next five years. Home prices could easily fall between now and 2020. There is every prospect that share prices will do much better than housing prices over the next five years and perhaps even the next ten years.

We suspect that the historical rates of return achieved by residential property will probably not be able to be repeated in the period 2015 to 2025. They may be, but the odds are against it. This means clients should consider other strategies as alternatives to traditional home ownership, especially in terms of wealth creation.

The good news is that there are various identified “other strategies” including:

  1. making super contributions up to the maximum concessional limits every year ($30,000 up to age 50 and $35,000 over age 50);
  2. making extra non-concessional super contributions every year (maximum $180,000);
  3. buying a property to rent out to a tenant and living cheaply elsewhere, perhaps with friends or family (perhaps after living in the property briefly to set it up as your CGT free principal place of residence, under the 6 year rule);
  4. taking a stepping stone approach. That is, buying something smaller and lower cost now, paying it off as fast as possible using an interest offset account, and then drawing the equity out to buy a new bigger and better home and keeping the initial property as a (very) negatively geared investment;
  5. arranging a loan facility and buying say $500,000 of shares rather than $500,000 of home, and putting the same effort into repaying this loan as would be put into repaying a home loan, reinvesting all the (after tax) net dividends (and taking care to manage timing risk); or
  6. a combination of the above.

For the record, we doubt a bubble will burst in the sense of a sudden significant drop/collapse in property prices. It will be more moderate than that; minor drops followed by a prolonged period of nothing much happening , and real (ie inflation adjusted) prices falling a bit each year until affordability resumes. That is how affordability works.

That is the ten year time horizon. Our thoughts and expectations change as we cast our minds further into the future.

The twenty-year forecast is much better than the ten year forecast.

Well-located homes in good suburbs will cost a lot more in 2035 than they do in 2015. For clients with this sort of investment timeframe, increasing their residential property portfolios and buying a home, or up-grading to a better home, is one way of accessing this longer-term growth.

The disadvantages of home ownership set out above are all valid and relevant. But the advantages are much more likely to outweigh the disadvantages once you move out beyond a ten year time frame.

In particular, the strong population growth expected over the next few decades dominates our thinking. This growth means home values will rise significantly in the popular suburbs, particularly Melbourne, Brisbane and Sydney.

The Dover Group