Australian property good investment? Part 4?rising rent good reason to ?invest??

May 3rd, 2007

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According to this story in the news media,

JUST over a year ago investors were fleeing the residential property market in droves, but a tightening rental market and healthier interest-rate outlook are luring them back.

In April, the percentage of new mortgages going to ?investors? rose, which might be a sign that ?investors? are returning to property ?investments.? Did these ?investors? make the right move with their wealth? At the very best, we believe such property ?investments? present no compelling value to us. At worst, we see such ?investments? as closer to speculation than genuine investing.

As you may recall in The Bubble Economy and Australian property good investment??Part 1: how money printing distort the property market, the previous property price bubble was artificially induced by funny money (i.e. ?printing? of money). With the entire economy awash with so much funny money, the government?s tax loophole encouraged that funny money to flow on to property. The effect was a price bubble driven by speculation and gambling. The resulting distortion to the property market led to the current rental and housing affordability crisis (see Australian property good investment? Part 2?Rental & affordability crisis).

The Reserve Bank of Australia (RBA) made the right decision of deflating the bubble back in 2003 by rising interest rates. The short-term pain of pricking a price bubble sooner is always better than letting it grow so big that its eventual bursting will cause much greater pain in the future. It was good for the economy that these ?investors? got hurt, learnt their lessons and left the property market.

But alas, the mob never learns. As we can see from history and today?s frothy stock market bubble in Shanghai, it seems that the masses always do extraordinarily stupid things before they get hurt very badly. Is April?s mortgage data a sign that the masses are coming back to shoot themselves on their foot again?

As we mentioned in Australian property good investment? Part 3?prospects of capital appreciation, traditional income growth is no longer the primary driver for the long term upward trend in property prices. In today?s context, the only way for property prices to continue rising is through the increase in debt. At today?s rate of interest, the quantity of money and credit is still rising in Australia. That means, the monetary policy in Australia is still loose (see What makes monetary policy ?loose? or ?tight??).

At this point in time, the RBA is still very concerned about price inflation. Though the last reading on the price index was very mild and below economists? expectation, one must not make the mistake of projecting this one-off figure into the indefinite future. As expected, a certain politician claimed that inflation is ?under control? and should trend down. Mark our words: though it may seem that price inflation is benign for now, at this current rate of money ?printing? (i.e. loose monetary policy), it will sooner or later rear its ugly head (see Have we escaped from the dangers of inflation?) somewhere else in the economy. To further press on our point, think about this: why are we seeing an outcry of rental and housing affordability crisis today? Such problems would not have occurred if not for the harmful effects of monetary inflation (see How to secretly rob the people with monetary inflation?)! Thus, we believe it is very likely that the RBA will raise interest rates further if it believes that the debt growth (that helps fuel property ?investment?) is getting out of hand. When that happens, it will be a repeat of 2003, when many property ?investors? got burned!

Now, to the main point of this article: is rising outlook on rent a good reason for ?investing? in property?

Recently, a financial commentator reckoned that the rental crisis means that property prices and rents will have to rise further. This is most probably the reasoning in the minds of many property ?investors.? We would like to highlight the flaw in this logic?it is the high property prices that are the cause of the rental and affordability crisis (which is the effect), not the other way round! See Australian property good investment? Part 2?Rental & affordability crisis.

There is another question to think about. Rising property prices are fuelled by rising debt. What fuels rising rents? The answer is income! Renters do not borrow money to pay for rents?they pay rents out of their own disposable income. Therefore, with the current pathetic rental yields, do you think it is realistic for rents to rise (in the absence of income growth) to the point of making property a worthwhile investment? Remember, with the economy at full capacity, rising wages will be one of the last things that the RBA wants to see?they will raise interest rates to pre-empt price inflation.

Lastly, should the Australian economy fall into recession, we can still see falling property prices, thanks to the default of high levels of debt (see Can Australia?s deflating property bubble deflate even further?). This will be the worst case scenario for those property ?investors?.