Let’s talk about affordability.
“House prices are unaffordable.” We hear that a lot, and we empathise with people trying to get a start in the property market. It can be tough.
We think affordability is the biggest driver of the decision to buy a house.
If we can afford it, we’ll buy it. If we can’t, we won’t.
Affordability is also a hot topic in the media – today and always.
When most people talk about affordability they cite the fact that house prices have increased more than incomes over the past 10, 20, 30, even 40 years.
And they’re right. In 1995, an 80 per cent loan to buy the median house in Australia was 1.6 times the gross household income. An 80 per cent loan at today’s median house price is 5.2 times today’s household income.
Household incomes have increased by 5.7 per cent in the past 40 years. This is higher than the rate that wages have increased because we have seen much higher female participation in the workforce with 47 per cent of the Australian workforce today now comprised of women.
While household income has increased by 5.7 per cent a year in the past 40 years, house prices have increased by 7.3 per cent a year.
However, we don’t think that’s how you should measure affordability.
To measure it that way is to compare an apple with an orange.
Firstly, the average punter isn’t looking at the loan amount – they’re going to be paying it back over 30 years. They’re more concerned with the repayments.
Secondly, a debt from 1995 is different to a debt from 2021.
The reason is that the cost of that debt is much cheaper today. Here is a comparison of a three-year fixed interest rate* over the past 26 years:
As you can see, interest rates have dropped over time. In fact, the interest repayment on an 80 per cent loan today amounts to 11.44 per cent of household income which is the lowest it’s ever been.
The best comparison on affordability – in my opinion – is the per cent of household income that goes into making principal and interest repayments on a loan.
In this respect, here is a comparison of the principal and interest repayments on an 80 per cent loan today versus previous years:
As you can see, the repayments in December 2020 were as low as they’d been since 2000 (before we had one of the biggest property booms ever). House prices have increased 14 per cent since then but are still well below the 33 per cent that repayments peaked at in 2010.
What does it all mean?
Well, we don’t think houses are unaffordable today.
In fact, if we use the 33 per cent number then based on average incomes today, Aussies could be willing to increase their repayments to $40,308 per year (which is 33 per cent of household income). That would mean a borrower could afford a median house price costing $1,105,000.
What if interest rates go up?
Well, if interest rates go up then so will wages and inflation.
Regardless, you can’t go wrong investing in land in high growth areas. We think the overall market will probably continue its run of growth. However, there’s thousands of markets within the overall property market. Investing in property is a long-term game and land has outperformed all asset classes in this respect. If you stick to that rule, you can’t go wrong.
Interested in knowing more? Check out the weekly podcast we do at The Double Shot Podcast.
James and Alex
* We have cited the three-year fixed rate because we think it’s the most accurate measure. The RBA monitor the average variable rate on outstanding loans. They say that figure is 4.5 per cent today, which is very high and in my opinion a result of banks not passing on rate cuts to their existing borrowers – a ‘loyalty tax’ if you will.