Visionary. Value focused.

Investing – Some thoughts on the Real Estate market

Recently I have been listening to quite a few podcasts and videos about real estate investing. And today I listened to a few pieces of thoughts that I find interesting. Which I decide to note them down for future references.

Tl; dr;

• Land is a commodity, house is a consumer good.
• Income growth is a major force to sustain real estate appreciation.
• Real estate is a strong force to push inflation.
• Real estate does not produce capital goods unless redeveloping.

House is a consumer good.

“A commodity is a basic good that is most often used as inputs in the production of other goods or services.” – Investopedia.

“Consumer goods are the end result of production and manufacturing, which is what consumer sees on the store shelf.” – Investopedia.

With the above definitions, we can clearly see that land fits the definition of a commodity, which is a basic input good that is used to produce; or in this case, develop; real estate. At the same time, the house is the final result of the real estate production chain, available for the consumer to purchase.

From this, we can see that if we treat real estate as an investment, the land is what we look at in the form of growth, as it is the only thing that appreciates in value. While the house degrades and goes out of fashion as other consumer goods, or as we call it “depreciate”. I have known about this for a while, but the explanation above so far is the simplest way to describe the fact.

Income growth sustains real estate appreciation

Australian income growth by year

As explained by Ray Dalio, production growth increases income, and as a result, increase affordability and push real estate price. If the income growth has not been too much, but the housing price is still going up, we need to figure out what caused it. At a macro-economics level, there are 2 other things that push housing price up, debt and foreign imports.

With debt, people in Australia rarely buy a property in cash. They almost always borrow most of the purchase amount from a financial institutions. The more we leverage, the more buying power we can afford to purchase one, two or multiple properties. This in turn will push the price up, especially in an auction environment, since everyone has the leverage to pull and they do not hesitate to get the dream house they want. However, without a good income, the buyers soon realize that it is challenging to keep up with the mortgage payments.

Foreign imports are pretty straightforward. People from other countries see Australia as a developed country with a stable government. They start to pour money into the Australian real estate market as an investment, or just a form of wealth preservation. For these people, it is difficult for them to borrow from Australian banks. Therefore they mostly purchase with cash. And because of the vast number of purchasers available with a limited amount of land, they push the real estate price up immensely. The cause of real estate growth is external and we all know external causes are not stable comparing to internal 

Real estate is a strong force to push inflation

Imagine a property worth $100,000 that is rented out for $200 a week. The market is growing for 10% a year in that area. In the next year, the house worths $110,000. Now the landlord has 2 options, either to keep the rent as is, or increasing it to fit the new “value” of the property.

This normally is not a problem for existing landlords, however it can be a big issue for the new investors who just bought into the area. They need to have the rent up to keep up with the mortgage repayment. Therefore the median rental price will be increased, without the change in supply and demand. This is what is known as the cost push inflation, and is generally considered as a bad form of inflation.

Real estate does not produce capital goods.

Probably the most controversial topic, however I think it has a good point.

Unless you are developing/redevelop the land, whether by sub-division, building granny flats or straight out building a new construction, exchanging blocks of dirt back and forth and drive the value up does not help improving the country’s economy since it does not produce capital goods, i.e. goods that are used to produce consumer goods and generate profits.

So would it be better if people do not dump so much money into the housing market, and pour it into other industries that could have improved our economy. In turn, it increases our income, and then increasing the housing market steadily?

I guess people are not patient enough for that to happen. Investing in economy takes time and we will not see a rapid growth in the housing market if that is the path we take.

Some final thoughts.

Is real estate investing good for an individual? Yes definitely. It increases our income by renting out the property. And there are more millionaires who get rich from real estate than any other form of investment in the world.

Is a rapidly rising real estate market good for the economy in general? Probably not, since if it is rapidly rising without a strong base to support; in this case, income growth; we could be over leveraging ourselves into the properties that do not produce enough income for us to keep it.

Summary

There are good and bad aspects of investing in real estate. We normally see it as a good form of investment for ourselves and the family. However whether it is good for the country, that is left to debate about.

Some ideas are inspired by The Economics of Real Estate.

By Tuan Nguyen