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NO B.S. FRIDAY: Great investors don’t learn from their mistakes

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Do you take the time to unpack your wins?

There’s an old adage investing that I really like:

“A good investor learns from their mistakes. A great investor learns from their successes.”

I think this is a really good one to remember.

In a way, it’s much easier to learn from our mistakes. When things go wrong, we’re much more interested in deconstructing what actually happened and what went wrong.

We’re primed to learn. We’re eager to avoid the embarrassment and setbacks that come with failure.

But when things go well… When a deal goes perfectly and we end up with a lot more cream than we were anticipating, we get on a high.

We’re full of juice and go. We just want to launch into another deal as soon as we can.

And the human biology is programmed to unquestioningly repeat successes. If eating those berries turned out well for us in the past, well then lets do it again.

But the modern world is more complex than our evolution ever imagined.

And there’s a real danger here if you’re not critically evaluating your successes.

I mean say you buy a site for development. You get a few months into planning and the numbers aren’t really adding up. But then the land gets rezoned, and you flip the site on to developers for a very tidy profit.

Win, right?

You made money because you made a smart buy.

But actually no. You made a mistake. You didn’t buy well. If you bought well, then the development numbers would have added up.

You made a mistake. But you got bailed out of your mistake by the re-zoning.

So this should be a big red stop sign saying, I need to take a look at my method here, because I’m buying lemons.

But that’s going to be hard to do if you just double or tripled your money. You’re going to be thinking. Let me at ‘em. I want to buy again.

In this situation, even with the best intentions and critical self-awareness, it is actually hard to hold your horses and take the time to analyse just how the deal went down.

And that’s when it’s actually fairly easy to unpack.

What about when you’re buying and developing in a market that’s got a run on?

How much of your profit margin is due to buying well and putting in a quality development? How much is just due to the market? How do you even know?

And right now, across Australia, there are 1,000s of property experts. People who’ve made lots of money and have sure-fire strategies for success.

At least they think they do. But the truth is most just got lucky. They bought at the right time and made their money off the market.

They just don’t realise it. In their minds, they’re geniuses. The results speak for themselves. If I wasn’t a genius I wouldn’t be making all this money, would I?

This is also one of the reasons why we see this bubble and bust dynamic play out in markets the world over.

On the way up, every one thinks they have the secret formula. They have some insight and strategy that 99% of people don’t have, and they’re turning that into coin.

They all do.

But at some point, the fundamentals bite, and the emperor realises that they’re naked. People realise that they’ve been buying junk, and there’s no way off a sinking ship.

Does this sound familiar? Dot-com bubble anyone?

Crypto-currency?

Now, I know I’ve been sitting on the fence a little bit over crypto’s, but now I’m calling bubble.

Why?

For exactly this reason. I’ve got all sorts of people in my ear about buying into crypto-currencies, and most have no idea what they’re talking about.

And we are well and truly into LaLa land.

Take “Fuck Token” (seriously, I’m not making that up.) That was up 370% in 24 hours last week.

I don’t even know where to start with that one. But it’s actually chump change compared to some of the numbers getting round…

There are now thousands of companies issuing coins. Rather than selling shares, they’re selling investors digital tokens (to people who mostly pay in Bitcoin or Ether).

So rather than IPOs we now have ICOs – Initial coin offering. It’s pretty much the same, just more ‘crypto’.

And some of the stories there are ridiculous.

There’s a token issued by Stratis that is up 101,168%. And that’s in a single year!

The NXT token is up 672,989%

They’re not typos. They’re actually results. In case your head isn’t spinning already, if you put $1 into a NXT token a year ago, you could now cash out $672,989.00.

(oh for a time machine.)

But what’s going on in the underlying business?

Maybe they’re doing great things, but is there any conceivable way that the business is 672,989% better than it was a year ago?

Short of discovering cold fusion, perpetual motion (or a time machine), there’s no conceivable way we can justify these results.

We’re in LaLa land.

And look, I know crypto has substance. There are multiple uses that have profound implications.

But then so did the internet in 1999. That didn’t mean that Pets.com was the billion dollar unicorn people thought it was.

Having a kernel of substance doesn’t protect you from hype and irrational exuberance.

But I am now being told to ‘get into cryptos’ by people who really don’t know what they’re doing.

I ask them what a crypto currency is and they say it’s like digital money. And I say, yeah, I’m aware of digital money. I do my banking in the 21st century.

“But it’s so easy, Jon.”

“Yeah, it’s easy until it isn’t.”

And look, that’s not to say there isn’t still money to be made. You might make another 670,000% before the whole thing topples over.

But if you’re going to do that, just be aware that you’re gambling now. The herd is on the stampede, and all the supposed ‘fundamentals’ in the world won’t save you when the herd turns.

There’s value in cryptos for sure, but now, more than ever, you need to know what you’re doing.

Don’t say I didn’t warn you.

What’s your shoe-shine boy telling you?

Hey China, you in or you out?

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Are Chinese buyers really abandoning Australia?

I’m wondering if this is all BS.

The talk recently has been that the Chinese are “abandoning Aussie property”.

Take this story from the AFR the other day:

Chinese real estate agents are reporting a sharp drop-off in Australian sales over the past six weeks as new property taxes take effect, while others report Beijing’s tighter capital controls are also hurting demand.

…David Wang, the vice-general manger of international sales at Chinese agency 5i5j, said sales of Australian property had dropped 80 per cent in July.

And he’s expecting an equally poor result or even worse figures in August.

“The main impact is from the introduction of new taxes in Australia,” he said.

Mr Wang said the Australian government may have “over-estimated the attractiveness of the market” for Chinese buyers.

I’ve seen variations of this story doing the rounds all over the place. Most haven’t questioned whether it’s true or not. They’ve just accepted that for some reason, China is just not that into us anymore.

“Have you found someone else?!?”

But you’ve got to remember that these Chinese real estate agents would love to see the recent sling of taxes aimed at foreign buyers removed. It’d mean more money for their clients, and more money for them.

So when they’re throwing numbers around like an 80% drop in sales, I tend to be a little sceptical.

The other thing to remember is that without Chinese and foreign buying, it’s difficult to square away what’s actually happening in the Australian property market right now.

The key chart here is this one. This tracks dwelling prices and mortgage finance.

You can see here that Housing Finance Commitments and Dwelling Price Growth normally move in lock step. That makes sense. It’s finance that buys houses after all.

But what’s interesting is that that relationship has broken down over the past couple of years.

Finance fell away, but dwelling values held up.

The other thing that’s interesting is that this is pretty much another one of those ‘just Sydney and Melbourne’ stories.

The break-away has been clear in Sydney…

…but most pronounced in Melbourne…

It’s not such a story in the other capitals.

So it begs the question: What’s with the disconnect? What’s caused it? Will it persist?

Of course, the most likely culprit is Chinese buyers. Why?

Because Transparency International (a corruption and money-laundering watch-dog) reckons that 70% of Chinese buyers buy with cash.

Cold hard cash.

So you’d have to imagine that that the Chinese would have to be a big part of the story. A large influx of buyers – the majority of who pay with cash – would certainly help explain why the relationship between finance and house prices is breaking down.

However it does suggest that the Chinese buy is bigger than we imagine.

Right now, the data we have isn’t saying that the Chinese buy is huge. The NAB survey reckons that foreign buyers account for 11.6% of new properties (trending upwards) and 5.6% of existing properties (trending downwards).

But remember this isn’t the official data. This is just some survey work from NAB. It might not be the full picture.

And the official data?

Well, that’s awkward. There doesn’t seem to be any.

(I’m sure it’s not that important.)

Fairfax did a little digging. (Interestingly, when I went to find this on The Age’s website, it’d been taken down. I had to go to the Illawarra Mercury for the link… Too hot to handle???)

Foreign purchasers are buying as much as 40 per cent of all new apartments in Melbourne, with new figures showing a surge in a tax raised from offshore investment.

Official data, released to The Age under freedom of information legislation, reveals that a tax on foreign buyers of residential property, introduced in mid-2015, has become a significant money-spinner for the Andrews government, with revenue almost doubling in a year.

The tax was levied on 4,000 transactions.

However, while the tax now generates substantial revenue of more than $133 million, it is not specifically itemised in state budget papers.

Property industry insiders and analysts believe this is because of the political sensitivity around foreign ownership and declining housing affordability.

The figures come as a separate analysis by leading property advisory firm Charter Keck Cramer found about four out of 10 of Melbourne’s new apartment purchases are to offshore buyers.

4,000 foreign transactions in a year in Victoria alone. The Chinese account for 40% of new apartments in Melbourne. 70% of Chinese buyers paying with cash. An ongoing disconnect between finance and prices….

Hmmm. I’m not a detective. But all these pieces of the duck are starting to look like a duck to me.

And that duck is not saying that the Chinese have “abandoned” Australian property. Far from it.

That duck is saying “Quack Qvaaaak Quvakk.” That loosely translates as the Chinese are here, they’re here to stay, and they’ll keep contributing to house price growth.

Some academics at Griffiths University said that between 2004 and 2014, a quarter of the price growth in Sydney and Melbourne as due to foreign buyers. And that was before finance and prices disconnected and the cash buyers landed.

Maybe it’s even more.

But that’s the problem with having world-class cities. They become world-class investment destinations.

That doesn’t change over-night.

So yeah, to me it all says, let the taxes stay. And take the self-interested whinging with a grain of salt.

What have you heard about the Chinese buy?

The fairy tale we tell young investors

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There’s a lot of stuff out there that is useful when you’re first starting out, but is actually BS.

If you’ve been reading my blogs for a while, I hope one thing is starting to jump out at you.

In many ways, ‘the cycle’ is the least interesting dynamic in property.

And that makes sense. Look at the ‘cycle’ in the broader economy – what does that give you? Maybe swings from negative 1 or 2 percent growth, up to 4 or 5 percent growth.

Not all that much to get excited about there. I wouldn’t get out of bed for a property deal that gave me 4%.

If we look at it closely, when we’re talking about ‘the cycle’, what we’re really talking about is the ‘over-correction’ dynamic.

So in the business cycle context, people get excited and things go well. But then the economy runs a little too hot. We overcorrect on the upswing. But then prices and wages go up. That starts to pull things back a bit. We’re in the middle of the road for a while. But then we pull back too far, people start getting a little nervous, they cut back spending, and we overcorrect to the downside… and round and round we go.

The ‘cycle’ describes a car driving down a straight road that maintains its course by swinging to the left, until it’s time to swing to the right. Then swinging to the right, until it’s time to swing to the left…. And so on.

It describes an observed phenomena in many natural systems that there is no static state. Rather, there is a continual process of correction around a desired average.

So don’t talk about the cycle. Talk about the over-correction dynamic.

And I know every property analysts and their dog in this country talks about the property cycle – but very few of them understand what they’re talking about.

And just as the ‘cycle’ gives you relatively small movements in the broader economy, the cycle, or over-correction dynamic, gives you very small movements in property prices. And by that I mean, ‘the cycle’ is almost impossible to identify in the middle of everything else that’s going on.

I mean, show me any significant trend in property prices over the past twenty years, and I’ll show you a structural force that was driving it.

The boom in Sydney from 2000 to 2003 – I would point to the flow through of the Olympic infrastructure spend, and the negative gearing changes introduced in 1999.

Or the slow down from 2003 to 2006? Two rate hikes and a whole lot of jaw-boning from the RBA.

2009 to 2012? Mining boom.

2013 – 2017? Foreign capital inflows and strong immigration.

You get the point. I’m simplifying to be sure, and there’s no way of knowing what the exact cause was… truth is, there’s always a number of factors pulling in different directions at any given moment.

But my point is that what we call ‘the cycle’ – the tendency for the market to move in swings and roundabouts because natural systems have a tendency to overshoot – is a very small part of the story.

Now, why does this matter?

It matters because a lot of investors ‘play the cycle’. And a lot of analysts out there encourage investors to play the cycle by banging on about the cycle all the time.

And they’re all missing the point.

One, the cycle, or overcorrection dynamic, is too small to create serious returns. It’s not worth dicking around with.

Two, it creates this false sense of certainty about future directions. It creates ridiculous ideas like: this markets done well in recent years. It must be due for a breather. Or, this market has done nothing. It’s due.

If you’re basing your investment decisions on ideas like this, you’re going to get slaughtered.

Let’s take Perth as an example.

Take the boom that took place between 2010 and 2015. Was the cycle telling you to get into that one?

Not at all. There was nothing in the Perth’s market history that would have given you any idea that that boom was coming.

Because that boom had nothing to do with the cycle. It was all about the mining boom and the surge of population that went with it.

Or take the correction that kicked in in 2016. That looks like the cycle right? Bad times follow good times.

But again, that had nothing to do with any inherent cycle – it was about the mining investment boom coming to an end, and population flows reversing.

And what does the future hold. Well, the cycle will bottom and Perth’s fortunes will pick up.

That probably is what will happen, but it won’t be due to any overcorrection dynamic. I’ll be watching what’s happening with the Western Australian economy, and how their managing their transition through the mining boom fall out.

When Perth’s market picks up again, it will be because the economy or population flows have created the right conditions for a recovery.

It absolutely won’t be because of the ‘cycle’.

So be careful with this. The idea of a cycle is fallacy.

It is a useful fallacy when you’re starting out. It’s good to remember that markets can go up and down, and it’s not just a one way street.

But as you become a more sophisticated investor, you need to let this go. Put it in a box alongside Santa Claus and the Easter Bunny.

If you believe there is a cycle, or it is the cycle that is driving things, you’re going to miss what’s really happening.

And what’s really happening – that’s where the money is.

Heard any BS about the ‘cycle’?

What is a house? (asking for a friend)

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Housing isn’t the concept that we thought it was… have you caught up?

What is a house?

If like most people you said something like, “a place where people live”, then you’d be right, but you’re missing a big part of the story.

Even if you put on your investor hat and said, “a place where people live, that you can also own and earn a rental income from,” again, you’d be technically right. Full marks from Investopedia for you.

But again, this is only part of the story.

Housing, as a concept, is changing.

And if you’re not watching this space, then you’re going to miss the biggest opportunities on offer over the next twenty years.

For a long while, you’re “a place where people live” definition would have served you well. Up until about the late 1980s, that was pretty much right.

But then ordinary Australians started cottoning on to the investment potential in property. They realised that housing was a place where people lived, but it was also something you could invest in.

The game changed, and a big part of the story behind the ongoing boom we’re living through is that more and more people are making property part of their portfolio.

But now the game is changing again.

Some of those changes are easy to identify.

Take the evolution of AirBnB for example. That has surged in recent years, and it’s a whole new way of thinking about housing.

Now a house is somewhere that people live, that can be invested in, and can give you access to the Tourism dollar if you fancy being a hotelier.

The latest stats show there are 115,000 listings on Air BnB right now.

And a study from the University of New South Wales shows that in Sydney, 60% of Sydney’s 20,000 listings are for entire homes.

That means there are 12,000 homes in Sydney, that used to just be a place where people lived, but are now a sort of quasi-hotel.

And if we extend Sydney’s experience around the country, that means we’re talking about something like 60,0000 to 70,000 homes, across the country, now dedicated solely to the short-term accommodation market.

This is a real shift.

I mean, we’re talking about almost a full year’s worth of housing supply, just never making it to market. That’s got to have an impact on prices.

Or take the way housing has become a ‘store of wealth’ for rich globalists.

Rich people (even aspiring rich people!) from China to the US, from the UK to Russia, are looking to Australian property, not because it earns an investment return, but because it gives them a way of storing their wealth…

(… and possibly hiding it from the authorities back home.)

There were almost a million empty homes on Census night. We don’t know how many are due to investors deciding that they’re better off leaving their investment empty, but we hear stories of entire apartment blocks in inner-city Melbourne and Sydney being used for just this purpose.

Again, this has got to have an impact on the market.

And again, we need a new framework for thinking about housing. This isn’t just “a place to live” or a place to invest in.

This is something different.

So what is it?

This is important. The people who made money in the early days of the internet were the ones who saw what the paradigm shift was really about. It wasn’t just a way to connect a bunch of boffins at elite universities.

(It was an unprecedented vehicle for porn!)

Same story with the blockchain technologies. The ones to make money will be the ones who see the full promise of the technology on offer – a promise that may take years to realise.

So how should we think about housing?

Well, at the risk of drifting off into abstract space, I would say this:

Property is the gateway between the real and the unreal worlds.

I don’t mean that if you set up your Ouija board in the right way, property becomes a portal for communicating with the dead.

I mean that there are fundamentally two types of economic activity. There’s real world activity – making cars, growing fruit, building stuff. And there’s unreal economic activity – writing blogs, marketing, mining for bitcoins.

No one is any better than the other, but at some point, all economic activity needs to be made real. We work so that we can ultimately buy real things – food, housing, clothing etc. You can’t live on blogs.

And while you can have a real economy without any unreal elements, you can’t have an unreal economy without any real elements.

So the unreal rests upon the real.

Property – and land in particular – are unique then because all real activity must be grounded in the earth. The minerals that make up your IPhone have to come from somewhere. Your factory has to be located somewhere. Your zucchinis have to be grown somewhere.

And so property is the place where all the unreal economic activity – the vast billions and billions of dollars that rush about producing nothing anyone can touch or see – it is the place where all this activity grounds.

It’s the way that lightning needs to ground to exist. A lot like that.

The great colossus of human economy must at some point pass through the gates of property.

And the bigger the economy becomes, the bigger those gates have to be. The more value they hold.

And so as our economies continue to expand rapidly, and as the balance continues to shift from the real to unreal, as it has done for the past 50 years, the relative value of property increases.

And so we digitised hotels – that revolution grounds out in property values. We digitalised taxi’s. Now everyday parking spaces are factor of production.

China produces a thousand billionaires. They want to ground their wealth into something real before it is taken away from them.

So this is what I’m suggesting. Over the long, long run, I’m thinking about property this way – it is the gateway between the unreal and the real worlds.

No modern economy can do with out it.

And once you have that level of necessity, its potential long run value becomes limitless.

What’s your framework for thinking about property?

Whispers of the next boom

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Warning – the economy might actually be a whole lot stronger than we thought.

Okay, little bit of a news flash.

You know that “moderation” in house prices we’ve been waiting for? That little bit of a pause we were expecting to let reality catch up? That softening, that slow-down, that plateauing?

Might not be coming.

In fact, in as much as there was a slow down / pause / time-out in the naughty corner, it might already be behind us.

And the next boom might only be a few months away.

How do I know this?

Well, I don’t. Not for sure. Some economists will tell you they have a crystal ball, but sooner or later the market comes along and gives them a swift kick to the crystal balls and their reputations shatter.

But, you’re always operating with less than perfect information.

And the thing that really jumped out at me was this report from the economists at CBA.

They were taking a look at the labour market data, and I was shocked at how strong recent months had been.

In my mind I’m still assuming that the labour market is still softening, wages growth is weak, and there’s little fire coming from that sector of the economy.

But that’s not what the data says at all.

In fact, if you believe the last four months, the economy is gearing up for another bull run.

And I know a lot of my readers are a canny bunch, and don’t put too much stock in the “official” numbers. And they’re right to be sceptical. So when they say the unemployment rate is 6%, you have to take that with a large grain of salt.

That said, the trends are useful. If the unemployment rate is going down, from whatever number it is, then house prices are normally growing.

So even if I don’t believe (or care about) the exact levels, I am watching trends.

And as I said, right now, the trends are actually pretty promising.

The take home chart from the CBA report is this one. It compares employment growth with GDP:

You can see that they tend to move together – which makes sense: you need to employ people to make stuff.

But right now a gap has opened up. Employment growth is heading north. We’ll have to wait and see what GDP does.

So the gap will probably close pretty soon, based on past experience. But which way? Will employment correct, or will the economy bounce?

Again, hard to say for sure, but the employment data is looking pretty solid.

Because when you break it down, all the signs are good.

Like the split between part time and full-time employment growth. We’ve actually seen a switch-out, with full-time employment growth picking up, at the expense of part time employment growth.

That’s a good thing. Firms tend to employ people part time when things are tentatively picking up, and when the future seems more certain, start employing people on a full time basis.

And when you break it down by state, it’s also looking strong across the board.

Victoria continues to lead the way (“spectacular” was the word CBA used), but growth is also holding up in NSW, and there’s been a quick bounce back in Queensland.

And even in the smaller states, and even in WA, we’ve seen employment growth pick up strongly in the past four months.

This is especially good news for WA. I can hear the pollies across the Nullarbor breathing a huge sigh of relief. Employment growth has picked up, and the unemployment rate has dropped significantly.

Perhaps WA has turned the corner?

So it’s all looking pretty solid.

Surprisingly solid even.

But look, I don’t want to lay my crystal balls on the line here. These are early days, and you can’t be too certain about which way trends are going until they’ve had time to properly establish themselves.

But by then, everyone knows about them.

So the scenario I want to flag is that the economy has actually got more traction than we thought. That’s going to keep feeding through to employment growth, and that in turn will help drive property demand and property prices.

Property price growth moderated over the first half of this year (though Sydney and Melbourne are still pushing at double digits), but maybe that’s all we get. Maybe once the rubber hits the road and the economy really gets going, we’ll start pushing back towards 10, 12 percent growth.

And when you look at the population growth data, that’s not so far fetched.

Of course, it could all still get derailed by something. Trump could bomb someone or China could get the wobbles. But in the absence of any sort of shock, you’d have to think that the most likely scenario is continued growth from here.

Economies do move in cycles after all.

We might not be quite ready to lock it in, but we need to start thinking and planning for it.

So watch out! Good times ahead.

What’s the feeling in your crystal balls?

The true source of inequality in one surprising chart

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Growing wealth inequality is driven by one of three things – business income, labour income or housing income. Guess which one it is.

Okay, I know we’ve been spinning round the outer-reaches of the academic universe these last few weeks, but do you want an edge or not?

Do you want to see the trends that the big players see? Or do you want to keep taking your financial play book from the Sun Herald? See how far that gets you.

The whole point of these blogs is about helping you see a bigger picture. The higher up the mountain you go, the more you can see.

If you want gags and ramblings… well, that’s what Friday’s for.

So bear with me a little longer here. I’m building to something. I need more than a few blogs to do it. Nothing worth having is easy. But trust me, it will all come together soon and you’re going to be amaa-aazed.

Ok, so last week, I showed you how falling wages are driving property prices higher. You never thought that sentence could even make sense, but I think you got the point I’m making.

The economy is a bunch of relativities. Everything in relation to everything else. The usefulness of labour is falling, so the relative price of labour must fall. That’s another way of saying that the price of housing, relative to labour must rise.

And that’s what we’re seeing.

But let’s slap a little more nuance on this picture. Let me pop a little swan made of meringue on top here.

Ok, so typically economist divide the factors of production – the stuff that makes stuff – into three groups – Land, labour and capital (machinery, factories etc).

Since land is fixed, economists just tend to put it to one side and focus on labour and capital.

(I know, you’ve got to wonder what they’re thinking.)

And so Marx said all history is the history of class struggle, between labour and capital.

A few years ago, Thomas Picketty, that French economist wrote “Capital” – which argued that wealth inequality was getting worse because capital owners were able to capture more of the surplus, at the expense of their workers.

And in all of this, land is just the place where they grow cheese.

And you can kind of get why. Land is just dirt to most people. It kind of has no character, no personality. It’s not able to rise up against its oppressive overlords.

The battle between labour and capital on the other hand – oh boy is that a story. It’s a theatre for all the hopes and dreams of the working class, all the aspirations of our entrepreneurs and captains of industry.

Land just doesn’t care about any of that. And it will still be there once all the workers and managers and capital owners are dead.

So it gets written out of the story.

And so then you see charts like this one:

This is the share of total income going to workers and to capital owners (in the way of profits).

The argument that people make – people like Picketty – is that labour’s share is falling and that’s a bad thing. That means workers have less power. Businesses have more. And that’s one of the factors driving inequality.

And that might all be true, but it is missing a huge piece of the puzzle.

Land.

Recently I did come across one economist who tried to put land back in the picture. This chart comes from a young grad student at MIT. It breaks capital income (from the chart above) into capital AND land (rather than just lumping profits and land income in together.

Look at what happens:

This is for the developed world since 1948. You can see that since 1980 in particular, capital’s total income share has been growing. That’s Picketty’s story.

But look at why. It’s not that regular business profits have been growing – the non-housing share of capital income has been pretty much flat.

All of the growth since 1980 can be explained by the increase in housing income.

Let that sink in for a second. If the rich are getting richer, if income and wealth inequality are getting worse then it’s got nothing to do with businesses, it’s got everything to with housing, and the way the rich uses property as the number one way, to build, protect and transfer wealth across generations.

I know as a business owner it may sound like I’m talking my own book here, but a careful and measured analysis of the above, highlights that the balance of evidence suggests that, taken together, all you pinko-lefties should take your redistributive business taxes and shove them up your bum!

(Nah, just kidding. You’re great. I love ya.)

But the central idea is that this hasn’t been a golden age for capital. Technology hasn’t made it easier to exploit workers and earn super profits.

If anything, technology has made the game harder. Technology depreciates in value and usefulness incredibly quickly (anyone want to by my Iphone3?), and the digital market place has meant that disruption is coming at you from every which way.

No sooner do you have a great idea, than a dozen firms in China are ripping you off.

Think about what AirBnB did to the hotel industry, what Uber did to taxis, what Amazon is doing to retail.

This is no capitalist utopia.

So labour income is falling. Capital income is falling, or it’s on the way down. The relative price of these two must decline.

Relative to what?

Land.

(Gee, it’s like you’re not even listening sometimes.)

As I’ve said before, in an economy where everything is getting less and less real, where more and more activity is moving into the unlimited infinity of unrealness, the relative scarcity of real things, commodities and real estate, increases.

As their relative scarcity increases, so does their price.

We’re still in the middle of a commodity boom that continues to surprise, and the real estate boom…

Well, we’ve put some great runs on the board…

But the game is nowhere near over.

Will capital’s share of income start to fall?

How falling wages are driving property prices higher

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Part three in ‘Ten Reasons Why the Boom has Ten Years to Run’ is something I don’t see anyone else talking about – how property became the new gold.

I don’t know if you caught this article a couple of weeks ago. The new Governor of the RBA, Phil Lowe, was urging workers to rise up and seize the factors of production.

Well, not quite. But he was urging them to demand higher wages.

The governor of the Reserve Bank has called on workers to start demanding large pay rises from their bosses. 

In a remarkable statement for a central bank chief, Philip Lowe said Australia’s economy was suffering a “crisis” in wage growth, and workers ought to realise the relatively low unemployment rate meant they could start asking for a larger share of the nation’s economic pie.

Lowe told a conference at the Australian National University on Monday the labour market was in better shape than some critics were suggesting.

 “The crisis is really in real wage growth,” he said.

He said despite the relative strength in the labour market, too many workers were putting job security ahead of pay rises, partly because they were worried about competition from “robots” and “foreigners”.

I don’t know if all of my readers are old enough to understand what a seismic shift this is.

Not that long ago, when central bankers used to worry about inflation, they would warn us about the dangers of a “wage-price spiral”. Where higher wages pushed up costs, which pushed up prices, which saw workers demand even more pay, and on and on it would go.

It used to happen.

But the last time it did Phil Lowe was in grad school.

And these day, central bankers aren’t worried about inflation. They’re worried about deflation. A lot.

As Phil points out, wages growth is now the lowest on record (which isn’t entirely as bad as it sounds since inflation is also around record lows).

And it is really hard to believe that this is because workers just don’t have enough balls these days.

This really feels like wishful thinking on Lowe’s part. It’s a central banker hoping for something, anything, to save the country from the horrors of deflation.

But this isn’t about the mental state of Australia’s workers.

This is about seismic shifts in the structure of the modern economy.

The de-physicalisation of the economy – where we spend more on apps than we do on furniture – has given us true globalisation. Our app developers can be living in any country on earth.

And the labour pool with access to a device and an internet connection is staggeringly huge, and expanding rapidly.

The price of labour is falling simply because the effective supply of labour is exploding. Every graphic designer in Australia is now competing with millions of other designers from every corner on earth.

That’s one.

Two is that technology has slipped the chain. At some point in the past 10 years we went from labour-augmenting technology (where technology helps workers be more productive, e.g a book-keeper using a lap-top to manage the company’s books), to labour replacing technology (We don’t need a book-keeper any more. There’s an app for that.)

This dynamic is churning through jobs faster than they can be replaced.

Humans are being made redundant. And so the price of humans is falling.

Lowe is wrong to suggest that people are irrational for “fearing jobs and robots”. It’s happening.

And this, is big new for property. It means property prices will go up.

But hang on Giaan. The conventional wisdom is that when people have more money, they can spend more on houses, and so prices go up.

And that’s true. Normally. But these aren’t normal times.

There are intense downward pressures mounting on wages.

But wages are sticky. They very rarely fall. Labour contracts, no disadvantage tests, unions and the public sector all help put a floor under wages.

We very very rarely see wages fall, even an incy bit.

Even at current growth rates – the lowest on record – they’re still growing.

But the economic adjustment must happen somewhere. The price of labour must adjust. It has to.

But where?

Well, the thing to remember is that prices are a relative concept. Prices help us understand the worth of one thing relative to another. Prices are meaningless in isolation. They only make sense in relativity.

Say, what if I told you that a widget is worth 4 wodgets (a currency I just made up.) What does that tell you? Nothing.

What if I said, a widget is worth 4 wodgets, and an apple is worth 2 wodgets.

Now you understand, roughly, what a widget is worth.

So if we understand that prices are a relative concept, and we know that the price of labour needs to fall, then we understand the price of labour, relative to other things, needs to fall.

Now, we can see that this can happen two ways. The nominal price of labour can fall, OR the nominal price of other things can go up, relative to labour.

And since the nominal price of labour is not allowed to fall, that means the adjustment is forced on to the price of other things.

What other things?

Well, theoretically, everything. But since globalisation is suppressing prices in the digital economy, expect to see the adjustment in the price of real things.

What real things?

Did some one say real estate?

So far, no one has created an app that manifests land and builds houses on it. Property is untouched by the digital revolution.

And so in a world where everything else is being swamped by gluts, the relative price of property must increase.

If it doesn’t happen through falling nominal prices – ie. Deflation, which central bankers will spend billions avoiding, then it will happen in nominal gains in property value.

And this, is what we’re seeing right now.

And this is what we’re going to keep on seeing, until the robots overthrow us and make us their slaves.

No, I don’t know what the end game is. But this dynamic is in full-effect right now, and it could take decades to play out.

So you want the big, big picture? You want the long, long-term view?

Property is the new store of value. Property is the new gold.

The sellers of labour (workers) will get poorer. The owners of property will get richer.

Which side are you going to be on?

Is it that bad? Are wage earners doomed?

The boom hidden within a boom

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The second instalment in ‘Ten Reasons Why the Boom has Ten Years to Run’ is something I call “The Densification Dividend”.

Think about this for a sec.

Imagine a suburb with one house. The house is valued at $1m. The median house price for that suburb is, obviously, $1m.

Now imagine some one comes along, subdivides the house and builds another house on the back block. Both houses are now valued at $600,000.

But now what’s the new median price of this suburb?

$600,000.

So the suburb has seen the median price fall from $1m to $600K. That’s a 40% fall. (Steve Keen is finally right. I had to construct a theoretical universe for it to happen, but a win’s a win.)

But do you see what’s happened here? Home-owners (only one of them) have seen the value of their property holdings increase 20%. But the median house price has actually fallen 40%.

Whooo-oooo.

Prices are down. Equity’s up. This is the Twilight Zone.

Someone once said that statistics are like a bikini. What they reveal is exciting, but what they conceal is vital.

We never hear the footnotes that go with property statics when people are talking about them in the papers or on the news. But no statistic is perfect. They’re an abstraction of reality. They’re not reality itself.

And that’s definitely true of median house prices. They’re good for giving you an indication of trends, particularly over short to medium time frames.

But they’re no good at capturing structural changes in the market – in this case, a move to higher-density living.

Now, what does this mean for us?

Well, pretty much across all the capital cities, there is a relentless drive right now towards higher density housing. Housing is being structurally reconstituted.

For a long time we’ve had a reputation in Australia for large homes on sprawling quarter acre blocks. We built as if we had an abundance of land and endless plains to share. (Where did they get that idea?)

However, the size of new homes actually peaked in 2009 at an average of 222sq metres.

And since the GFC it’s been falling. The average new home now stands at 192sqm, making it smaller than in 2001.

Partly that’s about the wave of apartment building we’ve seen in recent years, but detached house sizes are falling too – from 249sqm in 2009 to 223sqm today.

And our sprawling back yards are going the way of the Hills Hoist. The average lot size of vacant lots in the capitals has fallen from around 700 sqm in 1996, to about 450sqm today.

But none of this will be any news to investors.

Sub-division deals or townhouse developments can be some of most profitable deals going. They’re some of the sweetest fruit on the property tree, and the easy ones do seem like they’re getting harder to come by.

And the trend towards smaller houses and smaller lots seems locked in. It’s not going anywhere. For land in particular, it’s One Direction only.

(That was for you Niall. If you’re reading.)

And then there were some really interesting stats in the latest census results. The one that really jumped out at me was the surge in townhouse developments.

We here are lot about apartments but really, the biggest news in property is the emergence of the townhouse.

Between 2006 and 2016, the number of townhouses in Australia increased a massive 61%! Compare that with 14% for high-rises, and 11% for detached houses.

Now think about what that means.

Statistically speaking, higher density housing is putting downward pressure on median prices. Townhouses are cheaper than the houses they replace, even though there’s more of them per block.

So if we imagine an inner-city suburb where prices are growing at say 10% a year, those equity gains aren’t equally distributed.

Recent generations of home buyers – say someone who bought a new townhouse – they’re seeing house prices increase by 10%.

But older generations of buyers, say those who bought the original quarter acre blocks, they’re seeing that 10%, plus a whole lot more – the value of being potentially able to subdivide and develop.

And so there’s a boom within a boom – the older generations of buyers get two booms for their buck.

And the longer you’ve been in the market, the bigger you “densification dividend” tends to be.

But that’s the thing. Time makes “old buyers” of everyone eventually. As the relentless densification of our suburbs marches on, eventually everyone finds themselves the beneficiaries of a densification dividend.

I mean, Brisbane is a classic example. There’s a whole bunch of high-rises going up, but mostly they’re not replacing detached houses. Mostly they’re replacing those old 6-packs you see about the place.

So even if you bought a unit in one of those 6-packs 20 years ago – even if you bought something that you thought never would be – you’re still eligible for the densification dividend today.

But it isn’t something that is captured by statistics about median prices.

And if you look at the planning strategies for all the capitals cities, increasing densification is a cornerstone of all of them.

That means that any buyer in the next 10-20 years is going to be eligible for a densification dividend eventually.

Even if it doesn’t show up in the suburb-level stats.

This is what I mean when I say its the hidden boom within a boom.

It’s also one of the reasons why I’m more interested in land prices than house prices, but everyone talks about house prices so what are you going to do.

And it’s one more reason why this current boom has at least 10 years to run. This is number two. If you missed number 1, you can read it here.

So remember it. Densification dividend. I just made the term up, but I reckon you’ll be hearing more about it soon.

Have you see a densification dividend on any of your properties?

We’re already in a rate hike cycle… so what?

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When people say they’re worried about rate hikes, I say rates are already rising, and it hasn’t hurt anyone yet…

Last week I gave you the first reason why I thought this bull run had at least another ten years to run. Read it here.

I haven’t had time to pull the other points together, but I just wanted to clear something up.

Some people thought it was strange that I was talking about structurally lower interest rates when their banked had just jacked UP their rates – especially on interest-only investor loans.

So I just wanted to explain what I mean.

First when I’m talking about duration and the bond market and so on, they’re not seeing the interest rates increases that we’re seeing.

As far as they’re concerned, rates are still at rock bottom.

All the rate hikes that we’ve seen and that people are talking about are what we call “out-of-cycle”. (Forgive me if I’m going over old ground here).

That is, they’ve got nothing to do with the RBA’s regular monthly cycle of official interest rates. (Monetary Policy: Now with Wings)

It’s got to do with other stuff.

Right now that other stuff has to do with two things. The first is a new set of standards in global banking, called Basel 5.0 or something like that. Basel is the city in Switzerland where the Bank of International Settlements is located. The Bank of International Settlements is the public relations wing of the Intergalactic Order of Templar Knights and Space Lizards.

(No, seriously. Google it.)

The short of it is that the new Basel rules mean that banks have to be a little less slap happy with their loan to equity ratios, and at the coal face, that means higher rates for people like you and me.

(Curse you space lizards!)

The other place this stuff is coming from is our own APRA. APRA – the Association of Performance and Recording Artists – has seen a steady mission creep in recent years towards oversight of the financial sector. Now they’re worried that banks are a little too exposed to the mortgage market – especially investors and interest-only loans.

To put a lid on things, they’ve introduced speed limits – restrictions on how quickly banks can grow their investor and interest-only mortgage books.

At the coal face, that means higher rates for people like you and me.

(Curse you Molly Meldrum!)

You can get a sense of the first effect here. This chart shows the growing disconnect between official interest rates and the standard variable rate.

The gap opened up in the GFC, and has since got steadily wider and wider. Today, we’re looking at a gap of around 3.5 percentage points.

This chart just tracks the difference:

That’s pretty substantial. I mean, imagine what your interest rates would be if there hadn’t been this decoupling.

Banks would be practically giving you money.

So that’s one.

To get a feel of the second, this chart here overlays rates for investor and interest-only mortgages on the chart above.

You can see that the recent pick up has been driven by the premium that interest-only investor mortgages are attracting…

… just as Molly Meldrum intended.

And if you compare current rate settings with where we were at a year ago, you can see that owner-occupiers have seen a pivot – P&I rates are cheaper, while IO are more expensive.

But there’s no dodging it for investors. Investor loan rates are up about 0.3 perceantage points for P&I, and up a whopping 0.8 pp for IO.

That’s a pretty thorough disincentive. Many mortgage brokers are saying there’s no point even going for IO loans any more.

Anyway, long story short, interest rates are up. Not in the general economy, just in the mortgage market.

That means two things to me.

The first is that since interest rates in the general economy haven’t budged, the duration effects I was talking about in my last blog are still in full effect.

The second thing is that when chicken-littles are freaking about Molly Meldrum’s do-youself-a-favour rate hikes, I’m a bit like, whatever.

We are 350 basis points – or 14 rate hikes – into the current rate hike cycle. The rate hike cycle is almost 10 years old. It hasn’t trashed the economy yet. It’s not about to do it soon.

The Australian property market is one tough nut. A slight upward drift in book rates facing investors isn’t about to derail the whole show. Not by a long shot.

And that’s because interest rates are just one part of the story. I can think of at least 9 other factors driving prices higher…

But I haven’t got time for it this week.

Maybe next week.

Anyone out there copping some over-sized rate hikes?

Ten reasons why this boom has ten years to run

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Ok, I only had space for one this time, but it’s a big one. The rest to follow…

So I was telling my friend about a deal I was getting into and he was like, “Hey? Are you buying?!?”

And I’m like, “Yeah, of course I am.”

And he said, “Oh, I was just reading some of your blogs. I thought you were a bit bearish on the market at the moment.”

This surprised me. And so I looked back at some of the blogs I’ve written recently – apartment gluts in Brisbane, flammable towers in Melbourne – and I realised that it maybe had been a little gloomy lately.

But I wasn’t meaning to take a position. I just kind of follow my nose to whatever story is breaking and what’s capturing my attention.

And if you had to take a reading on my position, it’d still be bullish. Even uber-bullish. But that’s mostly because I’m looking at some long run trends. These trends either tend to be boring, or slow-burning, or both.

They don’t make for interesting blogs.

So just to be clear, let me lay out why I’m buying right now, and why I’m buying for my unborn grand-children.

I’ll try keep it simple, but forgive me if we get a little techy.

1. Duration
Duration is a financial concept used in measuring a bond’s value. It’s a way of working changes in interest rates into a bond’s price.

Long story short, the structural decline in interest rates has seen bond prices soar.

Property is the ultimate duration asset. While a bond matures at some point in time, property (like me) never matures. It keeps on generating income from here until infinity.

So how do you value an infinite income stream?

There’s nothing in financial markets like it. They don’t really know how to deal with it.

But what I can tell you is that a lot depends on where you think interest rates are going. If you think interest rates are going to “normalise” – pop back up to their long run average of about 7% or something, then you’re not going to put a lot of value on an asset that delivers an infinite income stream of 3-4%.

But what if you think rates are going to remain low? What if you think they might go even lower?

Suddenly an infinite income stream at 3-4% starts to look pretty attractive.

We’re now almost 10 years on from the GFC. For the first 5 years, most people thought central banks would normalise rates fairly quickly.

But this didn’t happen. Rates remained low, and any attempts even to raise them a little caused massive tantrums in the market.

And so now, slowly and surely, people are getting used to a low interest rate future. Look at 20-year government bonds – they’re offering about 3-4%. That’s where expectations are.

And so as more and more people come round to the idea that interest rates aren’t just magically going to normalise, the more demand there is for property. Not just from mum and dad buyers, but from institutional investors.

After the GFC, in America, we saw a tonne of institutional money head into residential property. Guys like BlackRock became landlords. We’d never seen that before.

And so as more people come round, and as demand goes higher, obviously prices go higher as well.

But do you see what’s happening here? The only driver of higher prices in this model is people’s expectations about future interest rates, and the slowly gathering consensus about our low-interest rate future.

And this is the thing. This process isn’t over yet. There are still people who think that rates will normalise. They believe the Fed and the RBA when they say they intend to lift rates as soon as they can.

(I think they’re dreaming. I think we’ve seen a structural and permanent shift towards lower rates through the saturation of the investment market (we’re not in the high-growth 60s anymore) and continual cost pressures from the production power-houses in Asia.

Technology is winning the race now. It is pushing costs down faster than demand can grow. Prices can only go one way from here. And interest rates will go with them.)

So there are interest rates hawks still holding out for higher rates. But every year rates hold around record lows, the number of hawks falls, and our demand herd grows.

Eventually everyone will come round, and this demand stimulus will have run its course, but the question is, how long will it take?

There’s no real way to know. My guess is that maybe we’re at 50/50 in the market, hawks to doves. Maybe a little more biased our way. Maybe 60/40.

My best guess is that it will take another 7-10 for all the interest rate hawks to come round.

That means 7-10 more years of growing demand – and growing demand from guys like BlackRock with very, very deep pockets.

So the boom has at least 7 years to run on this model.

But this is just one factor. I’ve got 9 more!

—

But I’ve run out of space for this blog. I’ll write more about the other 9 later. There’s a bit to it so I’ll have to find time.

What do people think? I know people value my opinion. Maybe I could make it subscriber only, just to give you guys access to it, and give you an edge over the herd. I don’t know if I just want to be throwing it up on the internet for everyone to read…

Would you want access to a Jon Giaan sealed section? Interested in your thoughts.

Do you see rates on hold? Where do you see the market balance at? 50/50? Or something else?