By the end of this article, you will discover I have made a prediction which is the exact opposite of what most people believe. You’ll also discover why I am happy to put my prediction in writing so that you can verify my claim in the future. Let’s check out what determines property price movements. From my observations:
- Short-term property price movements (within 1-3 years) are usually determined by human emotion (also known as human insanity).
- Medium to long-term price movements (3-10 years or more) are more likely to be beyond human insanity, hence they are more predictable and controllable.
Can we really predict human insanity? Some of the most intelligent people have been put to the test and still failed miserably. Economists have the unfortunate job of predicting human insanity, hence they earn the reputation of “having successfully predicted 9 out of the last 5 recessions”. What is the difference between human intelligence and human insanity? There is a limit to human intelligence. So what does determine property price movements over the medium to long-term? In my opinion, amongst many other things, property prices are predominantly determined by two factors:
- The money supply of a nation
- The wealth of a nation.
The money supply of a nation.
Let me explain. The money supply of a nation. Let’s take an extreme example to create a simple demonstration.
- Let’s say on this little island country called Australia, a few thousand years ago, there were only 10 houses (probably called sheds back then), and there was no money being used at that time.
- The island chief decides to issue some money called Australian Dollars for circulation. For the sake of simplicity, he decides that the money issued can only be used to buy properties and nothing else.
- The island initially issues only $10, so each house is therefore priced at $1 each. (Amount of money available divided by number of houses.)
- A year later, the island decides to increase the money supply to a total of $100 still with the same usage restrictions (can only be used to buy houses). Without any improvement to the properties, each house is now priced at $10 each. ($100 divided by 10 houses, equals $10 each.)
Now you can see how property prices can go up just by increasing the money supply of a nation. We don’t even need to discuss the supply and demand situation as these only influence short-term price adjustments.If we look at the median property price in Melbourne and Sydney:
- In the 1920s, property was priced at around 30;
- In the 1960s, property was priced at around AUD$10,00;
- In the 2010s, property was priced at around AUD$600,000.
You know that the median priced properties are not better than those from 90 years ago when you compare their land size, location and quality of the building. But the price tag just keeps going up and up with no end in sight. This is the power of money supply increase. If you look at a graph of Australian Money Supply vs Property Prices you will see how Australia has been increasing its Money Supply at around 9% a year compounding non-stop, and how it “coincidentally” aligns with the property prices increase over the same period.)
The wealth of a nation.
Have you ever noticed that regardless of which particular industry caused a nation to prosper at any given time, the wealth of that nation always ends up sitting in its residential properties? It has been estimated that around 70% of an industrial nation’s wealth exists within its residential properties. You can test this yourself, by looking around at 10 of your friends to see where their wealth is. You will quickly discover that the majority of their wealth is in their home, regardless of what line of work they do. In other words, every 20-30 years you will see new industries come and go, in cycles of boom and bust, but the wealth left behind those industries tends to stay in residential properties. Let’s take a look at some of the nations over the past 100 years. Each has had some incredible industries at different times that have tremendously increased the wealth of those nations. For example:
- The automobile industry, steel industry and IT industry each brought America enormous wealth during their individual eras. But where has most of the wealth ended up? In their residential properties.
- The manufacturing industry of China, the oil industries of Dubai and Saudi Arabia and the electronics industry of Japan, all these industries have come and gone, but the wealth they created remains behind in their residential properties.
In 2006, I had the chance to work with a multi-billion dollar international hedge fund to finance a AUD$1.5billion residential property development project. The managing director of this fund happened to be the head of the Asian Pacific division of one of world’s largest investment banks. His rationale for investing around AUD$200Million into this residential development project is too simple to believe, at least for people who don’t handle multi-billion dollars every day. On the trip to make his final decision to invest into the project, he said to me that it is always safe to invest, not speculate, in residential properties in a country which is becoming wealthier, regardless of which industry was predominantly responsible for creating that wealth. The reason is that the majority of the extra wealth is always going to end up sitting in residential properties anyway, with no exceptions. It’s just a matter of time. So the question to ask yourself is, will Australia become wealthier or poorer over the next 10-20 years? With the decline of the US and European economies, we are now firmly in the “Asian Century” as our Prime Minister recently put it. Australia is unusually well positioned to benefit from the growth of Asia, which represents 50% of the world’s population. Let’s look at what Australia has in terms of resources: