Long Run Growth Rate of Sydney Residential Property

You hear many people talking about how property doubles every seven or ten years. You also hear many people say that property only ever goes up in value. Let's do some calculations.

According to Neil Jenman's article Beware the Selling Machine, average house prices in Sydney in 1890 was $1,446.

According to the SMH article Sydney's Median House Price $505,000, average house prices in Sydney in 2005 was $505,000.

I set up the following equation:

1,446(1+r)^(2005-1890)=505,000

And then I solve for r the annual rate of growth.

It turns out to be 5.22 per cent. You can verify this by plugging in 5.22/100 into the equation above.

An annual growth rate of 5.22 per cent is approximately the inflation rate during that time period, and so in real terms houses didn't increase in value.

Interest rates today are about 7 per cent or thereabouts. If the long-run trend continues and houses continue to appreciate by 5 per cent per year, then borrowing at 7 per cent to buy an asset that appreciates by 5 per cent will see you lose money.

The same results have been found all over the world. Robert Aronen in a Motley Fool article titled The Worst Investment Ever (he's referring to houses), says the following: "Piet Eichholtz studied records on home sales in Amsterdam's premier Herengracht neighborhood from 1628 to 1973 and found an inflation-adjusted return of 0.2%. There were periods of rising prices and periods of falling prices, but not a continuous march upward with spectacular returns."

We see the same thing in America. Here is what I read in a Smart Money article titled Renting Makes More Financial Sense than Homeownership: "Robert Shiller, a Yale economist and author of 'Irrational Exuberance,' which predicted the stock price collapse in 2000, has recently turned his eye to house prices. Between 1890 and 2004 he finds that real house returns would've been zero if not for two brief periods: one immediately following World War II and another since about 2000. (More on them in a moment.) Even if we include these periods houses returned just 0.4% a year, he says." The house prices Shiller referred to comes from his own Case-Shiller Home Price Index, which tracks the prices of US homes.

These results do not mean that getting a house is not a good idea. Houses are important if you want somewhere to live. It is probably a good idea if you live in a house rather than a cardboard box on the streets. The notion I want to dispel here is that residential real-estate is a bullet-proof, safe investment that "always goes up" and "doubles every seven years." This is not true. Over the long run, in real terms, it never goes up and it never doubles. It just stays flat.

These results also don't mean that it is impossible to make money from property. It is possible. Even something with constant inherent value can have volatile nominal value. However, if property has zero growth in the long run then money any person makes cames at the expense of other people's losses. If you purchased a home cheap before the early 2000 boom and then sold it off right before the sub-prime mess, you'll make a lot of money, but the greater fool whom you sold it to will lose a lot. If you are insightful enough to be able to buy low and sell high in property, you are essentially cashing in on the misery of others.

I'll finish off with a lengthy quote from Neil Jenman. Jenman used to be in the real-estate business himself but turned his back on them to expose much of their shady practices. He is not against property as an investment, just what he calls "Selling Machines."

Let's be perfectly clear about one common-sense and constantly over-looked fact. If there really was so much profit to be made in investing in property, then these Selling Machine outfits would not be selling property en-masse, they'd be buying it en-masse.

But the simple fact is that there is more profit in selling property than in buying property - at least for these Selling Machines.

They have a huge infrastructure - big marketing campaigns, which can comprise anything from huge glossy ads in the property investor magazines to trained telemarketing teams.

They have teams of salespeople - known, of course as "property consultants" or "support members".

They have finance contacts, legal contacts, valuation contacts, developer contacts. It's a veritable Selling Machine designed to suck every cent out of inexperienced investors.