What is overvalued

No but have a shamwow and half a cup of coffee aka my portfolio

You're welcome to your opinion, even if it is wrong use the code: nobsonlysome for a 10% discount

 

Bob.com was taken so i just took rob.com

 

Economically speaking, there are several common indicia of financial bubbles. In real estate, the main ones are the median multiple (median household incomes relative to median house prices), the price-to-income ratio, price-to-rent ratio, debt-to-income ratio, price-to-rent ratio etc. All sorts of other market fundamentals are considered e.g. rents, tenancy demand, inflation, population growth, income growth, debt servicability, actual physical housing supply and so on. Typically, these fundamentals are all closely co-dependent so over time track along with one another - largely because significant changes in any of them indirectly cause changes in the others (e.g. if you see a fall in incomes, things like debt serviceability will fall, or if you see a rise in population growth, tenancy demand will rise and physical supply will fall).

Back to the median multiple. It's really the gold standard of housing bubble measurement because it is a measurement of what households can afford relative to the price of housing (this usually rises as a steady constant over time; it's not thrown out by things like dual incomes, rising prices, rising incomes etc as it is a ratio i.e. if household incomes rise, households buy more expensive homes, and house prices rise - but the ratio remains stable). On a long term basis, throughout the OECD, the MM tends to sit within a range of 2-5 (so house prices at 2-5 times household incomes). In booms and in large cities it tends higher, around 5, and in busts it tends lower. This 2-5 range also tends to be the rate at which incomes, inflation etc usually grow. The mean of the MM represents the long term historic trend, and a deviation from that mean often indicates a bubble. Australia's long term national mean of the MM is around 2-3, and slightly higher for Sydney. That's probably a bit on the lowish side, as Australia had a long period of house price depression prior to the 1950s, and the trend is typically taken over 100 years. Around 3-4 is probably a more sensible range.

Anyhow, so when economists say housing is "overvalued" they're usually referring to the MM or a variation of it, and may use other evidence or ratios to support this. The MM is used by Demographia for example when examining global housing trends. Bubbles grow due to unchecked speculation on the future price direction of an asset (so they essentially bet on where the primary direction of demand for housing as a consumer need will go). A "bubble" has no widely agreed-upon beginning, but most economists agree a MM over 5 indicates a bubble. Australia nationally is on around 6-8, which is unequivocally a bubble. Sydney is easily on around 10-12 or higher, with Melbourne not far behind. For interest, USA and Ireland were on around 6-8 too when their bubbles burst, with some large cities on around an 8-10. When bubbles do burst, they almost always regress back to or around the long-term mean of the MM.

So, it's somewhat crude, but that's usually what is meant when a market is described as "40%, 50%, whatever% overvalued". The specific number doesn't matter though as much as whether you're in a bubble. The thing about financial bubbles is they are inherently unstable - they're basically self-bursting. Investors enter markets to make a profit, but the higher prices go, and the more crowded a market becomes, the fewer people are able or willing to buy in - which eventually stifles returns, causing sentiment to (often quite rapidly) shift. Bubbles are grown by a positive feedback loop, usually fed by inexperienced investors making indiscriminate purchases expecting profits for little work and with little knowledge of the market. They buy simply because prices are going up, rather than with any real examination of market fundamentals. Bubbles are later burst by a negative feedback; as profits stall, investors leave, driving price down, which forces more investors out and so on. Manic speculation turns to mass panic selling.

A good recent example of a bubble is Bellamy's organic formula. People bought in with little knowledge of the product and little idea of why prices were rising or what would sustain them.

One thing to take away from all of this is that it isn't "doomer" talk. A good investor understands how financial bubbles work and knows that markets can at times become irrational and overvalued. These times should be planned for, because the trouble is, real estate markets move slowly. It's easy to become complacent when you hear "a crash is coming" every year for half a decade or more, but a real estate property cycle lasts decades. Ignore the bulls and also ignore the bears, because they almost always get the timing of corrections wrong - instead pay attention to fundamentals.

What is supply doing (excess supply spells trouble)? What is population growth doing (if it's falling, lookout)? What are incomes doing (flat or falling is a bad sign for market growth)? What are rents doing (low rental yields indicates oversupply or loose competition)? Are people over-leveraged (this is a problem as it risks future defaults when rates rise)? Is the market flooded with inexperienced investors at risk of panic at the first whiff of a correction? Look for other clues too, like whether properties are selling easily (ignore the vacancy rate, which is usually unhelpful in a bubble), how the banks are treating risk (are they clamming up? If they won't lend buyers probably won't pay higher prices) etc.

Don't fear bubbles - respect them. They are opportunities in disguise. It's difficult to time a market, but it's often easy to spot the clues a market is running out of steam. Have a plan, and consolidate if necessary, so you have some capital ready for the good deals to come - even if we don't see a crash here, there will be a correction someday. I have no idea when Australia's market will stall, but history tells us it will happen, and you know - be greedy when others are fearful, and fearful when others are greedy.

 

That's the best explanation I've ever read. Sometimes we don't want to hear the warnings.

 

Valuation process is the same. Look at the P. Look at the E (ie the income after costs). Compare this to the cost of borrowing (or the return on cash in the bank). Try to forecast the E going forwards. If the P gets out of whack on the high side that's a sell signal. If on the low it's a buy.

 

Hedgy...good post..one of the reasons why I truly believe that looking at stats and data is only one part of investing....the other part id the Psychology of the market.

Now what does that mean...well...most people are like lemming most will read that data and accept...very few people look at the fundamentals and get on the ground to do the research. At some point people will make the decision Sydney is too over priced (it is already happening in some sub markets in Sydney) when this happens the deflation of the market can be very quick...buy that a matter of months..

 

Thanks highlighter...best insight I've seen on this.

 

I thought about my portfolio and I'm thinking of flicking one which has:
* Recently boomed (65% gain),
* It doesn't have huge potential. It's a solid IP, but for me its kinda a boring IP. It's a townhouse. Can't develop the land. Not really worth renovating (apart from changing the carpet). Its not really one I'd short term let, nor can I really boost rental yield in any other way that readily springs to my mind. I can add something like aircon but it wont be a massive rental yield increase. It was freshly painted not too long ago. The kitchen and bathroom are decent and doesn't need replacing, a kitchen or bathroom reno is unlikely to add lots to the sale price. Maybe every dollar I spend I'd get a dollar back.
* It has around 4% rental yield on current sale price, not enough to bring in cashflow each month. (It may be near neutral with depreciation, but its currently negative on a rental income vs. Outgoings basis). Then again, it's from mid 1970's so its not brilliant for depreciation either.

Because the rental yield isn't high enough for me, I'm saying it's overvalued... ie. I wouldn't buy it at this price! But also I have since changed my strategy with short term letting and properties that have some other x factor just being much more appealing and more lucrative.
However, this property may well be worth anything up to an additional 50k sometime soon though, if Sydney continues to boom. Its still affordable for FBH wanting something that's not an apartment and its not too badly located. The Sydenham - Bankstown train line upgrade would be helpful for this IP. In any case, I keep an eye out for similar properties on the market and their sale prices. Similar properties still get purchased fairly quickly.

 

I'd make a similar decision if it were me - you might have got all or most of the value you're going to get out of it. Falling rental yields are usually a sign of oversupply. An area booms, construction often booms too, then you end up with too many landlords vying for too few tenants. Add in the fact many who bought the recent construction boom bought high, you risk price falls when those inexperienced investors realise they're not going to make the sorts of gains more experienced investors made by buying into a good area early.

If you sold now, well, you've made 60%. There's a possibility you could make more by holding, but there's also a solid possibility of a correction given the direction market fundamentals are taking in many areas of Sydney. According to the ABS and APM, Sydney grew at only 2.1% for the year (0.9% for units). There have been large falls in sales activity, a tightening by banks, a new unwillingness to lend to foreign investors, low rental yields, national population growth at a two-decade low, record-low wage growth, rising rates and widespread oversupply. In that scenario I think you really have to ask - where is my continued momentum coming from? (And there may indeed be a good answer). I do worry that in some areas we're experiencing something like a game of musical chairs. It's been game on for years, but someone thought they'd join in by adding chair after chair, and now everyone's just shuffling around.

I think apartments, units, townhouses in some areas, and new fringe suburban developments far from the city, are the riskiest markets right now. They've attracted a lot of development and a lot of recent and inexperienced investors - often foreign investors struggling to get finance. Detached family homes in established suburbs are what I personally prefer in slowing market. They are bought by long-termers, some suburbs are very competitive with families (especially those with good public-school naplan scores), upper and middle-income earners tend to have more reliable incomes, and these suburbs haven't been the target of a lot of developers or inexperienced investors at risk of panic selling. They're more expensive, but I feel they're more likely to retain and recover value, based money on Ireland's market.

 

I found this article very interesting. It's somewhat old but it's still very true in my opinion:

How Sydney house prices compare with other global cities