Tuesday, September 17, 2013

Gold vs Real Estate - Why I’m not buying the housing market

By Jordan Eliseo

With the recent weakness in gold prices, and the resurgence in Australian home values, the never-ending gold vs. real estate argument has taken a turn back towards brick’s and mortar, at least in the mainstream financial media who are heavily talking up the latest property price movements. But which is the better investment?

Both are ‘real assets’, and are theoretically limited in supply. Both should, at least theoretically, over the long run, protect purchasing power, in that housing also has a reasonable track record of maintain its value versus inflation.

But I’m sticking with bullion for a number of reasons, and the recent correction has only encouraged me to top up my holdings, at a discount to boot.

First is liquidity. Gold is highly liquid, with tens of billions of dollars a day traded around the world, the bullion I own (and that you own) is easy to sell when and if I either need to, or decide to.

Second is transaction costs. Yes there is a transaction cost to purchasing and selling physical bullion, but it pales into comparison versus the stamp duty, legal and agency fees required to buy a property, as well as the fees to a sales agent you’ll pay when and if you sell.

Third is ongoing management. Gold is like a good girlfriend. Pretty and low maintenance! You can pay someone to store it (free with ABC Bullion or for a percentage management fee for our allocated/premium allocated product), or you can access a private storage vault for a couple of hundred dollars a year.

Property needs constant attention. It needs painting, gardening, you have to pay council rates and property rates, and there are repairs and maintenance. And if its tenanted, you’ve got people to manage, or a property agents fees who’ll take a decent clip of the rent to remove this headache from you.

Fourth is leverage. Physical gold can, and typically is bought without leverage. Sure the price can go down, but you can’t lose more than your original investment, and over the long run gold is the only asset no one has ever lost money in.

For most property investors, you can only access is with excessive leverage (something that will be worrying the RBA right now with the latest news that over 30% of Australian mortgages being written today have loan to value ratio’s of over 80%).

For those investors, if the home value drops only 20%, and they are forced to sell, they’ll end up with less than zero. That’s something property spruikers don’t spend much time clarifying to investors, especially those encouraging people to set up a SMSF these days.

The fifth rule is diversification. If you have a $500k portfolio, you could easily have say 25% of your portfolio in gold, cash, shares and bonds. If you don’t like one asset class any more, or you want to rebalance, it’s easy to sell out of one or adjust your portfolio in order with how you are now comfortable.

In the case of property, chances are your $500k portfolio is just the one illiquid asset. If you decide you only want $400k in property, you can’t very well sell off 1 bedroom or the kitchen. Diversification is impossible.

All of those reasons are strong enough reasons to prefer gold over housing in my opinion, but there are two other ones that are particularly relevant for Australian investors.

The first is that the home will in all likelihood be the major asset most Australians buy throughout their life. As such, as a general rule, residential real estate is already going to be a major investment for most Australians, so the idea of concentrating more capital (and risk) in one asset class is one people should approach with appropriate suspicion.

But the final reason for being wary about investing in Australian homes, and preferring gold instead, is relative valuations at this point in the cycle.

Property has been in an incredible bull market for over 30 years. As a general rule, if an asset has gone up for 30 years uninterrupted, ask hard questions before throwing your money at it. We’ve all heard the comment about it being darkest before the dawn, but in this case it’s worth reminding readers that a star burns brightest just before it bursts.

This bull market in property has taken it to truly historic valuations, well above long term averages versus national incomes or versus rental yields. In the last decade alone they’ve grown from merely 4 to over 7 times the average annual income.

What that means is that Australians are so far in debt today, that even with interest rates at record lows, we are paying more, as a percentage of our disposable income, than what we were back in the early 1990’s when interest rates were over 15%!

That is something you don’t hear the big 4 banks talk about often.

It’s highly unlike a new house price boom will be sustainable, or will run for many years when its starting at such high valuation levels already.

Furthermore, one of the major arguments from property spruikers, and the big 4 banks (but then I repeat myself) as to why property prices will always rise is our supposed housing shortage.

Before you accept that one hook line and sinker, google the ABS Housing and Occupancy Costs report released this year. It shows over 75% of Australians reporting they have at least 1 spare bedroom in their home. With roughly 8 million households in the nation, that’s the better part of 6 million spare bedrooms already.

As times get tougher (and they are when you consider the unemployment rate is rising, as well as skyrocketing costs for utilities, insurance, health and childcare etc), Australians are going to come to the realization they don’t need all those spare rooms.

Maybe it’s a young family thinking they’ll only have 1 child, hence they only need a 2 bed house, or a graduating university student thinking they can stay with Mum and Dad a couple more years to save some rent money, or a couple of friends sharing a 3 bedroom house thinking that it might make sense to have another friend move in to save on rent.

Either way, there’s huge scope for Australians to use our existing homes more efficiently (gee that sounds like boring economist talk). And that’s exactly what we saw with the last census data, which showed that, for the first time in 100 years, the number of Australians living in each and every house actually rose between 2006-2011.

That’s a trend worth paying attention too, and it will prove a headwind for house prices.

Last but not least, the one thing you never hear property analysts talk about is the role of the ageing population. As it stands, the baby boomers, who represent 25% of the Aussie population, control 50% of the nations housing stock, and it is by far their major asset, underpinning their net worth.

Unfortunately, most are unprepared financially for retirement, with ASFA data indicating a couple between 61-64 would have only circa $300k in retirement assets. Even if they were to earn 8% per annum (won’t be easy considering the risks in the market right now), this money would run out within 7-8 years based on them spending circa $55k a year (ASFA estimate of requirements for a ‘comfortable’ retirement).

Bottom line, many are going to have no choice but to sell, so that they can unlock their existing equity in order to pay for their lifestyles.

More boomers needing to sell, coupled with less Gen-Y’s and Gen-X’s willing and able to buy. It’s hard to see prices rising sustainably with these dynamics in play.

Gold on the other hand, is ‘cheap’.

Relative to inflation, the housing, stock and bond markets, global money supply or as a percentage of total financial assets, gold is still hugely undervalued. On top of that, with interest rates at record lows around the world, and with central banks continuing to print money, we are still in the perfect macroeconomic environment for gold, despite the discomfort the current volatility is causing to some investors.

In fact, over the last 130 years, there have been 3 major cycles in relative valuations between gold and house prices. At each peak in gold (relative to housing), you’ve been able to buy an entire house in Sydney for 100 ounces of gold.

100 ounces of gold right now will set you back the better part of $150k. That’s barely enough for a deposit on the median Sydney home which is in the $700k range today, indicating in relative sense how undervalued gold still is today.

As such, if history is any guide, those ounces of gold will appreciate far more rapidly than the average house price in the years to come.

Each and every investor needs to make their own decisions, but market cycles, if they don’t repeat, certainly do rhyme.

For me personally, I am going to continue investing my money in physical gold over housing. One day I might make the switch, but it won’t be for a while, which is no problem at all. As the Rolling Stones said: Time, its on my side!

Jordan Eliseo
Chief Economist
ABC Bullion