Here’s today’s conundrum for you: if residential property is so overpriced, why can’t anyone make any money out of it?
According to highly regarded value investor Jeremy Grantham, Australia has the most overpriced property market in the world. I’ve written similar things myself over the past few years. And the numbers, when you look at the ratios of prices to income and prices to rent, are off the scale when compared with historical norms.
Yet the listed companies that operate in the property development game are struggling to make a profit. As a result, they trade at massive discounts to the book value of the property they own. NSW based AV Jennings has lost a cumulative $3m over the past three years and currently trades at a 56% discount to its $143m of net tangible assets (NTA). Queensland developer Devine has managed to make $25m over the same period, but that’s a paltry return on its $337m of tangible assets and it currently trades at a 47% discount to NTA. Sunland has no net debt and trades at a 48% discount to NTA. Another Queensland company, Watpac, has a construction business that justifies the current stock price. The $240m worth of property assets sitting on the balance sheet (net of Watpac’s total debt) are currently being attributed a value of less than zero. It hardly sounds like a property bubble, does it?
Most housing bubbles go hand in hand with a construction bubble, as people try and take advantage of the inflated prices. There are still 3.95 million bubble-built homes unsold in the US; more than 12 months’ supply. Here in Australia though, we have a housing market that is overvalued in relation to incomes and rents, but not overvalued in relation to the cost of construction (otherwise these construction companies would be making a healthy profit).
The obvious explanation is that it’s the price of land that is too high, not the price of houses. And this is surely a function of government policy – it’s not as if we have a shortage of dirt.
None of this means the price of existing housing can’t fall. House prices are a function of people’s ability to pay, and unemployment and interest rates are the two key drivers there. But it does mean we’re not going to get many new houses built under the status quo. People can’t afford substantially higher prices and construction businesses can’t make a profit with prices where they are.
Don’t expect governments to fix the problem in a hurry – for all the talk of ‘affordable housing’, affordable means lower prices and that would be political suicide for any government that causes it. If we’re going to have 40 million people in the country, something will have to give, but I do find the whole situation is something of a conundrum.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.