Episode #0081 - What has pricing to do with house prices?

In this episode of Pricing College we stray into an area we do not look at - asset pricing.   House prices are one thing most people have a view on.   We discuss how changing interest rates - really reflect lifetime cost of ownership and payment terms - and what value based pricing can tell us about it.     If there's one thing people love discussing in this era, it is house prices, houses, more houses your house, my house, how many houses do you have? And housing bubbles, housing inflation housing crashes. We've been through it already, I suppose in the last 10 or 15 years since the GFC, etc. So I suppose at today's podcast, we want to maybe give a separate view. A slightly different pricing view on house prices.   What's been happening with house prices? Well, let's look at this in terms of what the bank's been doing interest rates. The interest rates have just been going reduced further and further down to almost nothing. This means people don't have to spend as much on their mortgages. It's easier to mortgage repayments and potentially, what's happening to the prices from there? Are they going up as much when interest rates or the price of houses going up substantially more than the interest rate or things like literally static? If you see over years, Aidan and I were discussing this earlier. We're saying in a way that the value of houses sort of is almost remaining the same. They're not going up substantially as interest rates fall. And  Aidan's, the economist here, probably explained this sort of much better than me. He's not merely just an accountant he is also an economist here. We think it has ramifications on like, how price setting? What are the price calculations for price-setting calculations for houses? It seems very much the predominant driver here is spending on a national level, and even on a suburb by suburb level. Yes, we see competitive pricing, price setting dynamics, but it's more than that. It's banks looking at our ability to spend on houses. Which we are more than happy to as consumers of houses we when we see as an investment.   I think like let's say, this is probably Sydney but obviously, you know the metrics in your own backyard as well. So, let's say in Sydney in 2020, there's a house or a unit that sells for a million dollars.  I'm sure if you pop in to meet your elderly neighbours next door, they'll tell you, they regale you with stories they back in 1984. They bought a very similar property or their property for $20,000 and, what a steal. So you be looking down you go "oh, I wish I was born in a different era and paid 50 times the amount of what they are paying". But when we look at this from a pricing perspective, I suppose what we're talking about is the elderly neighbours who bought their property for $25,000 and you're kicking yourself that used to spend a million dollars. When you really look at it, is that what you've spent and what they've spent? If you look at your interest rate and your mortgage. Probably 2% to something in Australia below 3% in the UK, it might be one 1% I'm not exactly sure what it'll be in the United States. But when you go back to the mid-80s, interest rates were very commonly above 20%. Inflation was much higher in those years. And so the difference between a 20% inflation rate and a 2% it's so different. People look at the price tag, but in reality, that's not really what you're paying. You're paying that price, you're paying your mortgage interest. The capital and the interest over the period, the lifetime of the loan. Which might be 25 years or 30 years, depending on where you are. So, what you're doing is if you add up the actual lifetime costs of that property. Let's be honest, I haven't got the numbers in front of me but the difference between the $25,000 the elderly neighbours have spent when they factor right over 25 years or 20% mortgage Interest is going to be a lot close to what you're spending than the initial headline price. So when we talk about house prices, we really never talked about this factor. Very very few people will go and buy a property straight off the bat just with a bag of cash. I suppose 80% to 90% of people will have a mortgage of some form or another. And so the headline price is it's probably not the most the best reflection on the actual cost of the property. We often talk about the cost of ownership on this podcast. When we're talking about the cost of finance is so important. So, think about, what the interest rate dropping really does for you, or the industry is increasing? What the price was back in the 80s? So the question is, Are house prices actually in bubbles? Are they actually going up or down? Is that even a relevant concept when we factor in the entire lifetime costs the money that leaves your actual bank account? Is it really that different? And is it really a bubble? When we look at that you're just asking yourself, do house prices just stay static over time? And when they do stay very static, is it just purely a factor, the interest rates are pushing up and down your ability to pay?   I suppose ultimately they can't go up so high that people can't afford them. That would defeat the whole purpose of buying them and then the banks would be in debt. Because people wouldn't be able to buy and people wouldn't be able to pay their mortgages. So they're guiding very closely to the market's ability to spend. Interestingly with the shifts in migration from China to Australia. For instance, where we're seeing an increase from there in an amount that can be spent on a house. People have argued that that isn't one reason one driver for house prices to increase. But the bank's response to that is to lower interest rates. So people here can also afford to buy. The ramification of that though is that people are selling big houses, family homes.  Australians are selling them for what they consider to be huge amounts. Downsizing into smaller properties or even renting. So maybe as more Chinese people, with wealthy Chinese people who can pay almost cash upfront for houses. Take on the bigger properties, more land areas in suburban and also city areas. So, what does that going to do to the nature of the whole country? Well, we may see a much higher proportion of Australians renting. That's quite unusual for Australians to traditionally quiet into homeownership. So, we'll see a change there. I think in terms of surprise setting, there's going to be increased competition. It's gonna be a manual. It's gonna be optimal pricing on a suburban level as different suburbs get more interest from foreign overseas buyers, etc. There's going to be obviously on Northern Eastern beaches there's going to be more expensive. In lands going is gonna be cheaper. But, who knows? This is speculation. But overall interesting price setting based on consumer spending  and ability to pay. So I suppose anybody who's more interested in this sort of topic and credit, inflated credit, lead inflation and credit lead in a boom can look into more of the Australian School of Economics, which really focuses on those aspects. Often it's not factored in very much in modern economics. But I'm sure it has a lot of truth in it. I think just ask yourself the question when we talk about pricing, the pricing of houses. If you bought your house today, let's say at a million bucks and interest rates are 2%. Then you try to sell it in 12 months' time, and interest rates are for whatever reason, they're often 19 or 20%. Wish they were back in the 80s. What would actually happen to the price of your house? What would you estimate? Where do you think could market price for that house would be? If you're selling it to a young couple who wants a new home and they're taking out a mortgage. I don't know where the number will be. But I'm very certain that would not be the same price that you paid for it. So yeah, it's just a different alternative viewpoint. That hammers home the idea that pricing is not just the ticket price, it's the payment options. If you're going to buy a car, will they give you credit for that car? Will they do a trade-in? What's the lifetime of the loan? What is the APR? All of these sorts of things are so important in selling any product. Sometimes the offer on price tag can actually hide the reality. It's like a loan shark. It's like, you know, you might get a loan of 100 bucks. If you got it from the bank, you get a 3% or 4%. You get it from a loan shark. You might get a significantly higher interest rate and come up with fewer fingers at the end of the day. So all things are different on the offer on price tag often hides more than it gives.