If you ever wanted a detailed explanation as to why Australian property markets aren’t guaranteed to recover, we’d suggest reading Michael Yardney’s article titled to “Why our property markets are guaranteed to recover”.

Yarndey’s website describes him as “Australia’s most published property author and has probably educated more successful property investors than anyone else in Australia”. The only problem — based on his writing, he doesn’t appear to understand the difference between “price” and “value”. This is somewhat problematic when purporting to provide investment advice.

Yesterday, Yardney noted quite reasonably that Australia’s ageing population will lead to difficulties as baby boomers stop working and contributing to national revenue, and instead, start absorbing revenue. The problem is  Yardney then failed to understand the implications of this change. More fundamentally, Yardney appears confused as to how to value an asset. Instead of pricing an asset based on its potential income, he appears to suggest that prices are based on “population growth” and “increasing wealth” — this may lead to higher prices and rental income, but not necessarily. (Supply factors also play a role).

The only way to value property is by reference to the future net rental returns (after all costs) and comparing those returns to the “risk-free rate” (this is often considered the return received on government bonds, which admittedly, are not really risk free). If rental amounts are increasing, then purchasers could be justified in paying a high “earnings multiple” for the property (perhaps basing it on a yield of 5%).

The problem with Australian residential property (in capital cities) is that prices have far exceeded intrinsic values based on their potential returns. The average return on owning a property is  2-3%. That is about half the return on a term deposit. The reason prices are falling is that purchasers have come to the realisation that these prices are fundamentally too high. The property market, like any market, is not efficient, so for long periods, prices will be above their intrinsic value (or below it).

Over the past 15 years, property prices have increased at a far higher rate than inflation and wages growth.

In 1994, before the recent bubble, the median price of a property in Australia was $148,800. By 2010, the median price had rocketed to $450,000 — a rise of more than 200%. Wages increased at a far lower rate. In fact, had property prices tracked wage growth, the median house price would be $267,000. Had property prices tracked inflation, the median house would cost a mere $230,000. (The Economist came up with a similar figure, noting that based on rentals, property was more than 50% overvalued).

The reason for the increase in property prices? Debt.

Australian lenders (and the government as well) have facilitated a debt o-gy, which has allowed Australia’s mortgage debt to GDP to rocket from about 20% to 90%. House prices have risen not because we’re richer, but because Australians (and overseas buyers) have borrowed to “bid up” the price of property.

Yardney doesn’t appear to take this massive increase in debt into account — instead noting that property prices will increase because:

“I don’t think that anyone would argue that as a nation Australia will become wealthier over the next 15 years. Australia is well positioned to benefit from the growth of Asia, which represents 50% of the world’s population. We have vast resources that will be required by our growing neighbours, and we’re at the beginning of the mother of all resources booms.”

Aside from the fact that resource prices have already slipped substantially from their peaks (spot copper prices are down more than 20%, while iron ore spot prices had fallen to a 22-month low in October) — growth in resource prices have minimal effect on Australian property prices. About 2% of Australians work in the resources sector, and they are confined to relatively limited parts of the country. Quite simply, increased resource prices will almost certainly not lead to higher rental income, so it will not underpin higher property prices.

Yarndey then claimed that:

“On many accounts the average Australian is richer already than people living in most other countries, however some people living in Australia just don’t see that and complain and protest.”

Clearly, doing actual research isn’t Yarndey’s strong point. Australia’s GDP per person in 2010 (according to the IMF) was $US55,672. The United States recorded GDP per capita of $US46,860. However, Australia currently had a median property price of $450,000 compared with the US, which has a median price of $221,000. Australia may seem wealthier because of the housing bubble, but the problem is, sky-high Australian house prices do not represent real wealth. Much like a share in the dotcom in 1999 didn’t represent real wealth. Eventually, house prices must return to their intrinsic value — when that happens, Yardney’s mythical claims of Australian wealth will vanish.

Yarndey later stated that:

“We must also recognise the opportunity this will give us to boost our declining workforce and in turn, our country’s economic well-being through revenue raised from income taxes, as well as new Australians buying goods and services. And yes, that includes property.”

Exactly how purchasing over-priced property achieves this is unknown. Ironically, part of the reason for the property bubble is government policies such as the first home owner’s grant, concessional CGT and negative gearing, which means that property speculators pay a far lower tax rate than ordinary workers.

Property spruikers such as Michael Yardney can take some credit for helping inflate Australia’s housing bubble. But it’s up to Australian property buyers to recognise the difference between price and value.