Are reported property market returns exaggerated?

Friday 22 April 2016
Published by Rick Horvat

I recently came across an article which highlighted how Melbourne house values had increased by 10.7% for the year ending 31st of March 2016.  This is really quite amazing, and got me thinking; ‘I wonder if our house has had this same sort of return?’

We live in Thornbury which is north of the city, roughly 8km from the centre of town.

Thornbury has apparently had an average annual growth rate of 8.86% for the last 12 months.  Not 10.7%, but still not bad.

We bought our house for $470,000 in 2009 and it was recently valued at around $720,000 (we have it valued regularly just so we can see where we are at financially).  Based on these figures, our annual return has been 7.59% per annum.

But being my father’s son, I’m sceptical of this figure.

What if the figure being touted as the percentage return on property is inaccurate, and hasn’t actually taken into account all of the information required to determine the net growth rate on an asset?

Let me explain;

A client we were recently working with sold their house in an affluent Melbourne suburb for $1,200,000 (after costs).  They had bought this house 6 years ago for $700,000.

In looking at these figures, the return on this property was 11.9% per annum.

But this isn’t the full story.

Stamp duty at the time of purchase on this property was $39,000.

Over the 6 year period they held the property, the couple spent $250,000 on renovations.  They added an additional room, updated the kitchen, added another bathroom and redesigned the back yard.   It was a beautiful home when it was all done.

Taking into account this information, the total capital outlay for this property was $989,000 ($700,000 + $39,000 + $250,000), not the $700,000 previously mentioned.

Based on this, the actual return on this property in that 6 year period amounted to $211,000 or 3.5% per annum.

In June last year, PIMCO (one of the world’s biggest fund managers with over $1.5 trillion in assets under management) released a report discussing the rise in Australian household debt.  Within this report they highlight the continual link between the increase in household debt and the increase in the value of Australian house prices.

Maybe one of the reasons this debt is increasing is due to people borrowing money and spending this capital on their houses (or their investment properties)?  Maybe this is one of the reasons why house prices are increasing in value?

This ongoing capital outlay (to improve the property and therefore increase the property value), is not being considered when the performance of property is being reported, creating (in some instances, and maybe most) a false sense of asset appreciation.

When relaying all of this information back to our own house in Thornbury, our annual rate of return is a measly 2.9% per annum!  We would have made more money investing in a term deposit over this same period, although it’s pretty hard to live in a term deposit!

Obviously, there are properties that have had these amazing high, single digit/ double digit returns across all capital cities over long periods of time.  But as with any information that is fed to us, we need to understand how that information was derived and who is providing that information.