THE ROOKIE GOES LIVE | THE STRANGE ALCHEMY OF PROPERTY PRICES / by Patrick McComish

This week’s Update marks the first time I will be publishing using my website, adamhoward.com.au.   Pretty excited as I have now officially joined the 21st Century.

Firstly, a big thank you to The Audiophile for being patient with me and my demands while building the site.  For a legally trained aquaculturalist he builds a good website.

Before launching into a continuation of last week’s theme I thought a brief explanation of the website was in order.  Firstly, you will all have noticed I like to refer to people I speak with using a pseudonym or as like to think of it, a nom de guerre or war name.  Not that I consider business in the modern economy a daily battle, but there’s something there that appeals to me.

So, it only seems fitting that I also give myself one; The Rookie.  Why?  Because I know a little about a lot; the quintessential jack of all trades and master of none, I can carry on a half intelligent conversation on a lot of topics.  I just struggle when we get to details.

I have spent time in hospitality management, sports coaching, labour relations regulation, economic policy formulation and commercial banking, which have provided me with a diverse and sometimes muddled way of looking at the world, but one of the clear benefits has been the opportunity to meet a wide array of people and listen to their stories.

My nom de guerre, The Rookie, was given to me by another friend we will intriguingly call The Girlfriend (I AM married, after all) when she kindly made some invitations for my 30th birthday party.  I liked it as I had always felt like a bit of a pretender who always had more to learn, and that’s the way I conducted all my conversations with customers and friends, whether they were buying a beer, brushing up on their forehand, complaining about being underpaid, wanting to influence the Minister or asking for a bunch of cash: who are you, what have you done, did you succeed or fail, and why.

I guess the only thing I would say I have in great supply is a desire to meet people and listen to their story, work out their needs, wants, wins and losses and then turn these stories into a ripping yarn.  All I have had to do is work out who is my audience and change the story a little on that basis.

Hence, The Update by The Rookie.  It’s just me telling a story based on stuff I have read, heard or been told (with a bit of filtering to make sure it is at least close to the truth).

And now, back to our regular program.

Last week I left you with a couple of websites that provide reasonably reliable and relevant data regarding the WA property market, UDIA WA and REIWA.  You could also throw in realestate.com, although the search engine there is really slow and the site itself is too busy so that it becomes confusing.

This brings me back to a guy I have referenced previously, Nate Silver.  I follow him on twitter and watch any interviews on You Tube I can find because he has a really simple, pragmatic view to decision making and makes it pretty clear how he feels about “experts” and their opinions.

Silver also refers to the fox and the hedgehog, which I briefly spoke about last week, where the fox is cautious, probabilistic and always updating their view of the world on the basis of new information.

The hedgehog meanwhile, has a very firm idea of how the world works and interprets everything that occurs through that prism.

The media loves a hedgehog as they make big calls which are often controversial, show clear cause and effect and are predictive.  If you can get two hedgehogs on a show together with differing world views, then you have the potential for a ratings winner.

Think about any time you have Bob Katter on a panel.  You will also find the panel includes one or more liberal minded figures as there is a good probability a confrontation will ensue.

But this panel will not really reveal any new information that’s of benefit to anyone.   It will just be juicy viewing as two ends of the political spectrum go head to head.

Or a panel including Richard Dawkins, the world renowned atheist.  There is sure to be a representative of the church or some evangelical Christian there in the hope they go at it.

Once again though, there won’t be any new information presented, meaning it won’t be any easier to make an objective decision about the topic at hand after watching the panel discussion.  What will happen though is most viewers will have a much stronger subjective view of the topic.

This is what Silver is referring to in the title of his book, the signal and the noise.  The noise is everywhere, drowning out everything else.  It is sometimes hard to find the signal; the truth, the accurate data.

The media often does a great job of getting the “noise” out there, and it quickly becomes a truth, just because it was in the paper or on the news.  And I am not just talking about instances where the reported “facts” turn out to be wrong, but instances where the narrative reported is an easier story to sell.

Here is a clear example of that regarding the WA metro property market.

I listen to the news, read the paper and go to seminars/talks where the message is clear: the demand for smaller residential blocks in the metro area is growing.  At least, that’s the story I have been getting.  There was a piece in the news a few weeks ago discussing exactly this fact, noting the following changes in average block sizes over the years:

1950’s – 1980’s                900sqm
1990’s                               600 sqm (33% reduction on 1950’s)
2000’s                              450 sqm (50% reduction on 1950’s)
2012                                  350 sqm (61% reduction in 1950’s)

No change for almost 40 years and then a dramatic drop in size over the last 20 years.  Why?  Apparently household preferences have suddenly changed.  Older people downsizing who don’t want a garden to care for, or young professional couples who are either at work or out at dinner don’t have time to look after a garden.

That’s a nice theory, but from a personal perspective I don’t want a smaller piece of land, I want a larger one, but a larger piece of land is really expensive these days.

Now, we know from the data in the Update of two weeks ago that WA’s population has grown substantially over the past 10 years, feeding demand for land of any type.  But why smaller?

Then there’s the bizarre phenomenon of land becoming more valuable as the parcel gets smaller.  This also seems to support the “noise” that demand for smaller blocks is rising, as buyers are prepared to pay more per square metre for smaller lots, as shown in the below table:

The final piece of “noisy” data is the change in the house/land value proportions of total value over the past 10 years.  In the early 2000’s the house comprised 66% of the value, and the land the other third, or a ratio of 2:1.  By the end of the decade that ratio had flipped to 1:2.

One of the core tasks in my job is to get a property valued, and the valuation report often separates land value and value of improvements (the house).  Two examples recently are as follows:

  1. 3 bed, 2 bath residence in North Fremantle on 413 sqm, with house with 263 sqm of living space.  Value was split $775k land and $575k house, or 58% land and 42% house.
  2. 3 bed, 2 bath residence in Carlisle on 285 sqm, with house with 117 sqm of living area.  Value was split $350k land and $270k house, or 57% land and 43% house.

So, once you collect all the noisy data it is really quite easy to see why one would think the demand for smaller block sizes is on the rise. 

  • High population growth feeding demand;
  • Median block size dropping;
  • Price per square metre rising as block size decreases; and
  • An increasing proportion of total lot sales clustered across block sizes from 300 to 600 square metres.

This is why the media annoys me because all the above information was really easy for me to find, and it forms an easy to understand, cause and effect story around the rise in popularity of small blocks.  But it’s not the full picture and really, when you dig a little more, these phenomenon appear to be symptoms and not the cause.

The real drivers of decreasing block sizes appear to be as follows:

  • Creation and implementation of urban development boundaries (UDBs) by State Governments in the late 1990’s;
  • The increasing cost of developing land of any type, driven by statutory costs; and
  • Land becoming unaffordable for first home buyers or low income households since 2007.

I would bet the majority of readers don’t know what UDBs or land development statutory costs are, so you can see why any journo worth their salt would choose to tell the story around population growth, prices and “market forces”.  It’s easy, understandable and appeals to the mass market.

What about the apparent real causes?

Here goes.  UDBs are boundaries around urban areas which limit where land can be released, developed and sold.  They are a newish concept (the past 20 years), are largely arbitrary but then highly regulated and hard to change.

In WA this is managed by the Department of Planning.  If you are interested check out the site at www.planning.wa.gov.au, but I warn you, it is sleep-inducing stuff.  Heavy on management speak with lots of references to “sustainability and timeliness”.

The result is it is now quite a lengthy and costly process to get new en globo land on Perth’s fringes approved and released for development.

This has now led to the creation of another industry; urban infill development.

At the top end, this is where a big piece of land like the old Perry Lakes Commonwealth Games stadium is remediated and then sold as residential lots.

At the bottom end, this is where your Nan dies and leaves you her quarter acre block in Bayswater and the zoning allows you to subdivide into three blocks.

Let’s assume for a second that your Nan didn’t leave you the block; instead you decided to buy a block in Bayswater with an old weatherboard 2 x 1 on it for land value only.  If it was 1,000 sqm then you are probably buying it for between $800k and $900k, or between $800 and $900 per sqm.

Now, how do you make money out of this?

Well, let’s assume you want to make a 20% gross return on the purchase price of $900k, so $180k, and that the cost of knocking over the weatherboard, getting rid of the rubble, clearing and surveying the site, getting approval for new titles and installing the water, electricity and other essential services comes to about $200k.

One of the potential causes Iisted above for the rise in the cost of small blocks has been the increase in associated statutory costs; the cost of providing each site with water, power, roads, footpaths, telephone lines, etc.  Essential services.  More detail on these increases below.

Total cost of $1.1m and you want to make $180k.  If real estate agent’s fees are 2% of the sale price then that cost will be about $25k.  Local zoning allows you to divide the original block into 3 titles.

When you add all that up it comes to about $1.2m, meaning you need to sell those pieces of land for $400k each to make your money.

Now you have 3 new pieces of land of about 300 sqm each (allowing for losing 30 sqm each in the subdivision process) costing about $400k each.

That translates to $1,333 per sqm, up from $900 per sqm, or an increase of 50% in cost.

What about those statutory costs?  A character from a previous Update, The Beancounter, told me the ratio of land costs to statutory costs when developing land used to be about 60/40, but that this has now swung to 40 / 60, with the land costs remaining static.  This means there has been an almost 100% increase in the cost of providing essential services to new lots.

That seems excessive…

And that’s how the price per square metre of land in Perth goes up.  Buyers have no choice but to buy smaller lots as:

that’s all that’s on offer; or

they can’t afford anything larger.

As affordability drops the only answer is to create smaller blocks which cost less, but more per square metre.

So, buyers are paying more, but getting less and the media line is buyers are demanding more of that???

I think not.

This brings me back to our poker analogy, where you think a two card hand that includes an Ace is better than a pair of 2s.

Well, now you know it’s not, don’t you?

Food for thought…