Is a house the only way to make it? Editor's note

In last week’s editor’s note I explored what I characterised as the wishful thinking of investors who were anticipating a return to the low interest rate / inflation environment we experienced since the GFC. Next week I will follow-up on what that means for investors if this scenario doesn’t play out. This brief delay is in response to feedback from our latest podcast episode. Shani and I wandered into a storm by dedicating an episode to housing. We love hearing what investors around Australia think even if they think we are wrong. We’ve been wrong before. We will be wrong again. What I think is interesting and what may offer a lesson for all investors is the emotional nature of some of the reactions.

As investors we constantly hear stories about how others have achieved success. Some of these stories are embellished but most are good natured attempts at providing advice. The problem is that what was successful in the past doesn’t necessarily equate to success in the future. A point we tried to make in the podcast was that our evaluation of housing as an investment occurred at a very specific point in time. That point in time was not 10 years ago. It was not 30 years ago. It was on August 28^th 2022. All investments are forward looking. Most investors are living in the past. And in the past housing was a great investment.

A little appreciated aspect of successful long-term investing is to avoid the big mistake. We hear all the time about how finding a couple 10-baggers is the secret to investing. Unfortunately, what happens more often is people ‘discover’ these gems after they’ve had their run and pile in at the end. Sydney real estate has appreciated 146% in the decade ending in October 2021. Add in the leverage from a mortgage which amplifies returns and you are not quite at a 10-bagger – but pretty close. Sydney is also the second most expensive housing market in the world. Melbourne, Adelaide, Brisbane and Perth are in the top 20 most expensive markets. As an asset class, housing has some attributes that make it more likely to be a major financial mistake than other investments. It is the biggest investment most people make. There is leverage involved. Emotions come into play as it is easy to form an attachment as you envision a future within the four walls. The auction process awakens animal spirits as you furiously compete with your fellow bidders.

I have two friends that constantly talk about winning the lotto. They are dreamers and it is inspiring to hear them envision a series of amazing futures. It is a needed balance to my cynicism. And a lottery ticket is a conduit to a dream for the future - something in your possession that gives you the opportunity for a future filled with everything you think you want and need. A house or an equity holding can feel the same way. Thinking about housing prices appreciating the same degree they did in the last decade is the same feeling you get holding a lotto ticket. So does an investment in the share market when the S&P 500 including dividends averaged an annualised 17.6% return between the GFC low in March of 2009 and the end of 2021. It is not surprising that people react emotionally if you question the likelihood of these returns repeating in the future. What you are questioning is not the merits of a particular investment. You are questioning if the future they envision will occur.

Our podcast episode was not a prediction. It attempted to look rationally at a financial decision that is fraught with emotion. In the world of share investing, we should strive to rationally examine what assumptions are built into a share price at any particular time. We do this to make sure the future expectations are not impossible to meet. People investing in residential real estate should do the same.

The ultimate lesson for anyone who emotionally reacts to questions raised about an investment decision is to explore the source of that reaction. Is it because you are unsure of the investment prospects? Is it because you have a nagging feeling that the confidence you outwardly project is misplaced? Is it because your rationale consists of ‘this worked in 2010’?

I will conclude with an attempt to burnish my pedestrian article in literary genius. The question is who can best encourage independent thought? Robert Frost said, “Two roads diverged in a wood, and I—I took the one less travelled by, And that has made all the difference.” Dostoevsky implored us to consider that, “To go wrong in one’s own way is better than to go right in someone else’s”. But maybe the most appropriate quote comes from A.A. Milne who said, “The third-rate mind is only happy when it is thinking with the majority. A second-rate mind is only happy when it is thinking with the minority. A first-rate mind is only happy when it is thinking.”