My Theory on House Prices

At the end of the day, real estate investment is very similar to a 3 year bond.


You invest a large amount upfront, get coupons (rent) back as regular income and then (after sale) receive the full amount back (if you hold to maturity).


Obviously the risks are, capital loss and loss of coupons if the place is not rented. But in a place like Sydney not much of a risk. 3 year bonds in Australia have been yielding an average of 2.6% over the last 3 years, but 2.3% over the last year and under 2% over the last 6 months. Even with 80% occupancy, a $1.4 million dollar house earning rents of $750 a week will still give you a yield of 2.2% (or around 2.86% with negative gearing thrown in). And that's if house prices stay steady over the three year period.


Based on these figures, and because blind freddy could see bonds have been predicted to go through a bit of a correction, money has been flowing into Real Estate instead of bonds, causing (house) prices to go up and yields to go down.


However, once the US Fed starts increasing rates, I predict that the money will leave Real Estate and go back into Bonds (better liquidity generally). Hopefully this will take some of the investor activity out of Real Estate (they have lower costs of capital than Owner Occupiers due to the tax effect of negative gearing) and hopefully drop the prices a bit.


But we will see.