An assumption of ever-lasting favourable conditions when picking stocks would raise alarm bells for fund managers, but for some reason an ever-booming property market doesn't attract quite the same concern.
Using their stock picking techniques, Auscap Asset Management has determined the downside risks involved in property are too great to invest, especially when correlated over time with household income.
More Domain Videos
Canberra's auction market on the move
Every single district of Canberra has seen a lift in the number of homes selling at auction.
Australian residential property prices have experienced annual growth of 7.4 per cent and have not been exposed to a broad decline since 1991, prompting a view by many that buying houses is a relatively low-risk prospect.
"The inference is that past returns tell us something about future returns," Auscap Long Short Australian Equities Fund principals Tim Carleton and Matthew Parker said. "This extrapolation bias carries considerable risk."
![Australian residential property prices have grown by 7.4 per cent per year and have not experienced a broad decline ...](/web/20170119094009im_/http://www.smh.com.au/content/dam/images/g/t/s/l/5/t/image.related.articleLeadwide.620x349.gtu98v.png/1484812980471.jpg)
Usually, house prices rise in line with household income; when people earn more, they tend to bid up the prices of houses.
But Auscap says while household income has levelled off (now at 3.7 per cent per annum), property prices have continued to rise, increasing the downside risk considerably.
"Prices have risen to reflect the favourable macroeconomic factors," the fund managers said. "But like a stock that is pricing in the continuance of favourable conditions, this most likely means that the downside risks associated with investing in property are elevated."
On top of the fact income isn't growing anywhere near the rate of property prices, the amount of debt households are taking on to service bigger and bigger loans makes the prospect of stable market growth riskier.
![Auscap's Matthew Parker, left, and Tim Carleton have found few compelling opportunities following the market shakeout.](/web/20170119094009im_/http://www.smh.com.au/content/dam/images/g/o/n/u/e/u/image.related.articleLeadwide.620x349.gtu98v.png/1484812980471.jpg)
Record low interest rates have made it much easier for households to leverage themselves considerably in order to purchase property, but cheap debt may soon get much more expensive.
"With global interest rates close to the zero bound, it is hard to envisage significantly better borrowing conditions than currently exists," Auscap said. "The risk that interest rates rise over the medium term could be significant."
![Auscap Asset Management's Tim Carleton says the January sell-off in the sharemarket was overdue.](/web/20170119094009im_/http://www.smh.com.au/content/dam/images/g/i/q/t/3/p/image.related.articleLeadwide.620x349.gtu98v.png/1484812980471.jpg)
If mortgages costs increase, it's unlikely people will be buying houses with as much fervour as they do now, perhaps putting a dampener on prices and lessening the investment return.
On top of household wage growth and the cheap cost of debt, Mr Carleton and Mr Parker point to the possibility of rising unemployment and a slowing in overall economic growth (25 years of uninterrupted growth increases the likelihood of a slowdown) as further catalysts to avoid investing in residential property.
"The fact that growth rates in house prices have exceeded growth in household income indicates to us that prospective residential housing returns will be significantly lower going forward," the fund managers said.
"Certainly our conclusion would be that a continuation of the 7.4 per cent per annum growth in house prices witnessed over the last 20 years seems extremely unlikely in the absence of borrowing costs continuing to fall, which we see as limited given where interest rates are currently."