Questioning Australian Wealth

Cash flow is more important than the price of your house.

Thanks to the UBS Global Wealth Report, everybody knows that Australian households are among the richest in the world.

“Australia tops global wealth rankings.”

CEDA, Oct 29, 2018.

“Australians are the world’s richest people.”

Australian Financial Review, Sep 20, 2022.

“Australia remains one of the world’s richest countries. We’re ranked second in the world when it comes to median wealth per adult, well ahead of the likes of Switzerland, the UK, and the US.”

Morningstar, Sep 26, 2024

The price tag attached to Australia’s housing stock has more than tripled in the past 30 years. For Australian home owners, now 66% of the population, this has effected a considerable increase in their wealth when analysed on paper. For many households, the family home is their largest financial asset, and sale price on that asset has increased enormously, meaning that property has made Aussie families some of the wealthiest people in the world.

It’s a great story. Unfortunately, it’s not very accurate.

UBS may be justified in using an academic formula when ranking different countries, but surely what we really care about when we talk about wealth is the ability to make our lives better.

How to be rich

The problem is that in practise, expensive assets don’t make you rich. Cash flow does.

To unpack this further it’s worth stopping to consider what most people are thinking of when we talk about wealth.

If you visit an Australian primary school and ask the kids on the play equipment what it means to be rich, they’ll probably tell you it’s about having lots of “stuff”. Expensive cars, clothes, jewellery, and of course, a nice, big mansion.

Our association of wealth with “expensive stuff” is thanks to a phenomenon known as conspicuous consumption, described by social scientist Thorstein Veblen in his 1899 work, The Theory of the Leisure Class.

Building on Veblen, sociologists and marketing executives have understood for decades that one of the primary drivers of purchase decisions is not practical utility but social signalling. That is, when people buy a $1.3M Ferrari SF90 Stradale, it’s not because the car is literally 80 times more useful than a Hyundai hatchback. Actually, it’s the opposite.

Because both cars are perfectly suitable for getting you from A to B, purchasing the Ferrari demonstrates that you have far more money than you need to survive, and therefore you have the freedom to spend your money on something expensive that you don’t really need. If you’re struggling to pay the bills, you certainly can’t afford a Ferrari. If you buy a car at all you’ll choose the cheapest bucket of bolts that can get you to the shops and back. By contrast, owning a Ferrari implies that you have a massive disposable income.

There’s an interesting sleight-of-hand here which marketers have been exploiting for decades.

Considered carefully we see that conspicuous consumption works because expensive assets are understood to be a privilege of the wealthy. However, marketing campaigns are just as eager to portray such assets as the cause of wealth and success.

And so we end up with the thinking of the kids in the playground. How do you tell if someone is rich? See how much expensive stuff they own.

Of course, there’s a long list of celebrities and ordinary citizens who yielded to the temptation to live beyond their means, using lines of credit to buy the expensive stuff they couldn’t afford. It all looks very impressive in the short term, but when the cash dries up and the debt collectors come knocking, the illusion of wealth is revealed to be a sham. The cold hard reality is that assets do not make you rich.

The wealth mirage

The logic of asserting that Australian home-owners are magically more wealthy because the market price of their property has increased is not far from the thinking of the kids in the playground. The illusory nature of this wealth increase can be demonstrated by asking a few simple questions.

The first question to ask is, how did this increase in house prices come about? One thing we know for sure. House prices did not increase because all Australian homes suddenly became three times larger. Prices did not increase because the location of Australian homes improved, or because everybody carefully coordinated their renovations to ensure that the average aesthetics and quality of Australian homes dramatically increased. Australian house prices did not increase because of an increase in the actual utility of the houses. Prices increased because demand went up. More people were suddenly willing to spend more money to purchase Australian homes.

So in practical terms, when the average house price in Australia tripled, it didn’t truly benefit Australian households because it didn’t make their homes better in any practical way. The most notable thing that changed was the way that banks now treated these homes. A bank would allow you to borrow more money against your house than before. But tied up in this new ability to spend is a brutal fact: the bank is only willing to lend you that money because if anything goes wrong with the loan they can force you to sell your house and get back the money they lent you. There’s nothing exactly wrong with this, it’s just how loan collateral works. But it also doesn’t seem like a true increase in wealth on closer inspection. There are very real strings attached, limiting our options to utilise that apparent rise in value.

This underscores the next reason that increased house prices aren’t really an increase in wealth. Your house might be worth $1M but you can’t get access to any of those sweet dollars until you sell your house. Again, you could take out a bank loan using the increased home value as collateral but you better be confident that whatever you spend that money on is going to turn a profit, otherwise you’ll end up in a worse financial position than before.

If you do choose to sell your house, your options are still as limited as they were before prices went through the roof. In fact, the situation is worse. Whatever benefit you gained from the uplift in the price of your house is largely offset by the fact that everyone else in the street also saw their house price increase. And if you want to supplement your purchasing power by dipping into your cash savings you’ll find that this isn’t as effective as it was in decades past, thanks to the fact that the increase in wages has not kept pace with the increase in house prices.

So for those who own their home outright, the notion that increased house prices have increased their wealth is an illusion in most practical cases.

For those who have only entered the housing market in recent years, high house prices do nothing to make them more wealthy in any meaningful sense of the word. This is where we come to the all-important difference between assets, liabilities, and cash flow.

An equation for wealth

Let’s consider the definitions with some basic examples.

An asset is a resource with economic value that is held for the expectation of future benefit. A house might be considered an asset because you could expect to benefit from selling it in the future. You obviously get some immediate benefit from living in it also.

A liability is simply a debt that must be repaid. A mortgage is a perfect example. It’s worth noting that while you may consider your house to be a financial asset because of the potential to benefit from a future sale, the debt liability is immediate. And thanks to variable interest rates, it’s extremely difficult to judge the total size of your liability – i.e. the full amount over the life of your mortgage that you must pay to own your home outright.

Cash flow is the difference between income and payments made by a household. Positive cash flow means the household has greater income than it is spending. Negative cash flow means household debits exceed income. This is why controlling your cash flow is central to building wealth. It doesn’t matter how high your income is, if you have massive debts – such as a multi-million-dollar mortgage – this could reduce your weekly budget to a tiny amount. The margin for error with large debts is slim. Mess up your financial planning and the bank could close in and take away your home.

The good news is, the maths behind it all is pretty simple. To increase cash flow, your income must increase or your payments must decrease.

The bad news is, it’s often far easier for banks to increase mortgage interest rates than it is for the average wage worker to negotiate a raise. Furthermore, the larger the loan, the bigger the increase in repayments for even small increments in the interest rate. 1% of $350k is $3,500. 1% of $1M is $10,000.

What does this boil down to? Big debts without clear exit strategies are a threat to true wealth.

Big prices equal big risk

As Australian house prices have increased, so too has Australian household debt. The ABS Survey of Income and Housing 2019-20 revealed over 30% of households with debt 3 or more times their income. This is a marked increase compared to surveys in 2009-10 (24.2%) and 2017-18 (28.4%). Larger mortgages for the same homes means families are exposed to increased financial risk for a fixed quality of accommodation. This is clearly a step backwards.

At the turn of the century, it was easy for families to find what they were looking for in a home. The choice was primarily between peripheral conveniences such as a 10 or 20 minute commute. Today, if you want to live close to your job in an Australian capital city, if you want to raise your family in a private home, if you want to locate close to your parents and grandparents, these preferences must all be balanced against your appetite for considerable financial risk. Even outside major metropolitan zones, many houses have doubled in price within the last decade, presenting a serious challenge for families seeking to gain the security of home ownership while limiting their exposure to mortgage debt.

Sure, in theory, you could pack up the entire extended family including Nanna and Great Uncle Daryl and everyone could move out to Broken Hill together where house prices aren’t so high. And hopefully everyone can find remote-working jobs that pay the same as back in the city. And we could pretend that Broken Hill has the same liveable amenity created by the cashed up councils on the coast.

Alternatively, you could devise some sort of cross-family, intergenerational investment scheme to allow you to break into the coastal property market. This, of course, may or may not destroy the civil health of the family itself, depending on the financial acumen of the family involved and your knack with contracts.

Family assistance or not, many young families are taking on massive mortgages for the privilege of simply purchasing a modest family home. Until that mortgage is repaid, the house is a liability, and given the aggressive swings that are possible with variable interest rates, the liability carries great financial risk. As house prices continue to soar, this liability does not become less risky, but the viable escape routes for families seeking a comparable lifestyle and similar quality of accommodation diminish.

Families today have fewer high-value options and more hard decisions to make. In this respect, high house prices have made us poor.

What matters most

Holding the rights to a multi-million dollar housing asset is small comfort to a household where mortgage repayments have overtaken income, and cash flow has become negative. An expensive asset does not make you rich. Neither does a large liability.

So what does it mean to be rich?

Leaving the playground behind and returning to the Ferrari example we see very clearly that wealth is not an abundance of stuff. Nor is it an abundance of numbers on a property valuation report. Wealth consists in an abundance of options. Conspicuous consumption communicates wealth because it implies the Ferrari owner has many options for how they can spend their money.

With this in mind, it is immediately obvious that cash flow matters more than asset value. When income is far greater than debts, households can choose between a wide range of options in spending their cash. New car? New boat? New business venture? This is the freedom of a true increase in wealth.

If Australia had seen net household incomes triple we would be in an entirely different position to where we find ourselves today. The key macroeconomic factor capable of delivering such colossal improvements to quality of life is growth of national productivity. Indeed, it is productivity growth, not house price growth, which drove the meteoric rise of nations such as Japan, Singapore, and Korea in the second half of the last century. The wealth increase of these nations delivered the populations from the constraints of widespread poverty, providing improved living standards and expansive lifestyle options.

Conclusion

There is savage irony in the fact that a nation preoccupied with housing is not a nation poised to deliver breakthrough innovation for productivity. We will never know how many would-be Australian entrepreneurs of the current decade will instead find themselves mired in mortgage debt, paying inordinate childcare fees, and commuting for hours to visit family. Entrepreneurs of past decades such as Dick Smith have flagged their concern. Far from increasing the true wealth of Australian families, soaring house prices have reduced our freedom and flexibility.

Until we reject the lie of national wealth based on overpriced housing we will struggle to build a future for ourselves and the generations to come. It is imperative that we begin investing in our nation to create the options that constitute true wealth. This requires action on a scale we can’t afford to leave to private investors. Only bold public policy can restore the freedom that has been lost to the political negligence of the past three decades.

As a start, we need substantial housing options that extend beyond the provision of the market. We once constructed those options when we decided it was important to house our WWII veterans. We can build them again.