I have a fantastic investment opportunity I want to share with you.
I want to sell you a chicken.
And before you laugh, you should know this: if you had invested in one of my chickens a few short years ago, you would have been rich1. And now is your chance.
Um. How much?
One million dollars2, give or take.
One million. Don’t worry, you can borrow most of it. The banks will lend you 80% of the value, so you just need to come up with $200,000. If you don’t have it, ask your parents. They can use the money they made from selling their last chicken. Most of them have one – they got in early.
A million dollars for a chicken?
Well, you get all the chicken’s eggs. And it’s a pretty reliable chicken. She delivers eggs on average for 50 weeks of the year. Each year, she’ll give you around $35,0003 worth of eggs.
$35,000? How much do I have to pay in interest?
Around 5%4 each year. You borrowed $800,000, so that’s about $40,000 in interest a year.
What? So I’m getting $35,000 of eggs but paying $40,000 in interest? Aren’t I losing $5,000 each year? And hey, I already paid $200,000 in cash! At the very least I could have invested that and made 3%5 in a savings account. That would have made me $6,000 a year. So all up this chicken is costing me $11,000 a year?
Well, not quite.
Oh, thank god. What did I miss?
Well, you need to maintain the chicken in good health or she won’t lay eggs. Fix her cage, pay for her water, pay tax to the council, that kind of thing. Don’t worry, it’s not that much. All up, each year, the cost is between a third and half of the eggs she produces6. Let’s call it $10,000 to keep it simple.
Wait. So now she is actually costing me $21,000 a year?
Well, yes, technically I suppose. But there’s a silver lining to this. You are going to love this. Everybody does. The higher your loss, the more you get to save on tax! Assuming your tax rate is 50%, that means you get half back – $10,500 from the tax man. How good is that!
What? But if he is refunding me 50% of my loss, I’m still paying the other 50%. That means this chicken is still costing me $10,500 a year to own. Why don’t I just invest my money somewhere else, and buy the eggs from someone else’s chicken?
Everyone knows you don’t make money from selling the chicken’s eggs. You make money from selling the chicken!
But why will I make money from selling the chicken? Surely the value of the chicken has to be linked to the value of the eggs?
Oh, that’s easy. Everyone loves buying my chickens, you see. We are a chicken-loving nation, and everyone in this country wants to own their own chicken. They always have. The price just keeps going up and up. Look around you. Everyone is making money selling chickens. The price of my chickens doubles every 10 years, and that’s the bare minimum. The last few years have been even better. Two years ago, the price of some chickens went up 50%! Remember, the longer you wait to buy one, the more expensive it will be.
What’s to stop the price going down?
Down? That’s absurd. For one, there is a shortage of chickens. So prices just keep going up.
Oh right, so the price of eggs must be increasing as well?
Um, well sort of.
What do you mean, sort of?
At one point, when the economy was in better shape, the price of eggs was growing by around 2-3% a year. Last year, it didn’t really grow though. It went down in some areas, actually7. And it didn’t grow much the one before that, either.
How is it possible for the price of chickens to grow so much when the value of what they produce is going down?
Interest rates, someone told me. But anyway, don’t worry, people from overseas are trying to buy our chickens! They love our chickens. That is keeping prices high.
You are talking about China. Didn’t a similar thing happen with Japan a while back? How long did that last?
Maybe. I don’t know. That was a while ago. Anyway, the Chinese purchases are slowing already, I think. Some of them were actually illegal, it turns out. But don’t worry. No one likes selling their chickens at a loss, so the prices don’t go down. Look at the price history. Though there might be tiny blips, prices always go up.
For how much of that history was the cost of owning a chicken negative though? What happens if the chicken owners can no longer afford to own the chicken at a loss?
Look. Are you going to buy the chicken or not?
I just think that the price of the chicken should only go up if the value of the eggs it produces is going up too. And that doesn’t seem to be happening. The incomes of the people buying the eggs is flat at best – how will they afford to keep buying more expensive eggs?
I have to go. A lovely foreign couple is waiting for me in my office. They brought cash!
1 Sydney prices up 52% since June 2012 (source: https://www.corelogic.com.au/news/home-values-in-australia-continue-to-rise-as-rental-yields-slip-to-new-record-lows). This is total value – equity returns are much higher given the amount of leverage in a typical house.
2 Pretty close to the median house price in Sydney (about US$700,000), depending on the source and how you measure it. Corelogic estimates it was A$780,000 at 30 April 2016 by the way.
3 Sydney average rental yield 3.5% at 31 January 2016 per CoreLogic RP Data. $1m * 3.5% = $35,000. Note that Melbourne rental yield was 3%.
4 ANZ / NAB 2-5 year fixed rate loans at June 2016 are a bit above 5%. You can borrow at around 4.2% currently in Australia, but this is a variable rate that banks can alter whenever they like.
5 ING Australia savings account rate at June 2016 is 3%
6 This is a rule of thumb. Another is 2% of the total gross rental yield (in this case, expenses would be even higher for the example shown).
7 Corelogic RP data in Australia to April 2016 showed rental growth flat to declining in most markets over the previous twelve months, including in Sydney.