Bubble Bubble Toil and Trouble

Is it a housing boom or bubble?

MICHAEL YARDNEY

On the one hand many analysts see great times ahead with double digit capital growth predicted for some of our capital city real estate markets next year.

On the other hand, there are those who are convinced our market is an unmistakable housing bubble and expect an eventual significant drop in house prices which will leave ugly, rich property investors nursing heavy losses.

So are we in a housing boom or is there a bubble?

The bottom line is we are not in a “bubble”, but home prices lifting from their trough in the middle of last year.

 

 

What’s happening to dwelling prices?

The latest house price results from RPData – for the year to October – suggest a rather tame residential market in response to favourable influences such as low interest rates, an undersupply of new housing starts, strong population growth and rising consumer confidence.

As you can see the Sydney market is booming, but if you look back over the past decade Sydney home prices have barely grown in line with inflation, having risen only 2.5% per annum.

What’s happened since the market bottomed last year?

In general, home prices dropped in 2011, bottomed in mid 2012 and then started retracing as investors and home buyers embraced attractive market and economic conditions.

However, if you look at recent growth periods following previous market lows, specifically at the beginning of 2001, 2007 and 2009 you can see from the next RPData graph that the rise in values this time round (over the last 17 months) is significantly more modest when compared with the previous three growth cycles.

What we are experiencing is the normal machinations of the property cycle.

What happens is that property values rise then they slump for a while, then they retrace and finally go into the next expansionary phase as you can see in the following graph from Dr Andrew Wilson of Australian Property Monitors.

Current price growth around the 6% per annum mark is in line with the long-run average. While dwelling prices are up by around 9% from the mid 2012 trough, they are only around 1% above the previous (late 2010) peak.

And these gains are concentrated in Sydney (where real prices have changed little since 2004) and Perth (where population growth is strong). Price growth in other capitals and regional areas are more restrained.

But aren’t houses in Australia already too expensive?

Yes, they are expensive by world standards, but this is a reflection of the fact that most of our population is concentrated in a few coastal capital cities. We also have high quality, large housing stock generally on big blocks of land.

Plus the poor state of public transport in our big cities only increases the premium on properties located close to the CBD.

Of course this has some bubblers saying houses are now ”overvalued” because the rise in house prices over the past few decades vastly outperformed the rise in wages.

This overlooks the historic boost to household borrowing capacity that occurred in the 1990s with the halving of interest rates. This, in effect, doubled the amount households were able to borrow their income.

At the same time the relaxation of lending standards by banks in response to financial deregulation increased the amount banks were willing to lend against that income. These two factors are largely responsible for the increase in household debt between the mid-1990s and 2000s.

However, some bubblers are still convinced that debt levels are unsustainable and some shock will happen and the bubble will pop.

What about credit growth?

Strong credit growth has been cited as a key factor in fuelling the housing bubble.

The bubblers warn that if more people are taking on debt and become heavily leveraged a sudden change in the wider economy such as a rise in interest rates or unemployment could see mortgage holders struggle to repay their debt.

Fact is the low interest rate environment is not currently causing a strong rise in new credit. Sure credit growth has lifted off its historic lows from earlier this year, but remains very soft relative to previous years. Housing credit growth lifted by 4.7% in the 12 months to August.

Part of the reason why credit growth is growing at a slower pace is that about half of households, according to anecdotal evidence, have not been reducing their regular mortgage payments as interest rates fell, putting them way ahead in their mortgage payments.

Another factor in our favour is our banks’ high lending standards compared to the lax standards overseas that, in part, led to the USA housing meltdown in 2008.

Is the Reserve Bank worried?

The RBA doesn’t seem to be concerned by what’s happening in the property market nor should they be surprised by our rising house prices.

It is part of the RBA’s plan to rebalance growth as the mining boom fades. Their mission has been to stimulate our economy in general and housing activity in particular, so they would have expected some sort of price impact!

Recently, Dr Luci Ellis, the head of the RBA’s financial stability department, reaffirmed their position that we are not in a housing bubble.

She said Australia did come close to having a housing bubble a decade ago, but on the basis of a ‘‘dispassionate’’ analysis of the data, there was ‘‘no comparison’’ with the current state of the market.

Is the government worried?

Recently both Prime Minister Tony Abbott and Treasurer Joe Hockey explained how rising dwelling prices are generally a good thing for Australia considering the wealth effect we get when our homes increase in value.

So what could cause our property markets to collapse?

It’s not as simplistic as the bubblers think. House prices only fall when people are forced to sell their homes.

Sure the market will turn again one day, but that doesn’t mean property values will collapse. What tends to happen is people choose to simply remain in their home and wait things out while property investors also try and hold on rather than realising their capital loss.

A true collapse in house prices would require some large external shock such as:

  • High unemployment to trigger the wave of forced home sales. While unemployment is likely to creep up a little, no one is suggesting we’ll have a crippling unemployment rate in the foreseeable future.
  • High interest rates that would cause a raft of homeowners to default on their mortgages – again unlikely in the foreseeable future.
  • A recession that would cripple our economy. If our politicians play their cards right this is unlikely to occur. Or…
  • A severe oversupply of property. Now this could occur in a few isolated markets but generally we have an undersupply of properties around Australia.

In summary

An improvement in the interest sensitive housing sector is critical for Australia to successfully rebalance economic growth away from the declining mining investment boom.

As part of this, house prices need to rise to help boost household wealth and support consumer spending. More importantly, the RBA wants this to occur to encourage an upturn in the housing construction cycle.

Sure, Australian housing is already among the most expensive in the world, but just because something is expensive doesn’t make it a bubble. Property values are only just back to where they were three years ago.

Where will they be next year or the year after? 

Who knows?

I don’t have a crystal ball, but the fundamentals suggest we are at the beginning of the expansionary stage of the current property cycle, which could last a couple more years.

On the other hand, if property values keep increasing by the equivalent of 20% a year (as has happened in Sydney and Melbourne over the last quarter) then the cycle is likely to be shorter and once again property values could fall – but they’re unlikely to crash.

What is most likely to happen is that growth will slow a little in Melbourne and Sydney. At the same time as our economy gets stronger and house prices rise the RBA will put some hurdles in the way by raising interest rates and the cycle will slow down.

However, property prices are unlikely to crash!

In fact, according to John Edwards, founder of Residex, we haven’t had a property market crash in Australia since the 1890s.

Read Michael Yardney’s article online