Joe Hockey was heavily criticised in late 2014 when he dismissed suggestions of there being a housing bubble in Australia. But that’s politics. In reality there are many people who share the Treasurer’s view, and that’s what this post is about. Our post last week summarised the opposing side of this bubble debate.
No one disputes that house prices in Sydney have grown at bubble-like pace over the past three years. But anyone who rejects there being a bubble will also point out that Sydney heavily under performed the market before that. As shown in this report from the Housing Industry Association, Sydney prices only grew 31% in the 10 years to 2013, or an average 3.1% per annum. This compares to growth of 79% over the same 10 years in Brisbane, 80% in Melbourne and 143% in Perth! So you might say that Sydney now looks expensive, but being off the lower base it hasn’t yet reached a point that’s unsustainable.
It is also important to look beyond Sydney. In the past year there have been contractions in the Gold Coast and outside of Australia’s larger cities and towns (particularly in the non-prime markets of Western Australia and South Australia) there have already been corrections. More severe has been in the real estate markets of many mining towns which have nearly halved in two years due to the mining boom coming to an end.
So while there’s an argument that prices in certain areas of Sydney and Melbourne may have risen too quickly, to say there’s a housing bubble in Australia may be over-exaggerated, because it doesn’t apply to prices nationally.
The mining town example illustrates the forces of demand and supply. During the mining boom property developers rushed into mining towns and built accommodation very quickly (supply increased), however when the boom ended mining companies laid off staff and withdrew from projects. To save costs companies like BHP Billiton also began operating their own mining camps to accommodate workers, so demand for nearby real estate fell rapidly, and prices collapsed.
It is this same basic economic principle of demand and supply which underpins the fundamental reason many believe we are not in a bubble, and why prices won’t come crashing down.
The argument goes something like this…
Demand for housing is strong:
- Interest rates are at record lows which is an incentive for buyers in the form of cheaper credit
- Foreign investor activity is high, particularly from China, and this is being fuelled by a falling Australian dollar and a weakening Chinese share market
- Local investors have been very active, driven by lower interest rates and the favourable tax outcomes from negative gearing
- Population growth is strong (both via immigration and natural)
- Incomes are rising
- The average size of households is declining, so more houses are required for the same level of population
- Self Managed Super Funds are now able to borrow up to 70% to fund property purchases (prior to 2007 this wasn’t allowed, SMSFs can be an attractive investment vehicle because they are only taxed at 15% and they further benefit from a one-third capital gains tax discount for assets held longer than 12 months)
- The shift away from mining investment (and more recently the share market) is driving more capital into property
- There appears to be no substantial slowdown looming for the Australian economy
Supply is weak:
- Put simply, we don’t have enough supply to meet all of this demand
- This is evidenced by auction clearance rates which throughout 2015 have been very strong
- According to John Symond from Aussie Home Loans each year Sydney falls some 20,000 dwellings further behind what the market requires
- State and local planning regulations (“red tape”) mean that this supply issue isn’t one that can be overcome quickly or easily
Therefore short of a catastrophe, which could destabilise these market forces and be a trigger-event for a housing collapse, we are unlikely to experience major declines in Australian property values. This sentiment was recently endorsed by senior UBS economist George Tharenou and in this article Domain Group senior economist Andrew Wilson explains why a trigger-event is unlikely to occur.
What’s also important to highlight is that a number of the above forces are structural, meaning that intervention is either unlikely, or at least unlikely to have a sudden or substantial impact.
For example the Australian dollar could return to parity against the US, which would make it more expensive for foreign investors to enter the market. However this wouldn’t take away from the fact that Australian properties are still relatively large in comparison to what’s available in other countries and that they’re surrounded by a beautiful environment and nice weather. If you’re a Chinese millionaire deciding where to buy a house for your child while they’re at University you would also appreciate that Australia is a safe country with high quality/affordable education and a stable geopolitical environment. Regardless of whether ‘the Aussie dollar does this’ or the ‘Chinese Yuan does that’, these things will not change.
So if the Australian dollar moved against foreign buyers it’s unlikely there would be an immediate foreign investor exit which might otherwise cause prices to come crashing down. The imposition of stricter capital controls which limit the amount of money a Chinese citizen is allowed to remove from the country could be more serious, however there is little discussion about this at present and it would be inconsistent with the central bank’s previous lifting of capital controls in the Shanghai Free Trade Zone.
Similarly, foreign investment rules are such that non-resident investors are only able to buy new homes in Australia (as opposed to existing ones), and so there is a trend for foreign investors to favour new inner-city properties often close to universities. These properties are typically valued above the average national sales price making it less common to find wealthy foreign investors outbidding first home buyers who are generally buying existing homes and at lower ends of the market.
The government could change foreign investment rules in an attempt to soften price growth however that’s unlikely to make housing more affordable for first home buyers. More importantly from the perspective of the bubble debate it’s unlikely the government would intervene because the economy can’t afford to lose from the boost foreign investment provides the economy and the new homes it forces to be built (increasing supply).
With regards to local investors, one might look at property rental yields which according CoreLogic’s latest report are currently low and think it’s not ideal time to be buying investment properties. But this ignores negative gearing, which combined with our low interest rate environment continues to drive strong demand.
So long as investors are able to offset the net cost of borrowing against their taxable incomes, property investment will remain attractive irrespective of yields. And negative gearing is now entrenched because abolishing it would disadvantage too many people (including the politicians themselves). It would be political suicide. However if negative gearing was instead phased out over a much longer period of time, say 10-15 years, there would be less of a fall out and the housing market would have more time to adjust.
And this market adjustment is exactly what’s happening. Following APRA’s directive for Australian banks to slow investor lending, a number of banks have started to adopt a more conservative approach . Discounts on investor interest rates are being reduced and so to are the loan-to-value ratios for investor loans (previously investors only required a 5% deposit, now NAB and ANZ require 10% and Westpac requires 20% ). This will take heat out of the market as the investment proposition becomes more expensive.
The point here is that the market can be be controlled before disaster strikes. No doubt more houses will be built in an effort to boost supply and the RBA has the ability to increase interest rates (to slow the economy) if it needs to as well.
In summary, those who reject the housing bubble don’t deny that certain parts of the market are overheated, but they feel that the problems are localised to specific areas. The strength of demand and the shortage of supply give them confidence that at best prices will continue rising and at worst they will stabilise until more normal/sustainable levels are achieved. But the risk of prices falling 20% or more over a short period of time is not one they lose sleep over.
Who out there is bullish on house prices and have we missed any reasons in this post which support your confidence? Where are you looking to buy, and why?
Regardless of which side of the bubble debate resonates with you, buying property is personal. Everyone has different personal motivations for entering the housing market and different tolerances for risk.
But remember the power of emotive marketing and that fear attracts readers. Don’t believe everything you read and don’t look for the headline “Market up $20bn, we’re rich!”… because you will be unlikely to find anything.
