This post summarises the arguments in support of there being an Australian housing bubble in 2015.
Amongst all of the noise, bubble advocates are making two key points:
- 1. House prices have risen well beyond their true values; and
- 2. Debt levels are unsustainable
Price rises
On house prices, the common references are to Sydney where since values started to climb in May 2012, prices are up 43.1 per cent (largely due to investors and foreign buyer behaviour).
Others point to clearance rates rivaling levels not seen since 2009, and also to generic houses in unheard of suburbs selling for hard-to-believe price tags (like this one SF Economics recently alerted us to in Mount Druitt NSW, traditionally one of Sydney’s poorest suburbs – sold in April for $710,000).
A recent survey by Deutsche Bank concluded that Australian house prices were overvalued by 49% and that housing in Melbourne, Sydney and Wollongong has become more expensive than in New York.
The point being made is that prices have grown faster than underlying economic conditions suggest is appropriate, and to levels not reflective of economic fundamentals.
Rising prices then lead to problems with housing affordability and rental yields.
Bubble advocates argue that real wages (adjusted for inflation) haven’t nearly kept up with rising prices, and therefore that affordability is at it’s lowest levels in years.
I personally think the devil’s in the detail with this one as the data can be cut in so many different ways… for example affordability looks stronger if you don’t adjust wages for inflation, or if you exclude the lacklustre wage growth in poorer performing industries. The degree to which the current low interest rate environment (which assists affordability) factors into the analysis is also key.
Moving onto rental yields, these are calculated as property incomes (e.g. rent) divided by property costs (e.g. price) – they are an important metric for property investors to determine the potential value and return of their investments.
Rising prices have meant that rental yields are now well below historical averages . The fact investor demand for property remains strong (despite lower yields, which suggests either rents should increase or prices decrease in order for yields to revert back to their longer term average) suggests that yields are increasingly being viewed as secondary to the expectation of further house price rises. So an increasing number of investors are buying property not on economic fundamentals but rather as a speculative asset to flip – these are very bubble-like conditions.
Unsustainable debt
When bubble advocates talk about unsustainable debt they are referring to excessive household debt accumulated via borrowing money from banks, mainly for housing. This also leads to the issue the banks have of being overly exposed to property related assets. The argument is that the housing bubble is credit-fuelled, making it more susceptible to price adjustments, and more dangerous if it pops.
According to a recent study by Barclays, Australian households have among the highest debt levels in the world. As of December 2014 average household debt in Australia totalled 194% of annual income, significantly higher than the US peak of 135% in 2007, before the financial crisis.
Australian interest rates, debt and housing affordability – Barclays
A debt to a borrower is an asset to a bank. So as Australian’s borrow more money to buy real estate, bank balance sheets grow too.
Taking CBA as an example, research from LF Economics shows that in 2014 CBA held assets equivalent to 51% of Australian GDP, up from only 14% of GDP in 1999.
Mortgage lending by Australian banks currently account for approximately 66% of total new lending , in comparison to 53% in 2008.
According to CBA’s latest half year results presentation, 52% of its balance sheet is home loans (see page 117), versus the average US bank (~20%) and UK bank (~12%) (page 116).
The US and UK were both affected by sharp house price falls during the financial crisis, and although lending standards in Australia are stronger, and although our loans are full-recourse (meaning borrowers can’t simply walk away from their properties and obligations), the heavier exposure Australian banks have to real estate assets mean that falling prices are still a major worry. Bank losses would restrict lending and result in job losses, more significant losses would reverberate through the broader economy and be even more severe.
Banks continue lending to Australian homebuyers and property investors due to the love affair we have in this country for real estate.
But how do the above arguments sit with you?
The difficulty is that there is no formal definition or objective measure of what constitutes a bubble, so the debate continues.
Next week I’ll make a post which summarises the opposing views.
