Australia's property crash: Are we all doomed?

By
25/02/2014
We’ve been told for years by the likes of US-based analysts like Harry Dent and Australia’s home-grown pessimist Steven Keen that our property market is in a bubble and about to burst. It hasn’t happened. Yet. But could it finally come true this time around?

For a number of years now, bubblers and doomsayers have been predicting the bursting of Australia’s property bubble.

They told us we’re in denial about the impending gloom, blinded by our own exuberance about the consistent performance of the property market over the years.
 
The warning call has grown louder during the last few weeks when US-based author Harry Dent was in Australia to promote his book.
 
He tells us to “Sell all your properties except your home because when the crash comes, you won’t find any buyers and renters who would want them.”
 
His big claim this time is for Australia’s property prices to plunge 30-50% in the next few years due to commodity prices slowdown and the collapse of China’s economy.
 
He also claims that Australia’s property markets are mainly supported by Chinese buyers and therefore cannot be sustained.

Statements like this would no doubt cause even the most rational investor to pause and think: “Is there a grain of truth to this?” Is the claim that Australia has already started a property bubble and it’s heading for a crash within the next 2-3 years about to materialise?
 
Let’s look at the facts
Our trusted local economists of course disagreed vehemently and assured us that we’re not in a bubble. Even the IMF weighed in through its recent report that the sharp increase in house prices is no cause for alarm as the gains were mostly concentrated in cities like Sydney and Melbourne and more importantly, homeowner debts are still fairly moderate.
 
So let’s pull apart the doomsayers’ arguments about the impending collapse of Australia’s property markets.
 
Claim 1: Australia has a property bubble
Let’s clarify first of all, what constitutes a housing bubble?
Housing bubble is defined by rapid rise in property prices, where house prices are a long way away from what is fundamentally considered justified. This means house prices rising rapidly relative to wages or rents.
 
“Usually in a bubble you get a combination of easy money and lots of optimism about future growth,” explains Shane Oliver, chief economist with AMP. “Certainly that’s what Australia saw at various points over the last decade or two, particularly in Sydney. We certainly had a house bubble up until 2003/04, when we had easy money, but since then prices have gone sideways due to tighter lending and affordability constraints.”
 
The Perth market also went through it over the same period where prices had more than doubled in a space of three years around 2003-2006. It has since come down to a fair level.
 
The facts

  1. Strong price growth only occurred in Sydney and Melbourne
It’s true Sydney and Melbourne experienced an unprecedented growth over the past 12 months, which understandably fuelled bubble talk, but Oliver points out that this is simply in response to lower interest rates and adds that the growth didn’t occur across the board.
 
For example, Brisbane remained sluggish while Perth and Darwin both experienced slower growth over the same period. This indicates that only areas where there has been a massive pent-up demand have seen strong growth.
 
Housing market performance      
  Year-on-year Total gross returns    
Sydney 13.40% 18.30%    
Melbourne 11.90% 16%    
Brisbane 3.80% 8.90%    
Adelaide 2.50% 7.10%    
Perth 6.90% 11.80%    
Hobart -0.20% 5.20%    
Darwin 4.60% 11.20%    
Canberra 3% 7.50%    
8 capital city aggregate 9.80% 14.50%    
    Source: RP Data Dec 2013
 

  1. Lending remains tight
Another factor for a bubble to occur is access to easy finance which we don’t have in Australia.

If you’ve tried taking out a loan during the past five years, you know that the banks remain strict with their lending policies and only the credit-worthy are given the loan. This ensures that only quality creditors – those who can service their loans – are given finance and therefore capping unfettered property price growth and reducing forced sales in the future.
 
In Australia, developers are constrained by the slow land release and difficulty in accessing finance for development, which greatly reduces the chance of overbuilding in general.
 
  1. Australia has chronic undersupply
Some analysts may dispute the exact number of housing stock shortage, but there is a fundamental shortage of stock, says Oliver.
 
“We’ve been building 30,000 houses less than what we actually need so there is a chronic undersupply that’s accumulating each year,” he says. “That’s why each time interest rates come down, prices take off again. Worsening affordability is certainly a problem especially for first home buyers who are being squeezed out of the market. But I still can’t see a trigger for a crash.”
 
Claim 2: Australia’s property bubble was driven by China
There has been some anecdotal evidence showing increased activity in foreign buyers in areas around Melbourne and Sydney but this doesn’t mean they’re solely responsible for pushing property up.
 
The facts

  1. There is a strict rule on foreign ownership in Australia
The Foreign Investment Review Board (FIRB) has laid a strict rule on what type of properties foreign non-residents are able to buy or invest in. For example, foreigners cannot buy existing properties for investment purposes. Foreigners are allowed to buy one existing property as their home but are not allowed to rent any part of it.
 
If you look at the type of properties sold in these areas, you’d see that the majority are existing dwellings and only a handful are new builds.
 
  1. The biggest real estate investors are NOT from China
A quick look at the FIRB site, which details investments by foreign nationals, shows that during 2011-12, the biggest real estate investments came from the US ($8.16bn) not China which invested only half of that ($4.18bn).
 
  1. The proportion of real estate investments by foreign nationals is quite small
The number of approval for foreign investors is too small to cause an inflationary boom according to Catherine Lezer, mortgage advisor with Smartline.
 
“One theory that seems to be gaining some traction is that foreign investors (non-residents and temporary residents) are driving price growth. We have done some research into this claim and have found that foreign investment is unlikely to be a primary cause of growth in the broader market.
 
As you can see from the chart below, the FIRB approved 10,118 residential property purchases in 2011/12.
 
Approximately 8,000 of these approvals will proceed through to a purchase says Lezer. “This number represents approximately 2% of the total properties purchased in Australia over 2011/12. Hardly grounds for an inflationary boom,” she explains.
    Residential
Location Number of approvals Developed $bn For development $bn
Various 131 1.26 0.66
NSW 3,048 0.97 5.95
VIC 3,765 1.08 5.5
QLD 1,582 0.37 2.32
WA 877 0.28 0.84
ACT 86 0.02 0.1
SA 543 0.17 0.15
NT 33 0.02 0.01
TAS 53 0.01 n/a
Total 10,118 4.18 15.52

Source: FIRB Annual Report (2011/2012)

Oliver points out that this misconception about China fuelling Australia’s housing boom arose because Australia has enjoyed a massive party over the past decade driven by the Chinese demand via higher export price. However, he notes that Australia has been through a number of property booms in the past without China’s help.
 
“If you look back between 1995 and 2003 when Australian prices went through the roof, people didn’t even talk about China’s demand, and yet prices surged,” he says.

Claim 3: The end of the mining boom will drag the Australian economy and property markets with it
 
Another favourite claim by the doomsayers, but anyone who’s lived in Australia over the past 7-8 years would know that the country experienced a two-speed economy whereby those resource-rich states such as Western Australia, Northern Territory and Queensland grew rapidly while the rest of the country languished.
 
“They [doomsayers] tend to think the Chinese boom pushed property prices in all capital cities. Well, not all capital cities benefited from the China boom,” says Oliver.
“In fact, if you look around 2003-2005 when the so called 'China boom' was taking off, Sydney property prices were actually going through a bit of a funk or a range band. Sydney has only recently come out of it when the China Boom ended and as a result of lower interest rates.”
 
The facts
The slowdown in commodity demand is no doubt a drag to the Australian economy, however Oliver explains that this would also allow the non-mining states to return to a normal and sustainable growth.

“I think the ending of the China boom, provided China doesn’t crash, is actually a good thing,” he says. “Provided that China ends up with slower but more stable growth of around the 7-8% level it’s not going to be a disaster for Australia. In fact it will bring us back to a more balanced economy. That’s why property prices have picked up now that the mining boom and China boom have ended. It’s taken a lot of pressure off interest and the Aussie dollar started falling, which is a good thing.”
 
Risks not to be ignored
Dent warns Australians not to listen to the government, economists and people in the property industry, like us, who have vested interests. However, he himself has an agenda that is to sell his new book when he made those pronouncements.
 
Nevertheless, there are a number of risks that every investor needs to be aware of.
 
  1. Property prices overshooting
The IMF warned that “a prolonged period of rapid price growth could give rise to expectations-driven, self-reinforcing demand dynamics and price overshooting”. In other words “irrational exuberance” as coined by former US Federal Reserve chairman Alan Greenspan.
 
This means that if the current rally in property prices is simply fuelled by buyer exuberance without fundamental support, then it could result in unsustainable growth.
 
  1. Rapid interest rate hike
Economists are predicting the Reserve Bank will raise interest rates towards the end of this year or early next year and some are worried that the RBA may hike in rapid succession.
 
Borrowers who have extended themselves might find it difficult to service their loans and the higher interest rates could bring forth a rise in mortgage delinquency.
 
However, Oliver points out that this is unlikely to happen because a property bust would be bad for the economy and that the RBA would be keen to avoid it at all costs.
 
“Next year if interest rates go up, it will cause a dampener in price growth. It’s not going to cause a crash in the property market but we’re likely to see some property price growth contraction over next year which I think is good for the economy.”
 
  1. Massive building boom
There’s no question that there has been some overbuilding in some parts of Australia, specifically in mining towns and in some cities like Melbourne, the Gold Coast and Sunshine Coast. However, in general, the building construction is still well below demographic demand and has been falling for a number of years according to Oliver.

“If developers do what the US builders did before the crash and build well above demographic demand, then we’re in trouble,” he says. “I find it hard to see this happening given the constraints on land release. Over the past few years, we’ve been building fewer homes each year, so there’s a chronic undersupply. That’s why each time interest rates come down, prices take off again.”
 
Oliver expects construction activity to pick up next year, which he believes is a good thing “because it will fill the gap in the slowdown in the mining sector”.
 
So should we be worried about the impending property market collapse? No, we shouldn't. But we need to be vigilant. As investors, we need to be aware of what’s happening in the market as a whole. But we also need to question everything that we read or hear. Who are these people making these claims? Do they have vested interest? What’s their real agenda?

The property industry is full of self-proclaimed experts as it is and it can be quite difficult to figure out who we should listen to.

Therefore, the best way to ensure you’re making the best decision for your own situation is to get educated. When you’re well-informed, you would be less likely influenced by the ‘noise’ in the market and will avoid making knee-jerk decisions.

When you’re knowledgeable, you make smart choices and take appropriate actions confidently.



 

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Comments
  • Mike Wilby says on 25/02/2014 06:03:45 PM

    All the above does make some sense and as a half way point between bear and bull a fairly flat market looking forward seems realistic , something not covered is the link between property freehold/rental prices and the level of income required to service loans or rents -- the same income levels which are making Australian exports/manufacturing enviable economically - surely something has to give or we have to try and trade flat fo 10 years whilst the rest of the world picks up..?

  • Mike Wilby says on 25/02/2014 06:06:00 PM

    yes that should have said un-viable not enviable -big difference!!!

  • Don't Prop Up the Ponzi says on 26/02/2014 04:15:39 PM

    Another article reassuring us there's no bubble. For many years the average house cost 3 times the average wage. Now it is more like 9 or 10 times the average wage in our cities, yet writers like this one claim there's no bubble. By all measures, Australian housing is deemed unaffordable. Demographia rates our price as "severely unaffordable" and "seriously unaffordable." Nowhere in Australia is ranked "affordable" or "moderately affordable".

    So, if we are in a massive housing bubble, why hasn't it popped yet? Because government policies have been put in place specifically to keep it propped up. Our housing bubble is a government-sponsored Ponzi scheme relying on a supply of "greater fools" to keep paying ever-increasing prices for dwellings.

    Nila talks about a chronic undersupply. Well of course we have an undersupply - land is dripfed and supply is choked to create this undersupply. Then, we have the highest rate of immigration in the western world, a deliberate measure to increase demand on housing.

    And we have unrestricted foreign investment. Contrary to Sweeney's statement about the strict rules on foreign ownership, these laws are not only easy to get around, and are flouted constantly, many purchases are not reported to the FIRB in the first place, and the FIRB has stated as much. The FIRB is in place to simply rubber-stamp almost every application and turn a blind eye to any shonky business. There are many, many anecdotal reports of foreign, especially Chinese purchases of established dwellings, and there is no doubt that the Chinese are having a massive impact on price rises in certain areas. There are no true official figures, and if there are, the government and FIRB refuse to disclose them, presumably because there is plenty to hide.

    There is plenty to fear in this bubble. The Chinese are restricted to one property each in China, but can buy as many properties as they want here. They were also buying up big in Canada, but now that Canada has clamped down due to the impact of Chinese investment in Canada, that means even more money is headed our way. And as the amount of wealthy Chinese grows, there are more Chinese who can afford to buy Australian real estate (and intend to do so) than there are Australians. Please don't misunderstand me. I am not China-bashing. They are acting within the law (and what they can get away with) in a desperate bid to get their money out of China and out of the reaches of the corrupt Chinese government. But many of these Chinese investors have made their money by corrupt means and can easily outbid Australians in an uneven playing field. Our government is well aware of this, and is allowing Australia to be sold out to the highest bidder in order to keep property prices high.

    I know I have rambled on here but I am quite passionate about informing people of this housing bubble that we have had for so long that many people think our exorbitant prices are normal. They are not, and have nothing to do with affordability, nor with fundamentals. They are propped up artificially, and both sides of government are to blame. Of course, those with property have vested interests in seeing their values rise, so the government are pandering to the majority. But there is no question that we have a housing bubble. How long it lasts depends on how much the government is prepared to throw at it to keep it going, unless it eventually bursts under its own weight.

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