Australia's property crash: Are we all doomed?

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

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.

2. Lending remains tight

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.

3. Australia has chronic undersupply

“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

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.

2. The biggest real estate investors are NOT from China

3. The proportion of real estate investments by foreign nationals is quite small

“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.

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

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.

2. Rapid interest rate hike

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.”

3. Massive building boom

“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.