Hedgie: Oz house prices are gonna crash

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Check out this report by APT Capital Management: Australia’s Housing Bubble. Is the luck running out?

1While numerous aspects of Australia’s economy have experienced something of a setback in 2015, the housing market is surging on with all cylinders firing. As is clear from the chart below, prices have been rising fairly steadily for some time and are now at an all-time high. The initial trigger for the market was when Prime Minister John Howard cut the capital gains tax rate on residential property in 1999. Since then, the continuous and often rapid price increases have been driven by numerous factors. These include Australia’s long stretch of strong economic growth, limited housing supply in some of the most desirable areas in major cities, rising demand as Australia’s population increases, and banks’ liberal lending standards.

Most crucially, and responsible in particular for the uptick since the early 2000s, have been structurally low interest rates; the almost inevitable accompaniment to house price rises. The RBA’s policy rate has been falling for years and is currently at an all-time low of 2%. This rate and its implications, as well as the issue of lending standards, shall be addressed more closely later in this report.

Low interest rates have not only made home-purchase financing more affordable for domestic buyers, but have also set off an influx of speculative investment from both at home and overseas, largely from Asia. Government data suggest that foreigners are purchasing around a third of all new homes nationally, concentrated in inner Sydney and Melbourne. Speculators are also attracted by capital gains tax concessions and Australia’s secure and consistently growing economy. This investor demand has been playing a key role in heating up Australia’s housing market. In 1985, around 85% of Australians owned the houses they lived in. Today, this figure is less than 50%

Is There a Housing Bubble?

Liberal lending standards and low interest rates are largely responsible for driving up Australia’s property prices, while its macroeconomic indicators are beginning to look weaker. This already provides cause for concern. If house prices are rising in a way that is healthy and sustainable, it should be as a part of wider economic strength and in line with other improving fundamentals. However, it appears that they are in fact becoming increasingly detached; a development characteristic of a bubble.

If this is 2indeed the case, Australia is heading for even more troubling times when the bubble bursts, as bubbles inevitably do. A significant house price correction would seriously damage the broader Australian economy.

In line with this logic, numerous economists, analysts and journalists have voiced their concerns. Nobel prizewinning economist Vernon Smith, for example, told the Australian Financial Review in July 2015 that there is ‘a pretty good bubble in Sydney and Melbourne’ and added that ‘it is hard to believe it is very sustainable.’ Indeed, the prevailing sentiment is increasingly of a dangerous market, with near universal acceptance that the Australian housing market is unsustainable in its current form.

However, there are some who do still continue to celebrate the strength of the Australian market. This category includes the authors of the Deloitte Australian Mortgage Report 2015, which was tellingly subtitled ‘Let the good times roll.’

The aim of our report, therefore, is to verify whether there is indeed cause for concern when it comes to the Australian property market. This shall be done in accordance with our assessment criteria, listed below. These are derived from the symptoms that, historically, have tended to accompany housing bubbles and can generally be recognised during their inflation. They give an indication as to the state of the market and the relationship between prices and fundamentals. For each, the extent to which it is present in Australia, or is likely to be in the near future, shall be considered.

Housing Bubble Assessment Criteria

Listed below are our seven assessment criteria for property bubbles, in accordance with which this report is structured.

 House price changes

 House price to income ratio

 Housing market mania

 Availability of cheap mortgages

 Mortgage market regulation & lending practices

 Household debt levels

 Borrowers’ ability to make mortgage repayments

Here is the conclusion:

Ultimately, fears over the Australian housing market are indeed founded. Our indicators overwhelmingly suggest that there’s a bubble, and that it will be dangerous when it bursts:

 The rate at which house prices are rising is sharp, persistent and increasingly detached from fundamentals. It’s also an issue that affects a clear majority of the population.

 The house price to income ratio is rising and is already higher than it was in the US prior to 2008.  There are clear signs of mania in the market.

 The percentage of mortgages that have interest-only periods is high and rising.

 Regulators’ attempts to restrain banks’ lending seem to be too little, too late.

 Overall household debt as a percentage of incomes is high and rising, as is mortgage debt.  Australians’ average mortgage repayments constitute an unsustainably high percentage of their incomes.

 Households’ ability to make their mortgage repayments is likely to be compromised in the near-mid future by adverse macroeconomic conditions and potentially also an interest rate rise.

Cumulatively, these findings and developments show that Australian house prices are not on a sustainable path and that the market is heading for real trouble. Australia’s properties are overvalued and becoming even more so, with no clear catalysts for a healthy slow-down.

Although the currently rising prices are generally welcomed by homeowners, and feed back favourably into the wider economy via the wealth effect, they are not reflective of healthy economic fundamentals. Such beneficial effects stand to be undone when the bubble bursts. The coming house price correction will further harm Australia’s already sluggish economic growth.

The higher prices rise, the more damaging the pull-back is likely to be. With such a large proportion of their profits and balance sheets comprised of mortgages, Australian banks are particularly vulnerable to such a correction. We do not believe their recent and planned capital raisings to be sufficient to maintain their capital adequacy ratios once the bubble bursts.

It certainly seems as though Australia is on a collision course with some harder financial times than it’s been used to.

Calling the top of an asset bubble is notoriously difficult, but according to our criteria – the level of mania, the increasing overvaluation, etcetera – it seems not be too far away; the cycle appears to be nearing its end. This is echoed by the increasing media and analyst attention to the issue in recent months.

There’s a lot more in the report with some excellent charts. Rather than excerpt the whole thing, read it in full here.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.