Hot air can’t bust a housing bubble that doesn’t exist

If I’ve read one story about a possible housing bust in Australia, I’ve read a hundred.

Barely a week goes by without another breathless warning from some property pessimist, columnist or overseas economist about a looming price collapse.

It’s complete nonsense, in my opinion.

For starters, there is no national housing market. Prices vary wildly from place to place, and always will.

So while Sydney or Melbourne may look pricey, most other cities simply don’t.

It seems that ever since the property market bottomed just over two years ago, some (mainly foreign) commentators have suggested we’re in a property bubble about to burst.

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.

In many cases these were the same property pessimists who told us we were going to crash after the GFC; but now they were saying it is related to the China-driven mining boom fading. Of course there’s also the local property pessimists who’ve been waiting for over a decade for our property prices to crash.

So are we in a housing boom, is there a bubble and is it going to burst?

The bottom line is we are not in a “bubble”. Sure property prices are expensive in some locations, but that doesn’t make a bubble. To better understand why I say this, let’s do a Q&A.

What is a housing bubble?

A housing bubble doesn’t just mean high prices — prices can be high in response to basic supply and demand.

A housing bubble is defined by rapid rise in property prices, where house prices are a long way away from what is fundamentally considered justified and generally occur when speculators enter a market where demand is already high and attempt to profit through short-term buying and selling, further driving demand.

It is usually also associated with strong credit growth.

What’s happening to dwelling prices?

The latest house price results from RPData – for the year to October – suggest a rather tame residential market.

After a mid-year lull home prices started rising again and are up 9.3% over the past year in response to favourable influences such as low interest rates, an under supply of new housing starts, strong population growth and rising consumer confidence.

However, individual performances remain patchy and mixed, both between the different capital city markets and in different market segments within each capital city, reflecting the underlying impact of local supply and demand as well as economic factors.

Source: RPData

As you can see the Sydney market is booming, but if you look back over the past decade Sydney home prices have only just outperformed inflation, having risen only 3.8% per annum.

Hardly bubble material here.

What’s happened since the market last bottomed?

In general home prices dropped in 2011, bottomed in mid 2012 and then started retracing as investors and home buyers embraced attractive market and economic conditions.

We are experiencing the normal machinations of the property cycle. What happens is that property values rise then they slump for a while, then they retrace and finally go into the next expansionary phase as can see in the following graph.

Current price growth around the 9% per annum mark is in line with the long-run average. While dwelling prices are up by around 19% from the mid 2012 trough, they are only around 10% above the previous (late 2010) peak.

And these gains are concentrated in Sydney (where the market was flat for four years between 2004 and 2008). Price growth in other capitals and regional areas are more restrained.

Let’s put things into perspective

Here’s another way of looking at what’s happened to property prices over the last decade:

Isn’t this what the government wanted?

Yes, the Reserve Bank lowered interest rates to stimulate our economy and balance out the results of the mining boom slowing down.

Low interest rates that improved housing affordability which contributed to increased home buyer demand. This led to higher house prices, which encouraged builders to build more new homes (building approvals are about as high as they ever have been) leading to a construction boom.

Higher house prices create a wealth effect increasing overall consumer confidence and this has been positive for retail sales.

So this is exactly what the RBA was looking for – it wanted the housing sector to rebalance our economy away from the mining sector.

But aren’t houses in Australia already too expensive?

Yes they are expensive by world standards, but this is a reflection of the fact that most of our population is concentrated in a few coastal capital cities. We also have high quality, large housing stock generally on big blocks of land.

Plus the poor state of public transport in our big cities only increases the premium on properties located close to the CBD.

Of course this has some bubblers saying houses are now ”overvalued” and “unaffordable” because the rise in house prices over the past few decades vastly outperformed the rise in wages.

They seem to be ignoring the preferred measure of housing affordability, at least in Australia, which is the proportion of income spent on housing costs.

For home buyers (not renters) the best measure of affordability is repayments on hew housing loans as a percentage of household disposable income. This measure is now around the average of the last 30 years for Australia at a little over 20%, and falling due to low and stable interest rates.

Currently typical standard variable housing rate is at historically low levels, household saving is at the highest level for 25 years and household debt has been flat as a proportion of income since 2007.

What about credit growth?

Strong credit growth has been cited as a key factor in fuelling the housing bubble.

The bubblers warn that if more people are taking on debt and become heavily leveraged a change in the wider economy such as a rise in interest rates or unemployment could see mortgage holders struggle to repay their debt.

Fact is the low interest rate environment is not currently causing a strong rise in new credit. Sure credit growth has lifted off its historic lows, but still remains soft relative to previous cycles.

Part of the reason why credit growth is growing at a slower pace is that about half of households, according to anecdotal evidence, have not been reducing their regular mortgage payments as interest rates fell, putting them way ahead in their mortgage payments.

Another factor in our favour is our banks’ high lending standards compared to the lax standards overseas that, in part, led to the USA housing meltdown in 2008.

So what could cause our property markets to collapse?

It’s not as simplistic as the bubblers think. House prices “collapse” (not a cyclical correction but collapse) when people are forced to sell their homes and there is no one willing to buy them.

Sure the market will turn again one day, but that doesn’t mean property values will crash. What tends to happen is people choose to simply remain in their home and wait things out while property investors also try and hold on rather than realising their capital loss.

A true collapse in house prices would require some large external shock such as:

1. High unemployment to trigger the wave of forced home sales. While unemployment is likely to creep up a little, no one is suggesting we’ll have a crippling unemployment rate in the foreseeable future.

2. High interest rates that would cause a raft of homeowners to default on their mortgages – again unlikely in the foreseeable future.

3. A recession that would cripple our economy. This doesn’t seem to be on the radar of any economist for the foreseeable future. Or…

4. A severe oversupply of property. Now this could occur in a few isolated markets but generally we have an undersupply of properties around Australia.

So what’s ahead?

I must admit that I can’t see property values continuing to grow at double-digit rates forever. This is unsustainable at a time when inflation is less than 3% and interest rates are as low as they are.

However, despite many factors affecting long-term property values, the two big ones are:

1. Population growth, and
2. The wealth of the nation

Combining both these factors is a powerful stimulus for property price growth – more people needing to live somewhere, and being able to afford to pay to do so.

There is little doubt the population will continue to increase as Australia imports people to help replace the retiring baby boomers. In fact, the population is likely to grow by 10% in the next five years alone.

At the same time, we are geographically situated in that part of the world that is going to drive the world’s economy in the next few decades.

Australia’s proximity to China, India, Indonesia and Japan has been forecast to have a massive wealth flow-on effect as these four nations will produce over 58% of the total Gross Domestic Product (‘GDP”) produced by the top 10 nations by year 2050, according to a report by PwC.

To put this in context, China’s GDP is expected to be 10 times larger by 2050 than it is today.

The economic strength of our major trading partners will ensure the long-term strength of Australia’s economy.

At the same, this flood of wealth in our region will bode well for our investment in Australia as foreigners will be keen to divest some of their money into Australia, which is seen as a safe economic and political haven.

Some will buy property here to give their children access to better education, while others will buy property to strengthen their future residency/visa applications.

The final word

Sure Australian housing is already among the most expensive in the world, but just because something is expensive for some that doesn’t make it a bubble ready to burst with property prices dropping dramatically.

Although prices can drop dramatically in the stock market and property in specialised locations like mining towns or holiday spots are subject to large swings, the price of well-located residential properties where the average Australian lives are historically more stable.

We haven’t had a property bubble in Australia since 1890 and we haven’t had capital city property values in Australia fall through the floor since then. And they are unlikely to do so in the future.

You see…

The property market is the only investment market controlled by non-investors. Seventy percent of properties are owned by mums and dads as their homes. They don’t sell up when the economy tanks or the stock market crashes. This gives residential real estate a level of stability not available in other asset classes.

All the unease about a housing bubble is unfounded, but if property values keep rising at the rate they have in Sydney and Melbourne we could get ourselves into trouble and have a correction (not a crash.)

However, the good news is that the rapid price rises of the past year or two seem to be moderating.

Michael Yardney is a director of Metropole Property Strategists – creating wealth for their clients through independent, unbiased property advice and advocacy.

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