Get set for a fall in house prices: Gottliebsen

Houses prices fall for two main reasons. First, where demand has been reduced – usually the largest factor determining this is reduced income.

Over the weekend I was discussing the local and global economy with a prosperous tradesman. I mentioned that the value of American houses had fallen sharply. He was amazed and asked: “How can houses ever fall in value? What I paid for a house is what it’s worth – how can it decline?”

The value of bricks and mortar is deeply embedded in the psyche of a generation of Australians. The majority of Australians have forgotten that residential property fell about 20% in the 1990-93 slump and that in some areas it was close to 50%.

Houses prices fall for two main reasons. First, where demand has been reduced – usually the largest factor determining this is reduced income. In today’s world a large proportion of the working population are contractors and many of them are finding the going tough.

Second, even if people are fully employed, the banks play a huge role in setting house prices. If banks are forced to cut back the amount they are prepared to lend on dwellings (sometimes cutbacks may only apply to a type of dwelling or a region), then buyers cannot pay the old value levels. This can happen for several reasons, but is usually due to higher official interest rates or a squeeze on bank funding.

In the US there has been a dramatic fall in the amount available for houses. Moreover, Americans fund their house purchases on a non-recourse basis, so if the house across the street is available at 45% of your mortgage, why not throw the keys back to your lender and virtually halve your mortgage.

The American banks’ suffering was dramatically revealed to the world by NAB CEO John Stewart. The severity of the US housing fall has been caused not so much by falling personal income but because banks and other American lending institutions have withdrawn support from the housing market.

When houses are rising in price, banks encourage people to borrow against their dwelling’s equity and foster the belief that houses can’t go down. In America, bank and mortgage executives could not envisage houses falling in value – let alone more than halving.

Just as the public does not understand that houses can fall in value, so many bankers do not understand that they play a huge role in setting house prices. It’s amazing but true – if banks or mortgage lenders toughen their lending criteria quickly then it is those same banks and lenders that will suffer losses on their past loans. American bankers have found this out, with devastating consequences.

Underpinning our housing market is the high rate of migration. But at the same time, people have started to rent holiday homes; more children are staying at home, and the spare bedroom often now has a permanent resident. In other words, the high price of houses is effectively causing more high-density living, which may mean that we are overstating the shortage of houses.

This article first appeared on Business Spectator

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