Is the Australian Property Market in a Bubble?

aussie property bubble

Want to make a quick $150,000? Too easy.

Buy a unit…paint it.

Hold on to it for 14 months.

Then sell it for $150,000 above the price you bought it for.

This worked for some lucky unit owners in Mitcham, Victoria. They sold their property only 14 months after purchasing it for a handsome 25% profit.

Their cost? Just some paint.

The truth is, we’ve seen some incredible gains over the past few years in property, especially in the Sydney and Melbourne property markets.

Just to show you what I mean, check out the graph below. The cumulative change in dwelling values from January 2009 to August 2017 was 101.4% for Melbourne, and 113.7% for Sydney:

Aus Property Values

Source: Core Logic

Those are some amazing gains. Especially when you compare it to the interest rate you would’ve received if you’d kept the money in the bank instead.

It’s not surprising then that Australians are keen to get on the property market…and to take on a lot of debt to do so.

26 years of growth has made the Aussie property market one of the most expensive in the world, and Australians one of the wealthiest…but also some of the most indebted!

Yet this rapid growth is dividing Australia.

Bring the subject up during a party and you’re sure to create a hot debate.

Are we in a property bubble?

Is the property market in a bubble? Or are these high valuations justified?

Is this growth real? And more importantly, is it really creating wealth?

We are told that property prices have been fueled by population growth and an undersupply.

But, as The Age recently reported, while population in Victoria may be growing, living conditions of the current population are not getting better. In the eight years following 2008, income per person in Victoria rose just 0.8% while Australia as a whole, grew 7%.

Rapid price increases are also attributed to a property undersupply. Yet according to recent research by the Australian National University, between 2001­­–2017, Australia has had an oversupply of 164,000 dwellings.

Where do they report undersupply is located? Not where you expect.

The majority of Australia’s housing surplus is situated in the inner-city areas of its major capitals where growth has exploded, that is, Brisbane, Melbourne and Sydney. This is due to a large amount of units being constructed.

The housing market is now showing signs of a slowdown.

According to Core Logic, national property prices stayed flat in November 2017, and grew just 0.2% in the quarter ending on the same month. Sydney lost 0.7% for November and 1.3% for the quarter. The combined capitals lost 0.1%.

As Tim Lawless from Core Logic said, Sydney is the property motor:

Softer housing market conditions across Sydney, which comprises roughly one fifth of national dwelling stock (and approximately one third by value), has a material influence over the headline growth trends.

The dip in prices comes after tighter lending requirements and banks raising interest rates — even though the Reserve Bank of Australia (RBA) is fighting to keep them on hold.

Factors that could cause a property market crash

What are the dangers circling the property market? There are a few.

For one, there is the risk of higher interest rates.

Interest rates are at record lows. Household debt to disposable income is maxed out. According to the RBA, in the last 20 years, household debt to income ratio has almost doubled from 98.6% in March 1997 to 193.7% in June this year. Much of that debt is tied up in mortgages.

The problem is, the increase in house prices has not only multiplied debt, but is also causing something called ‘wealth effect’.

You may have heard of it before. It basically means that, as households perceive the value of their assets increasing, it makes them feel like they are sitting on a lot of money…so they spend more.

Yet with such high mortgage debt, this property market may only be sustainable as long as interest rates stay low.

The RBA seems intent on not raising rates, but they may have to, especially since central banks around the world are starting to increase rates. The bank of England, the European Central Bank and the US Federal Reserve, are looking at slowly raising interest rates and unwinding their balance sheets.

Another factor increasing risk in property is wage growth.

Many households have had massive gains in property values, but they are cashed out. According to the RBA, 77% don’t have enough cash to cover a quarter of their debts.

You see, while property prices have been growing, salaries have been doing this:

Wage Growth Australia

Source: Trading Economics

And with slow wage growth, the appetite for taking on more debt is winding down.

In fact, in 2015–2016, based on the ratio of debt to income, the RBA classified 29% of households as over-indebted. Most of them are in Sydney or Melbourne, and one in four are high-income households.

The truth is that low wage growth, paired with higher living costs and even larger mortgages, is taking its toll. And the RBA may be keeping rates on hold, but commercial banks are slowly raising rates. People are spending much of their income on paying off debt.

How long can the RBA keep rates this low?

Another risk to the housing market is a rise in unemployment.

The unemployment rate is currently low, yet underemployment is at record highs. That is, people that would want to work more hours, can’t get them.

There is also the risk that unemployment could start to increase.

Data published by Digital Finance Analytics show that in September 2017, around 28.9% of households were suffering from mortgage stress. What they mean by mortgage stress is that the net income does not cover household costs.

You see, households are spending more on bills and higher mortgages, which means they have less disposable income. In turn, this is slowing household consumption.

Household consumption makes up 55% of the economy. This could be the reason why consumer spending is slowing.

Weaker property prices could also mean a slowdown in residential construction…and an increase in unemployment. Residential construction is the third largest employer in the country.

Australian Banks exposed

Another immediate danger is that Australian banks could be overexposed to property.

According to the Sydney Morning Herald, over 60% of Australia’s banking system loan book is on residential property. They hold around $1.51 trillion in mortgages.

If people can´t afford to pay their mortgages, it could leave lenders in trouble.

One of the dangers is in interest-only mortgages.

Interest-only mortgages are usually used on investment property and pay no principal — just interest — for an initial period, usually five years. Once the initial period is over, mortgage payments spike up to include the principal.

Much of the big four portfolio is made up of interest only mortgages. That is, 50% of Westpac’s, 40% of Commonwealth Bank of Australia’s, 37% of Australia & New Zealand Banking Group’s, and 32% for National Australia Bank. People already suffering mortgage stress could be forced to sell when this interest only period ends.

Australia avoided the global financial crisis in 2008, and it hasn’t had a recession in 26 years.

The lack of recession combined with cheap and easy money has caused asset prices to soar in certain areas, and Australian household debt to balloon.

Expensive property, no salary growth and high debt, could leave households exposed to a property crash. A rise in interest rates or unemployment could do just the trick.

Is the property market in a bubble? Maybe it is, or maybe it isn’t. The truth is that property will continue to rise while people have confidence in it…and credit is still cheap and available.

We won’t know for sure if it is a bubble until it crashes, if it does…by then, it will be too late.