Australia’s Household Debt is Creating the Illusion of Wealth

Situated in Sydney’s popular inner west, the small one bedroom unit had an impressive view of Sydney harbour. And even more important, it included a highly sought after off-street car space. The price: in the high $400,000s.

Sydney water views and a private parking space in Sydney for less than half a million? Bargain!

A quick search for similar properties revealed that prices for a similar property — even one in the same building — were in the low 600s.

So why such a price difference?

Probably this apartment is underquoted. What I mean by underquoted is a property advertised at a lesser price than the seller’s asking price or auction reserve. The low price creates the illusion of a bargain, which attracts more interest in the property.

You see, the trick to selling a property is to get as many people as possible to view it, right? That way your marketing skills look great in front of a seller, and you get the most people in for the auction. The potential buyers may be wasting their time attending the auction, but the agent gets a good turn-out.

And the more people at the auction, the more chance to sell at a higher price. After all, we all know how things can get heated once the competitive instinct kicks in.

Underquoting may be illegal. But it is one of the ‘dirty’ tricks of the trade used by property agents to make sales. They have to get the money for the BMW payments from somewhere.

The truth is that Australian property is hot right now. Property prices have almost doubled since 2009, and keep on rising.

The IMF is now warning that Australian ‘private debt has continued to accumulate at a fast pace’. And this debt, fuelled by mortgages, is exposing the economy to a future crisis.

Australia is not the only country with an insatiable appetite for cheap debt. Canada’s household debt to GDP has also ballooned to 98.7%, and is now higher than its GDP.  Australia’s household debt to GDP is even higher, a whopping 125.2%.

There are many similarities between the Australian and Canadian property markets. For one, Canada’s own two most liveable cities, Vancouver and Toronto, are propelling the housing market. In Australia, it’s Sydney and Melbourne.

And the house prices in Canada have also been rising at record levels. Mostly fuelled by a low supply, low interest rates, and an increase in foreign investors.

Canada is now taking measures to cool the market. In August, British Columbia imposed a 15% surtax on foreign buyers. The tax is having the desired effect. Home sales for September fell 33% compared to last year, according to the Australian Financial Review.

Yet the problem in both Australia and Canada is income. You see, salaries are not rising fast enough compared to property prices.  And now household debt as a relation to income is also rising to new highs for both countries.

Cheap debt has created an illusion of wealth. And now we have a ticking time bomb in our hands.

You see, Australian households are able to service their debt because unemployment and interest rates are low — for now.

And unemployment has been kept low because, when the mining boom ended, the construction sector took its place. Yet now the construction sector is set to slow. Australia needs to find another golden goose to keep the economy going and unemployment low.

And with so much debt on the line, the RBA is now restricted. It cannot raise the interest rates too high, or it will risk a crisis.


Selva Freigedo,
For Markets and Money

Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.

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