Australia’s Property Correction, Not Bubble

Newspapers and media alike continue to obsess about the Australian property market. I’m sure you’ve had your fill of the articles…so bear with me.

Almost 70% of dwellings are owner-occupied. So the media focus makes sense, because most Australians have a vested interest in the subject. And almost every pundit has an opinion on Aussie property. Some will tell you it’s too high and will crash by more than half. Others are confident it will continue to grow.

However, it’s the crash scenario that reports are chanting. It seems we can’t get away from the headlines about Australia’s property bubble. Economist Lindsay David wholeheartedly believes we are in a bubble. David wrote Australia: Boom to Bust, which was released in 2014.

Ever since his book was published, he’s been warning investors of the ‘coming crash’. And if this ‘crash’ were to unfold, it would be disastrous.

Property makes up a large portion of Australian’s net worth. A ‘crash’ won’t just hurt average Australians, it will cripple them. And residential owners won’t be alone in their struggles. Commercial real estate owners, many businesses and banks will all be feeling the pain.

According to banking regulator APRA, as of March this year Aussie banks held $1.6 trillion worth of property on their balance sheets. These consisted of domestic commercial and residential properties.

And the banks’ exposure to property is growing. Exposure to residential property increased by 8.7% on the previous year’s figures. Commercial property exposure rose even higher. It increased 10.4% on prior year’s figures.

It’s safe to say that, if property went under, many banks would follow thereafter. However, until now, we’ve just been assuming property prices will collapse. Is this a realistic view to have?

To answer this question we need to look at what drives property prices. You might say that supply and demand is the master of all prices. And you’d be right. But this still leaves us with another question. What drives supply and demand in the property market?

Keeping things simple, it is driven by two things. The first is population; the second is income. Of course, there are other factors involved. But these are two of the more influential ones.

Australia’s population set to more than double
The effect of population growth on property prices is pretty straightforward. The more people there are willing to buy property, the higher that prices will be. If we look at Sydney and Melbourne, this logic matches up. Sydney’s population is estimated to be 5.25 million this year, and Melbourne has around 5.2 million.

And it’s no coincidence that both have the highest property prices in the nation.

High levels of population combined with land scarcity cause property prices to increase. And while Australia is geographically huge, only around 10% of our land is habitable. Most of this habitable land is along the coastal areas. So even with a relatively low population, Australia’s usable land is highly sought after.

In 2015 Australia’s population grew by 1.3%. This took our total to 23.8 million. It’s expected our population could double by 2061. The ABS believes Australia’s population will surpass 30 million within the next decade.

However, both of the above figures are optimistic…at least as far the property market is concerned. The ABS had to assume two babies to every mother, and 280,000 migrants per year, to get these metrics.

Lower estimates would still tip us over the 30 million mark within the next decade. And these millions of additional residents need somewhere to live.

Not all of them will buy property, but many will. And those that don’t buy still need to rent a place to live. This rent helps pay off the mortgages for property investors, thereby supporting property prices. That’s why I believe any fall in property prices will be more of a correction than a crash. The increase in population will help to keep prices up. On the other hand, if the population remains stagnant, or even drops, then a different story could unfold.

Population growth isn’t everything. Just having people in the country doesn’t automatically make them buy property.

This brings me to the second important influence on property prices: income.

Four years of declining wage growth
It’s pretty obvious that, if you can’t afford property, you won’t buy it. And it’s well known that Australia’s wage growth is far slower than housing price growth.

At the end of 2015 the average full time adult received $1,556.30 each week. By using simple arithmetic, this comes to around $80,000 per year — less taxes. This was a 1.2% increase from last year’s figures. And these growth figures have been declining for a long time already. Average quarterly wage growth has dipped from 0.9% to 0.4% over the last four years.

If this continues it’s going to spell trouble for property prices. You can’t expect people to buy property when there’s no way they can afford it.

As mentioned before, APRA is making it harder for Australians to afford property. Their aim is to lock down and decrease investor loans. They believe reducing investors in the market will slow down prices.

But sluggish wage growth still seems to be the biggest hurdle for many Australians. Median property prices were around $695,788 as of March this year. If we compare this to the average income above, houses are 8.7 times gross wages. Just as a comparison, this is almost double the wage to house price ratio of the US. Yet it still isn’t the highest of all. In 2015, property in London changed hands at nine times average incomes. So while Australian property is selling for quite high prices, relative to average incomes, a ‘crash’ is still hard to envision on these statistics alone.

Australian property is higher than most in relative terms, but don’t sweat the bubble talk. A downwards shift in prices will be more like a correction of 5–10%, not a crash of 40–50%.


Härje Ronngard,
For Markets and Money

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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