The Housing Bubble

The Housing Bubble

Plenty of ink has been used by both sides of the housing bubble argument.

Who’s right and who’s wrong? Time will tell.

From my perch on the Gold Coast, it’s difficult to understand the nuances of the Melbourne and Sydney property markets, to form a definite opinion on whether there’s a bubble or not.

The only bubbles we see on the Gold Coast these days are from the whales as they migrate north. The Gold Coast property market is not quite as flat as a pancake, but it’s a long way from being the main topic of discussion at a barbeque.

Whereas on my reasonably frequent trips to Sydney and Melbourne, property is front and centre in most conversations. Those who are in the market are eager to tell you what the place next door or around the corner sold for. They feign surprise at the prices being paid, but are inwardly happy (even gloating) at their good fortune of being in the market.

Then there are those who are either too young or too income poor to be burdened with a hefty six or seven-figure mortgage and those who opted to wait for the market to cool its heels. They also look on incredulously at the upward price spiral…wondering if they have truly missed the boat.

They’re the ones who are eager to change the topic at the barbeque.

There are a number of reasons bandied about as to why property values are increasing.

  • The reluctance of government to release more land for subdivision and local councils gouging developers for land improvement costs.

  • Overseas (mainly Chinese) investors recognising value for money (compared to New York, London and Singapore) and also a desire convert yuan into hard assets.

  • Investors taking advantage of the tax deductions from negatively geared property.

According to the defenders of the property market, these influences make Australia unlike any other international property market. Therefore, comparisons with other boom and bust countries (that have experienced similar price to household income metrics) are not ‘apples to apples’. This type of defence sounds to me a little like that pre-bubble catchphrase — ‘it’s different this time’.

Perhaps we are different. Perhaps there are unique circumstances underpinning the property markets in our two major capital cities.

I do know that betting against these markets has been a very costly and frustrating exercise…to date.

If there’s one thing history has taught us, it’s that extrapolating past returns into the future is fraught with danger.

The reason for this is so blindingly obvious…the conditions that created those past returns (positive or negative) may or may not exist into the future. Nothing stays static.

Interest rates change. Population levels change. Household incomes change. Work practices change.

A decade ago, Oxford Street in Sydney was a bustling, trendy fashion precincts. Landlords were making a ‘motsa’. Today this once trendy street is a shadow of it former self…shoppers are greeted by empty shops and buildings in desperate need of repair. Things change.

The Reserve Bank of Australia’s recent warning on the property market produced a flurry of articles on why the market is not overheated. The content of a few articles highlighted to me why you need to apply critical thinking to the vexing question of where the property market is headed.

The Australian published an article titled ‘Why price rises won’t bring the house down’.

The article included these quotes from Paul Bloxham, chief economist at HSBC.

‘In Sydney prices are becoming a little frothy now but the national average house price to income is around 4.2, only a little above 4.1, which is the average for the past decade.

‘Sure, house prices are much higher now than for much of the period after WWII but such comparisons ignore the impact of financial deregulation, which has led to permanently lower interest rates, and the growth of double-income households.’

Financial deregulation has led to ‘permanently lower interest rates. I beg to disagree.

The inference is greater competition has led to interest rates driven lower and staying lower…permanently. Here are synonyms of ‘permanent’: lasting, enduring, indefinite, continuing, perpetual, everlasting, eternal, abiding, constant, persistent, irreparable, irreversible, lifelong, indissoluble, indelible, standing, perennial, unending, endless.

Eternally low interest rates. Wow, that’s a big call. Would you like to bet your house on that?

The reason we have low interest rates at present is due entirely to the financial sector’s lack of ability to regulate itself. Remember subprime? We have low interest rates because the Fed, ECB, BoJ, BoE have all conspired to rob savers and reward borrowers.

Interest rate suppression (the central bankers cure to the ills foisted upon us by the unscrupulously deregulated financial sector) is why we have the lowest interest rates in history. Let’s not kid ourselves.

Permanently low interest rates. I think not. Things change. In five or 10 years’ time, we may find ourselves in an inflationary world…courtesy of the cheap and easily printed money of today.

For example, in 1970, rates were 5% and in 1985 they hit 15%. Nothing is static or permanent.

Double income households have been an enormous booster to home prices. Long gone are the days of the husband’s income being the only one used to calculate home loan affordability.

These are the two powerful drivers behind property prices — the use of two incomes in home loan calculations, and the lowest interest rates in history.

Combined, these drivers equate to a capacity for higher debt levels. That was then, but what about the future?

Unless lenders start to include the income of adult children in household income, then it’s fair to assume the kicker from double incomes is not going to be repeated.

Second, interest rates could go lower. However, this would most likely be as a result of a sick economy rather than a healthy one. Not a conducive environment for property values.

Other articles reported the views of property investors. Here’s some excerpts:

Honestly, my husband and I still believe the market will keep going up…

…and I think that even if the market goes down there is little risk in Glebe compared to other places…

It [property] is something tangible. It won’t burst and it won’t lose value overnight. Shares tend to go up and down.

These sentiments remind me of Hyman Minsky’s famous saying, ‘Stability breeds instability.’ In other words, when risk has been discounted from an investment, it’s at its greatest risk.

A very wise investor once told me that when someone prefaces a sentence with ‘you can’t go wrong buying…’, you should run a mile.

The above quotes are not exactly saying ‘you can’t go wrong buying property’, but they appear to have discounted out any possibility of a sustained fall in values.

This is a sign of investor complacency…extrapolating the past into the future.

But what happens if interest rates go up? Incomes stagnate? China stumbles?

There are so many variables that can alter the price of an asset.

It’s estimated the GROSS (before rates, body corporate fees, insurances, maintenance) rental income is around 4%. Minus the expenses and you’ll scrap in a NET income return of 2%…provided the property is tenanted.

While property values are rising (or there is the prospect of prices rising), investors are prepared to ignore the pitiful income return. Growth is the name of the game.

The global economy is facing some very stiff headwinds — China slowing (possibly to 5% per annum growth), Europe teetering on deflation, Japan still in a deflationary funk, and the US growth rate continuing to disappoint.

It’s hard to see robust salary and wage growth in this sombre environment.

Without rising incomes, there’ll be a cap on property prices and home buyers will struggle to increase the amount they can afford to borrow AND tenants will struggle to pay higher rents to compensate for the (dare I say, permanently) rising costs of council rates, body corporate fees, insurances and maintenance.

My gut feeling is property values are overheated rather than in bubble territory.

Personally, with buy and sell transaction costs of up to 10%, I wouldn’t buy into an investment for a paltry 2% income return.

So when the music stops on capital growth, it’ll be interesting to see how many investors hang there.

In the near term, values may take a breather. This settling period may prove unsettling for some and prices may soften.

However, the real test for the robustness of property prices is yet to come.

Eventually, the unintended (negative) consequences of the central bankers’ stimulatory actions (suppressed interest rates and QE) will filter into the global economy. Unless of course ‘it’s different this time’.

Asset values (shares and property) that have been pushing the boundaries on historical valuation metrics are going to be the first to snap.

While we may not have a bubble, there’s no doubt a world flooded with cheap and freely available money has floated asset prices higher.

My advice is to be cautious, because it appears that not many other people are.


Vern Gowdie
For The Markets and Money Australia

Vern Gowdie

Vern Gowdie

Editor at Markets & Money

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

He is a feature editor to Markets and Money and is Founder and Chairman of the Gowdie Family Wealth and the Gowdie Letter advisory services.

Vern Gowdie

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5 Comments on "The Housing Bubble"

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Its a bubble that will continue to inflate as narrow vested interests (Politicians with a collective pool of $300m invested in property, the banks, construction, etc) can’t afford to let it collapse. It will continue to misdirect investment to non productive assets. The only way I can see it collapsing in the near future is if the Australian economy is hit by an external economic shock. When the Australian economy turns down it will be nasty given that the real economy has been hollowed out by the growth of a parasite finance sector. The growth in GDP over the last… Read more »
Mark Tomarket

Bank shares plunging, foreign carry trade investors fleeing…..can’t wait to see what funding costs are like in 6 months. Check out any of the recent ASX major shareholding announcements of the Big Four – its all one way traffic and that’s outbound.

Of course it’s always worth being cautious in any investment. Incautious investors are the ones likely to get burned in a crash or other correction. Having said that, a steady and milder correction is more likely than a crash for the Australian property market. Of course, it’ll be different if there’s a crash in one of the external factors that affect the market (like the Chinese economy) but that’s inherently unpredictable and those kinds of risks affect any investment. Even then, we don’t have a bad economy in the fundamentals, there are buffers that might stop a crash being too… Read more »
linda kable
Now in Australia (and the US) we have wage deflation for the first time. I agree unemployment will continue to climb and manufacturing continues to go off shore where there is no minimum wage. Some baby boomers from now are down sizing but family sizes are now smaller in Australia (1.6 kids per couple averaged across the whole of Australia – 22 million pp) and the younger generation do not have the money nor want these big houses… so I believe house prices will come down in 2015. They have been propped up by first home buyer grants, and the… Read more »

Yep, Oxford Street has changed, and it took only 1 thing to do it, Bondi Junction. This is how easy it is for things to hurt, even though you think they are rock solid.

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