‘Price is what you pay and value is what you get.’
Australian households are getting poorer.
As Corelogic reported recently, household’s net worth is dropping, and much of it is because of property prices falling.
But, with household debt at record highs, we are also using more of our incomes to pay debt.
According to Corelogic, housing debt makes up a total of 28.3% of total housing assets.
All that debt means that, in December of last year, households spent a whopping 9.1% of their disposable income to pay interests…and this is at low interest rates.
With stagnant wages, it could mean that any extra income — like a tax cut — may very well go to pay off debt instead of boosting spending.
That’s the thing with debt. You are bringing your spending forward, but at some point all that debt will need to be repaid.
High debt and falling house prices may mean that those who bought at the peak are risking owing more than what the asset is worth.
As Corelogic noted:
‘With housing values falling and expected to keep falling, the ratio of assets to disposable incomes is likely to fall over the coming quarters. Although most households will likely remain in a position whereby the value of their assets is significantly higher than their debt, no doubt an increasing number of recent property purchasers will have higher levels of debt than the value of their asset. This is probably an area of most concern for the RBA. If this leads to reduced consumer expenditure an in-turn slower economic growth it may be a trigger for either lower official interest rates or changes to mortgage lending policies (or both).’
And, depending on when prices start rising again, you could be stuck at negative equity for a while.
As you may remember, yesterday we talked about the Irish property bubble and how prices rose quick. People got lost in the hype of the moment…and then property prices collapsed.
Caught in the middle was Paddy Kelly, a long-time property developer who was looking at selling his home for €30 million in 2009, but couldn’t find any takers. The home ended up selling last year at a much lower price, €8.1 million.
As you can see, prices can be subjective to what people want to pay at the time, and prices can go up and down depending on emotions…and at what point of the market we are in.
It is getting increasingly harder to discern value
There was an interesting publication on this by Leonard Nakamura from the Philadelphia Fed’s Research Department done soon after the property bust in the US.
As he noted (emphasis mine):
‘As we pick ourselves up from the crisis, we see that one source of these mortgage problems has been the validity of the home appraisal, which is supposed to be an objective and expert dollar valuation of the house that should help make a mortgage safer and more marketable.
‘Unfortunately, the appraisal process can go awry and often has. As we shall see, appraisals have been biased upward. This made mortgages riskier, since too much was lent out on homes. One of the safeguards, the appraisal, failed to perform its role of limiting mortgages to the underlying value of the houses.
‘Now a reverse risk is at work: The bias is going the other way, causing home valuations to be underestimated, and this may make new mortgages harder to obtain. If so, this could delay improvement in housing markets, which, in turn, could cause house prices to fall more than they otherwise would, possibly causing additional losses to mortgage lenders.’
That is, appraisals are biased to the upside during the build-up. And biased to the downside when the market turns, as lenders scramble to reduce risks. Yet this can make the recovery longer.
The problem is that, as he continued, during the hype, all parties have an interest in a higher appraisal. Especially as prices detach from salaries and from reality. As Nakamura continued:
‘What appears to be occurring is that the parties directly involved in the transaction have a mutual interest in a somewhat upwardly biased appraisal. […]
‘[T]he mortgage contract gives the appraiser too much power to accidentally prevent house sales from concluding. This creates a strong incentive for the appraiser to bias the appraisal upward and for the other parties — the mortgage lender and the real estate broker — to want to hire biased appraisers. Note that typically the buyer is not a “victim” of an appraisal that is biased high. If the appraisal is too low, and if the seller will not lower the price, the buyer will have to come up with a larger down payment.’
It is getting increasingly harder to discern value.
Well, for one central banks keep making debt cheaper. Easy credit can affect prices, and as you can see, with easy and free flowing credit there is a clear incentive for higher appraisals. And as prices go higher the more prices inflate.
Also, the mainstream media isn’t helping with emotions. You see, it is getting harder to discern what’s real out there and what’s not.
My point is, don’t confuse price with value.
Stay tuned for more…
Editor, Markets & Money