Sunday, November 28, 2010

Housing bubble? No but, yeah but …

Talk of a housing bubble and an imminent collapse of Australia house prices gathered steam recently with reports of a senior Treasury official sounding the alarm on house prices as ‘the elephant in the room.’ (Read the story here). So is there a bubble, and if there is, will it burst or slowly leak? And what’s likely to happen next year?

Our media tend to focus on extremes – so balanced reports of what’s happening in the housing market are hard to find. Better to give exposure to doomsayers like Steven Keen (the Professor who predicted a 40% fall in prices, remember him?), or boosters like the many real estate agents or investment advisors, trying to pry money from your hands. A Treasury official may sound like an impartial judge of economic events but don’t worry too much about what one official may have to say – they’re notoriously inefficient in predicting economic outcomes. When’s the last time you heard of a government getting its budget forecasts even close to right?

That said, there are widening views about house prices in Australia and the banking system’s high dependence on a stable housing market makes this a deadly serious subject. The question of a ‘bubble’ presumes a risk of imminent collapse, which would mean economic calamity for many recent buyers without the equity buffer to ride it out, along with much of the economy.

So are prices too high, and if they are, do we risk a rapid fall? Yes, and no – in that order (and in my opinion).

The question of house prices hinges on people’s capacity to pay. Even with latest data showing the average wage has reached $65,000 per annum, median prices around $450,000 are still high – being around seven times average incomes. New entrants to the market find it especially hard, given their incomes are typically lower than average. Two income families are now the norm out of necessity, but even then, the combined household income is under pressure to fund a home at the lower end of the market (say high $300s). New product isn’t generally available for much under $400k – so gone are the days of moving out to the urban fringe to buy cheap.

Pressure on peoples’ capacity to pay is also being exerted via other means – rising utility charges (especially electricity, and now water), motor vehicle registrations, day care costs (a reality for the two income family) and so on. That’s why small movements in interest rates, adding $50 a month to mortgages, are hurting many. With all that in mind, it’s hard to see how prices can rise any further without substantial wages growth, and if that happened, the RBA would cool the growth by raising rates further, cancelling out the increased capacity to pay. Turn it whichever way you like, further rises in prices in the next several years are hard to foresee.

A further point on the RBA is their concern that rising prices, in the absence of new supply, would be a worrying trend. And that’s exactly what happened in the past couple of years – prices rose, and new house starts fell. Glenn Stevens, Chief of the Reserve Bank, warned of this over a year ago:

“A very real challenge in the near term is the following: how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices. Given the circumstances – the economy moving to a position of less than full employment, with labour shortages lessening and reduced pressure on prices for raw material inputs – this ought to be the time when we can add to the dwelling stock without a major run‑up in prices. If we fail to do that – if all we end up with is higher prices and not many more dwellings – then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over‑leverage and asset price deflation down the track.”

(You can read my article last year dealing with why Glenn Stevens was right to be worried about the housing market by clicking here).

So if we assume prices are now at a peak, what’s the risk of a rapid fall? Still pretty minimal I suspect, for a number of reasons.

The cost of new supply is one factor supporting a floor in prices. Developers would be releasing more stock to the market now if they thought the market was there. But the prices needed for new stock are determined by a range of underlying inputs – the high cost of raw land approved for development; the time cost of development assessment; the cost of taxes levies and charges; and the actual build cost the structure. This means the cost of new supply can’t fall (unless developers start selling at a loss). That new supply is around the mid to high $300s for apartments in Brisbane, and probably closer to $400k for a house/land package in a new estate. (Victoria’s new housing market is noticeably cheaper and their politicians are debating moves to make it even more so through cuts to stamp duty. A shame we don’t see that in Queensland).

New supply is also slowing, so there isn’t a big surplus of new stock floating around. Developers won’t sell for a loss and buyers can’t afford (or don’t want to) pay the necessary price for new product, so it isn’t being created. Plus, population growth – once an engine room of growth for the Queensland economy – is slowing, fast. Net interstate migration is falling fast, so we’ve become reliant on breeders and overseas migration for our growth numbers. That’s growth with a different demand profile to what we’ve been used to. So the demand isn’t there as it used to be, and neither is the supply.

Investors have reportedly been keeping the market alive but they will realise that the concept of negative gearing relies on capital growth for the sums to stack up. If prices are at or near their peak, it could be a long wait for capital growth to compensate for the yield losses on mortgaged rental stock. But unless investors are quickly forced to sell, there’s little likelihood of a flood of investment stock hitting the market.

Slower sales rates are already making themselves felt however, and vendor expectations are confronting buyer sentiment, which means prices are being dropped to meet the market. This will have to show up in median price data soon enough, but the percentages won’t be the calamity predicted by bubble theorists because as soon as reported median prices fall, bargain hunters will create a new floor of support. There are always plenty of punters who can’t say no to a perceived bargain.

Further to that, employment promises to remain strong. I remember the media laughing at claims (not so long ago) that unemployment would fall to 5%. Well, in the midst of the GFC, it’s barely moved from there. Provided people have incomes, and provided the cost of living doesn’t get further out of control, and provided interest rates don’t hit double digits, there won’t be that many people in a ‘forced to sell’ situation which would create the imbalance of supply and demand needed for a ‘bubble’ to burst.

The more likely scenario is not a burst but a slow leak. If next year we start to see median prices falling, the media will latch onto that and headlines will scream ‘collapse’ but in reality, a fall of even 10% will only being prices back to their 2008/2009 levels. Not good news if you’ve recently lashed out on a big mortgage and bought the most expensive house you could possibly afford, but those people are a minority in the market. (Media reports will of course focus exclusively on that minority).

Confidence will not be high if the media turns gloomy on all things housing, but perhaps it’s the breather the market needs? We can’t really sustain further increases in prices unless we are willing to consign an entire generation to non home ownership. Higher income households will unlikely be affected, and investors who bought more than three or four years ago will still find the increased rental incomes over that period sufficient reason to hold. There’ll no doubt be some movement in the median price figures, but it’s also quite probable those figures will be based on much smaller volumes of activity.

None of which is especially exciting for 2011, and possibly also 2012. Maybe real estate will for a time stop being the BBQ stopper it’s become, and we’ll see fewer shows on TV about how to make fast money on housing, and fewer spruikers occupying column centres in the press, talking up the future prospects of housing as a ‘make money’ proposition, as opposed to being somewhere to live.

Market stability doesn’t generate headlines, and once you stop reading daily or weekly reports about the housing market, or when TV shows like ‘The Block’ have faded into a memory, it could then be the time to dive back in. But that time may be a while away yet.


  1. You make a lot of sense, Ross. These are interesting times we live in and adjustment is the name of the game. The one inescapable reality is that if expectations don't change, then a generation is going to forfeit that wondeful birthright of ours: home ownership

  2. Ross
    join the "talking sense" is a lonely institution and one which, sadly, few really want to be part of these days