Deleveraging and Australian Property Prices

by Stubborn Mule on 22 July 2009 · 60 comments

car-smallA few weeks ago, I had a preliminary look at Australian property prices. That post focused on rental yields and argued that the fact that property prices have consisently outpaced inflation over the last 10-15 years can be associated with a steady decline in rental yields which has been matched by a decline in real yields in other asset classes. What I did not address was the argument that debt deleveraging will lead to a collapse in property prices just as it has done in the US. That is the subject of today’s post.

The Bubble

The bubble argument is a compelling one. The chart below shows the growth in Sydney property prices over the last 24 years. Prices rose fairly consistently over this period at an annualised rate of almost 7%. Over this period, inflation averaged around 3% per annum, so property prices grew at a rate of approximately 4%. This means since 1985, the cost of a typical house has risen by a disconcerting 123% over and above inflation. Little wonder that many people see the property market as a bubble waiting to burst.

sydney-recent

Sydney Property Prices (1985-2009)*

The fuel driving the property market has been the rapid growth in household debt, most of which has been in the form of mortgage debt.  The next chart is taken from Park the Debt Truck!, a post which looks at trends in Government and household debt in Australia. The highlighted regions show the periods of Labor federal governments. Household debt began its upward trajectory during the Hawke and Keating years, but really gathered pace during the Howard years. With the help of continually extended first-time home-buyer grants, growth is yet to slow now that Rudd has come to power.

Govt and Household Debt

Government and Household Debt in Australia

This expansion of debt has been a key factor driving up property prices. Without the easy access to money, the pool of potential home-buyers would be far smaller and with less demand pressure, prices would not have risen so fast. A very similar pattern was evident in the US, but in late 2006 the process began to lose steam. Property prices faltered, debt became harder to obtain, borrowers began to default on their loans leading to foreclosure sales which put further downward pressure on prices. The bubble was bursting.

So far I am in agreement with the property bubble school of thought. Where I part ways is concluding that Australia will inevitably experience the same fate, resuting in a collapse in property prices, possibly in the range of 30 to 40%.

Deleveraging

Words can be powerful. Once you use the word “bubble” to describe price rises, it seems almost inevitable that the bubble must burst. Similarly, “reducing debt” sounds like a good thing, while “deleveraging” sounds like a far more ominous destructive process. But all deleveraging really means is debt reduction and it can happen in a number of ways:

  • borrowers use savings to gradually pay down debt
  • borrowers sell assets to pay down debt
  • borrowers default on their loan

When it comes to borrowers selling assets, in some cases this may be voluntary. But it may be that they are forced to sell. A good example is in the case of margin loans to purchase shares. If the share price falls, the lender will make “margin call”, requiring the borrower to repay some of the loan. Selling some or all of the shares may be the only way to raise the money required. When borrowers default on a secured loan (such as a mortgage), the lender will usually sell the asset securing the loan in an attempt to recover some of the money lent. In this situation the emphasis is usually on ensuring a speedy sale rather than maximising the sale price.

Forced sales are the ideal conditions for a price collapse, particularly if lenders have become reluctant to finance new borrowers. If debt reduction takes the form of gradual repayment, the pressure on prices is far less. There will certainly be less demand for assets than during a period of rapid debt increase, but this can simply result in neglible growth in asset prices for an extended period of time rather than a price collapse.

To understand what form debt reduction will take, it is not enough to consider the amount of debt. The form of the debt is very important. Some of the key characteristics that will influence the outcome include:

  • the term of the loan (the length of time before it must be repaid)
  • repayment triggers (such as margin calls)
  • interest rates

Short-term loans can be very dangerous. In 2007, the non-bank lender RAMS learned this the hard way. It had relied heavily on very short-term funding (known as “extendible asset-backed commercial”) and back when the global financial crisis was simply known as a liquidity crisis, RAMS found itself unable to refinance this debt. It’s business collapsed and it was purchased by Westpac for a fraction of the price at which the company had been listed only months before.

The most common type of loan with repayment trigger is a margin loan. There is no doubt that a significant factor in the dramatic falls in the Australian sharemarket over 2008 was forced selling by investors who had used margin loans to purchase their shares. There are also other sorts of loan features than can be problematic for borrowers. Another one of the corporate victims of the financial crisis was Allco Finance. It turned out that they had a “market capitalisation clause” attached to their bank debt. This was like a margin call on the value of their own company and was an important factor in the collapse of the company.

Even if borrowers have long-term loans and are not forced to repay early, if they are unable to meet interest payments, they will be in trouble. A common feature of the US “sub-prime” mortgages at the root of the financial crisis was that interest rates were initially low but then “stepped up” a couple of years after the mortgage was originated. While the market was strong, this was not a problem due to the popular practice of “flipping” the property: selling it for a higher price before the interest rate increased. Once prices began to fall, the step-ups became a problem and mortgage delinquencies (falling behind in payments) and defaults began to rise. In some states, the phenomenon was exacerbated by laws that allowed borrowers to simply walk away from their property, leaving it to the lender, who had no further recourse to pursue the borrower for losses. On top of all this, rapidly rising unemployment put further stress on borrowers’ ability to service their mortgages.

So, how do Australian mortgages look on these criteria? The standard Australian mortgage is a 25-30 year mortgage with no repayment triggers. Most mortgages are variable rate and, despite the banks not passing through all the central bank rate cuts, mortgage rates are at historically low levels. In part due to the regulatory framework of the Uniform Consumer Credit Code (UCCC), lending standards in Australia have been fairly conservative compared to the US and elsewhere. The Australian equivalent of the sub-prime mortgages, so-called “low doc” or “non-conforming” mortgages, represent a much smaller proportion of the market. Many lenders cap loan-to-value ratios (LVR) at 95% and require the borrower to pay mortgage insurance for LVRs over 80%, which encourages many borrowers to keep their loans below 80% of the value of the property. Interest step-ups are rare. Mortgages are all full recourse.

The result is that while US mortgage foreclosure and delinquency rates have accelerated rapidly, they have only drifted up slightly in Australia. It is not easy to obtain consistent, comparable statistics. For example, deliquency data may be reported in terms of payments that are 30 days or more past due, 60 days or more or 90 days or more. Of course, figures for 30 days or more will always be higher than 90 days or more. Nevertheless, the difference in trends is clear in the chart below which shows recent delinquency rates for a variety of Australian and US mortgages both prime and otherwise. The highest delinquency rates for Australia are for the CBA 30 days+ low doc mortgages. Even so, delinquencies are lower even than for US prime agency mortgages 60 days+ past due.

Delinquency Rates (III)Delinquency Rates in Australia and the US**

All of this means that the foreclosure rate remains far lower in Australia than in the US. Combined with the fact that mortgage finance is still increasing, due largely to the ongoing first-time home-buyers grant, there has still been little pressure on Australian property prices. In fact, reports from RP Data-Rismark suggest prices are on the rise once more (although I will give more credence to the data from the Australian Bureau of Statistics which is to be released in August).

Once the support of the first-time home-buyers grant is removed, I do expect the property market to weaken. Prices are even likely to fall once more with the resulting reduction in demand. However, without a sustained rise in mortgage default rates, I expect deleveraging to take the form of an extended lacklustre period for the property market. Turnover is likely to be low as home-owners are reluctant to crystallise losses, in many cases convincing themselves that their house is “really” worth more. Even investors may content themselves reducing the size of their debt, continuing to earn rent and claim tax deductions on their interest payments.

The biggest risk that I see to the Australian property market is a sharp increase in unemployment which could trigger an increase in mortgage defaults. To date, forecasters have continued to be confounded by the slow increases in unemployment and now the Reserve Bank is even showing signs of optimism for the Australian economy.

Australian property prices have certainly grown rapidly over recent years. Driven by rapid debt expansion, prices have probably risen too far too fast. But, calling it a bubble does not mean it will burst, nor does using the term “deleveraging” mean that prices will inevitably follow the same pattern as the US. In the early 1990s, Australia fell into recession and the commercial property market almost brought down one of our major banks. Meanwhile, house prices in the United Kingdom collapsed. Despite all of this, in Australia, residential prices simply slowed their growth for a number of years. I strongly suspect we will see the same thing happen over the next few years.

* Source: Stapledon

** Source: Westpac, CBA, Fannie Mae, Bloomberg.

By the way, notice anything unusual in the picture at the top?

UPDATE: Thanks to Damien and mobastik for drawing my attention to this paper by Glenn Stevens of the Reserve Bank of Australia. It includes a chart comparing delinquency data for the US, UK, Canada and Australia. The data is attributed to APRA, the Canadian Bankers’ Association, Council of Mortgage Lenders (UK) and the FDIC. Since these bodies do not appear to make the data readily available, I have pinched the data from the chart and uploaded it to Swivel. It paints a very similar picture to the chart above.

Delinquency: US, UK, Canada and AustraliaMortgage Delinquency Rates

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{ 48 comments… read them below or add one }

1 Damien July 22, 2009 at 8:48 pm

Another interesting data point is graph 6 on page 8 of http://www.bis.org/review/r090522a.pdf. There’s been a significant reduction in the house prices to income ratio over the past few years, without a catastrophic drop in house prices.

2 metasonix July 23, 2009 at 7:26 am

Yeah, the garage door is inaccessible to a car……

3 stubbornmule July 23, 2009 at 7:28 am

Points to metasonix for the first correct answer!

4 Andrew July 23, 2009 at 10:05 am

A couple points that make Australian different from US

1) Majority of Australian mortgages are variable where on the US they are fixed so American haven’t had the benefit of Central bank reductions as result Americans haven’t any changes to their mortgage repayments when the economy started heading south where most Australian had substantial payment reductions.

2) In US Mortgage repayment are tax deductible and there is no incentive to make additional payments, In Australia majority mortgage holders have been paying extra building more equity via redraw which has substantial effect in reducing delinquency rates

3) Sub prime brought a new class of borrower to real estate market in the US this hasn’t happen in Australia with low doc loans

4) Home ownership in Australia is with approx 1/3 of all houses in Australia own outright which has had stabilizing effect on prices

5) Mortgages in the US are non recourse so the mortgagee can just walk away this not the case in Australia.

6) Default rates in US where 10 higher than Australia prior to sub prime crisis

Regards

Andrew

5 stubbornmule July 23, 2009 at 10:29 am

Andrew: you make some good points here, but there are a couple of qualifications:

1) While most US mortgages are 30 year fixed rate mortgages, there are also no break costs for refinancing. So, when mortgage rates fall, people can refinance at the lower rate. The problem is that, while the central bank rates in the US have fallen a long way through this crisis, mortgage rates have not fallen nearly as far. One of the reasons for the Fed’s quantitative easing was an attempt to reduce mortgage rates.

5) Not all states are “walkaway” states with non-recourse mortgage loans. According to this list, there are 20 walkaway states, including California. It is still an important point of difference.

6) Over many years, Australia has had significantly lower mortgage default rates than either the UK or the US, in part due to the points you have made here. I expect this phenonemon to persist.

6 Andrew July 23, 2009 at 11:13 am

Yes I agree that there is no break cost fees involved but the cost in refinancing in the US is typically around 1-1.5% of your loan amount which is generally much more that what is paid in Australia

7 Mike July 23, 2009 at 12:36 pm

Just a few quick points on the 123% real price rise of the last 24 years.

Firstly real incomes have risen. Secondly real disposable incomes have risen faster. Third point. The “median” house has gotten bigger and shinier with more features.

Fourth the growth in land prices is partly due to government investment in infrastructure (e.g. every house within walking distance of a new station gains X dollars, each freeway gives a price bump to those conveniently located.)

Fifth more women work and work longer before having kids. Its now much more common for DINKS (who are the price setters in many areas) to have 2 incomes well into their 30s.

However I still agree there is a bubble effect due to people’s assumption of ever-rising house prices and the willingness of Australians to over-stretch themselves to meet the middle-class aspirations. My feeling is that unless unemployment goes higher and stays higher we won’t see a price crash.

A sub-1% default rate doesn’t flood the market with properties. I would be interested in knowing what the natural turn-over is. Slightly increasing the supply probably only shifts a small distance the supply-demand price point intersection.

8 stubbornmule July 23, 2009 at 3:51 pm

Damien: thanks for the pointer to the Stevens’ paper. I’ve pinched the delinquency data from it.

9 James July 23, 2009 at 5:08 pm

I think you underestimate the role of sentiment in bubble bursts. Maybe the worst effects of the GFC have been held off due to the offsetting benefits of the ongoing Chinese boom or maybe it’s due to Australians’ stubborn mulishness in denying the inevitable.

10 stubbornmule July 23, 2009 at 5:21 pm

James: sentiment, or behavioural bias perhaps, are another factor supporting the “stickiness” of property prices. Many people have a strong loss aversion that leads them to avoid selling in a weak market. It’s much easier to convince (delude?) yourself that your house is still worth more for the place down the road that sold for a song than to convince yourself that your BHP shares are worth more than the ones that traded this morning.

Of course, the relative strength of the Australian economy and employment in particular is a critical factor supporting prices. China is part of the explanation as is the fact that our banks were better positioned (luckier rather than smarter in all likelihood) than many around the world. On this point, it is interesting that the banks that have performed the best through the economic crisis are Australian and Canadian banks and Australia and Canada also have the lowest mortgage delinquency rates. Make of that what you will.

11 Mark L July 23, 2009 at 5:50 pm

@James: If people continue “denying the inevitable” for long enough, doesn’t it then become evitable?

12 James July 23, 2009 at 5:57 pm

Mark L – to quote St Augustine “Lord, give me continence and chastity – but just not yet”

13 Patrick July 23, 2009 at 6:55 pm

Epic fail whoever built that house

14 stubbornmule July 23, 2009 at 6:56 pm

Patrick: got that photo when it was doing email rounds a while ago. Not sure whether it’s faked or not, or where it’s from. It is funny though.

15 Patrick July 23, 2009 at 9:01 pm

I view the housing market as some form of giant Ponzi Scheme really. The above inflation price rises and the large disparity between average incomes and average house prices is fueled by debt. People can’t afford to buy these things, so they borrow money, which pushes up prices, so people have to borrow even more money, pushing up prices even further and so on until it reaches a point where average house prices are so high that mortgages cannot be sustained by average incomes and prices will crash. (not exactly a ponzi scheme, but you get the idea)

I am obviously ignorant of many aspects of the economy, but why do we have mortgages at all? If people cant afford something, why, instead of going out and earning more money, are they allowed access to easy money which does nothing but create an unsustainable inflationary feedback loop in the long term?

Giving lots of people money to buy things they otherwise could not afford does nothing but inflate prices. All the first home buyers rushing into the market because of the first home owners grants think they are getting a free 14 or 21k, when in reality they are just paying that much or even more…. more for their properties, although this was obviously the real purpose of the original grant and the boosts, the keep the bubble inflated.

Why can’t we just pay for things with the money we have and earn instead of financing them with debt? Foreign debt that is, I understand the differences between household debt and governments running deficits. That way inflation and house prices should rise more or less in tandem with personal incomes.

Or if I am making incredibly ignorant statements here, please enlighten me.

16 John Moussa July 26, 2009 at 7:07 pm

Great report yes yes and yes! We need a massive ajustment in housing prices, the economy will do well in having one, why ? Because its busting up families and giving many home owners a false view of what there house is really worth.
Who sets the prices?

Banks and realestate agents only one word can describe these charlatans, Greed!!

Banks want you to borrow and agents pop up the price for a bigger commission.

Keep these liars honest someone should put a class action against them.

in 25 yrs house prices have increased over 150% now that is a miracle when land value
has not gone up that much nor has goods and commodities mmm maybe they should
start a church.

17 stubbornmule July 29, 2009 at 12:34 pm

Patrick: debt is like a knife: it is very handy, but if you are not careful, you can cut yourself. While it is true that every asset bubble has been fueled by debt, the converse is not true: it is not the case that all debt leads to bubbles.

A key role played by debt is assisting in managing inter-temporal earning differences. What do I mean by that? As an example, most people do not earn very much when they are young, but their earnings grow over time. As a result many people would not have enough money from their own earnings to spend on a car, a house or other things, some of which may be important to help grow their future earnings. But when they are older, they may be earning more that they require. Debt effectively allows the young person to borrow from their own future earnings. A similar situation can arise for business. A company may have the ability to generate significant earnings from, say, a widget factory but does not have the cash to build the factory. Debt allows such a company to build the factory and the resulting widget revenues still leave a profit after paying the interest on the debt.

Of course, not all debt is used in this way. Debt is also used to purchase speculative assets, which can generate asset price bubbles. So while debt can be dangerous, it would be a mistake to outlaw it altogether.

18 stubbornmule July 29, 2009 at 1:11 pm

Patrick: coincidentally, I also just came across this post on whether all debt is bad. Mind you, I don’t agree with all the conclusions here, particularly in relation to the supposed inevitable collapse of Australian banks.

19 Jobs business August 8, 2009 at 10:44 pm

The real estate prices have gone up all over the world. It’s definitely true that when it comes to borrowers selling assets it is voluntary some times but mostly they are forced to sell.

20 Ace - T August 25, 2009 at 9:41 pm

Focusing on individuals in Sydney:
(1) With Rudds, budget deficit, tax hikes will subsequently over the next 5 years.
(2) Salary increases flat.
Therefore, expect real income increases to be below averga for next few years.

Current market
(1) Tax home Income to Mortgage ratio = 6x.
(2) Dual Income already priced in to the housing market.

Difficult to price in “strong” future growth.

Sydney property market next few years:
(1) 3 year + 5 year money already priced in 2% interest rate rises. Expect a rate(s) from November onwards. 2% increases will hurt on a mortgage of 400-500k.
(2) Following removal of the 1st home buyer and 50% stamp duty exemption govt grants 31 dec 2009, expect bottom of the market to come under pressure.
(3) Energy prices subsequently rising. Expect this to continue.
(4) UK, US in particular have “de-leveraged” very fast. Sydney has yet to really reduce debt to asset values.

Prognosis: Sydney medium property prices likely to underperform the inflation rate for the next few years.

Over time, inflation will increase faster than property prices will grow – effectively eating away value. Also real disposable income will start to fall as tax hikes, higher interest rates and higher living costs eat away real disposable income.

effectively, the sydney & to some extent the australian property “bubble” will be burst through a mechanism of “1000 cuts” over time slowly eating away at value.

21 bubblepedia August 31, 2009 at 9:57 am

Hi stubbornmule. Nice blog. I agree with the guts of it.

The argument whether it is a bubble or merely an unsustainable enormous price without obvious justification or concomitant rise in either rents or the incomes people use to pay to live in the houses does seem a bit semantic.

The japanese property bubble took over a decade to reverse, and I suspect that japanese people who bought their first home in 1990 don’t really care what it was called, or how fast it corrected.

There are aspects in which it is ‘different here’, and the structure of our mortgage market is one of them. Unlike some US states we cannot walk away. However nor can the japanese, and nor can the british.

I can’t really see how the fact that delinquency rates have not risen much tells us that they will not rise. Roll your mortgage delinquency chart back to 2006 and you can make the same argument for the US and UK. they hadn’t risen so they weren’t going to. It’s true that high foreclosure rates improve price falls, but price falls increase foreclosure rates too as owners are unable to sell out at a profit.

Roll a first home buyer’s life forward a few decades and ask them if they care whether they bought at the top of a bubble or an enormous price rise without obvious justification, or whether they care that prices rolled gently down a hill for decades rather than falling off a cliff two weeks after they bought it.

Houses are a long term investment. Are there any examples of such price rises from more than a few decades ago that were not reversed eventually?

22 stubbornmule August 31, 2009 at 10:14 am

bubblepedia: “Bubble” is not a very clearly defined term, I agree, but given the image it conjures up, it strongly suggests an unsustainable price rise that will suddenly burst, rather than one that will drift sideways or even slowly downwards for an extended period of time.

Also, I certainly agree that that fact that delinquencies have not risen yet does not mean they will not in the future. My argument is simply that it would be very surprising to see prices collapse dramatically before delinquencies pick up and some advocates of the bubble theory seem to suggest that the bubble could burst any day now, which I think is less likely. I think that the a significant pick up in delinquencies, most likely due to rising unemployment (or underemployment) represents the biggest risk to house prices.

Of course, none of this should be taken to mean that I think that property represents a great investment opportunity today. Even if I am right and there is no crash, but a sideways drift, that doesn’t represent particularly attractive return on investment.

23 Libertarian August 31, 2009 at 4:41 pm

Thank you ‘stubbornmule’ for the first class analysis and both ‘bubblepedia’ and ‘stubbornmule’ for the first class dialogue.

24 stubbornmule August 31, 2009 at 5:25 pm

Libertarian: Thank you (and bubblepedia) for the feedback. Give me decent dialogue and analysis rather than entrenched positions any day! Unfortunately some on both sides of this particular debate have a tendency to pick up an almost religious level of conviction and deafness to debate. I do try to avoid doing the same.

25 Bryan Kavanagh September 2, 2009 at 12:58 pm

I enjoyed the discussion, too. I define a real estate bubble as when total real estate sales in Australia get beyond 19% as against GDP (or 18% seasonally adjusted). Over the last 10 years the ratio has held to 30% (29% sa) for a good part of that time. We put $2.4 trillion into real estate sales between 1999 and 2008 and some $675 billion of this was in the bubble, so it’s a bubble alright!

Oh, wait! I’ve just heard on the radio that the government stimulus package has worked. There’s no recession and it’s happy days again! So, please scrap the previous para!

26 frank muller September 5, 2009 at 1:33 pm

hi all

I just come back from germany ,when i compare prices too australia,what i get for 400k aud-260k euro ,i get castle in germany and still have money left.
all is overpriced and not worth half of the price

27 stubbornmule September 5, 2009 at 4:23 pm

Frank: it’s been a long time since I was in Germany, but as I recall there was much less of a buying culture there than in Australia. Many people rent all their lives without feeling the compulsion people here to “own their own home”. I don’t know whether tenancy laws or taxation is a significant factor driving this difference or whether it is more of a cultural phenomenon. In any event, assuming this is still the case, it makes sense that the lower purchasing prices leads to more reasonable prices.

28 Andrew September 5, 2009 at 4:26 pm

In Germany their is laws that your rent is limited to CPI increases so over time it becomes very cheap

29 stubbornmule September 5, 2009 at 4:30 pm

Andrew: very interesting! That would certainly help make renting more attractive. I wonder whether there are any side-effects, like the practice of paying key money in some rent-controlled areas in the US (especially Manhattan).

30 Bruce Aulabaugh September 28, 2009 at 12:43 am

Great website.
I suggest that it would be useful (for bubble testing) to check price of Aust house to Aust price of gold per oz over last 40 years. The Price of median US house in ounces of gold ($US) for some key data points since 1972 is:

200 oz in 1973 (after gold backing of dollar removed by Nixon); 100 oz in 1980; 525 oz in 2001; about 200 oz in 2009.

cheers
Bruce

31 property prices October 2, 2009 at 8:19 pm

Its a nice blog about property prices.
Thanks.

32 Pakistan Property October 13, 2009 at 6:48 pm

I don’t think that Sydney property growth is behaving like a bubble which can burst any time , due to good governance by Government economy is stable enough here in AUS that is not too much affected by World economical crisis. I hope better future of real estate in Sydney.

33 Lifetimerenter November 10, 2009 at 4:34 pm

I truly believe that the housing affordability will remained strained if not completely out of reach for many many years to come. I have read reviews for the last 5 years that all predicted that this year would be the big burst then the following year and so on. The market here is just far to strong.

Admitteldy i am bewildered by it, i am 28 married with the ideal DINKS senario. For me to own a one bedroom unit in melbourne 12km from the city it will now cost me (thanks to Rudds FHOG) $405,000 or $572 a week on current rates. No backyard and no real prospect of being bale to do anything other than rent it out as student accomodation. Low-income somewhat impoverished south eastern suburbs an average home will set you back $350-410,000. Who in the world can afford this mortgage on below average wages.

We talk about market regulation and this is just dellusionla, these people afford it because debt has been redesigned to allow for this. How many loans today are being centred around interest only?? Peopel are being forced to take on these loans not fully understanding that they are worse than rent, they will be condemned to the house for life whether their life cirumstances change or not.

I know this first hand, my wife and i with our $56k deposit settled on an affordable amount of borrow $280,000 over 25 years. This meant that although not as well off as we are now we would still be able to save a little and enjoy luxuries occasionally. The fella at mortgage choice sat us down and explained that he could quite comfortably get us approved for around $590,000 on an interest only loan and that we should look at properties in a much higher price range. I though this was madness and we couldn’t find anything in our price range so we gave up. What scare me though is the ease in which the money was being offered and how many in my position just ran at it with the blind faith that property ‘always goes up’

34 stubbornmule November 11, 2009 at 11:03 am

Lifetimerenter: interesting story re Mortgage Choice. How long ago was that? I’d be curious to know whether anything has changed post-GFC.

35 lifetimerenter November 15, 2009 at 4:06 pm

Hi stubbornmule, no it wasn’t that long ago at all it was around May/june of this year when we were in ‘go’ mode trying to get something as the market exploded. I have a mate who is frantically trying to get something now, he has a 60k deposit single income of 70k and they have approved him for $465,000. He went to an auction on a 2 bedroom 40 year old apartment, needing full renovations on saturday, it went 68,000 over the reserve and sold for 489k. It was in Elwood which (in case you don’t know) is about 10-12km outside Melbourne near the bay.

He is now seeing whether they will give him more, he is now so scared at missing out of the boom he will do anything necessary to buy a place, any place!!

It scares me as there really doesn’t seem to be an end in sight and property seems really strong, almost seems like it doesn’t have an end. Even if it fell 40% from here (worst case dooms day scenario) i am still unable to afford this anyway, it is sad i will have to raise my kids in a 4 walled concrete box, not how i envisaged my life when growing up……………………

36 stubbornmule November 15, 2009 at 6:45 pm

lifetimerenter: a $465,000 loan on an income of $70,000 is scary. Many years ago, banks used the rule of thumb of lending no more than three times a borrower’s annual salary and this loan would be more than double this level. Unless there is reason to expect an imminent jump up in your mate’s salary (e.g. they are about to finish training and move to a better paid job), this is a very significant loan commitment. At current interest rates, your mate would be paying almost 50% of their gross salary on the mortgage, well over the 35% level that is taken to signify “mortgage stress”. With a loan of that size, your mate would be left with less than $400 per week after tax and mortgage payments and every 1% increase in mortgage rates would eat up another $90 per week. This sounds like a very risky proposition.

37 lifetimerenter November 16, 2009 at 3:45 pm

Hi stubbornmule, yeah i’ve done th maths on it to and thats why i have backed away but he like others a bedazzled by the trend of the market since 2003. He is annoyed with me for telling him to hold off, he now feels that listening to me has put him behind the 8 ball by about 30% on average and if he gets in now he won’t miss the next 30%.

Banker, (land rats) real estate agents and the general public who own property are all reaffirming his insecurity. He is in sales and although his wage may grow slightly to lets say between 80-90k he will never earn more than this unless he wins tattslotto ot changes career so all figures processed by the bank have been on this data.

If this is indicative of how they have been lending i hope the market doesn’t stop rising because interest rates will start moving upwards again and we may have our very own subprime disaster looming

38 lifetimerenter November 18, 2009 at 11:43 am

We can’t seem to win, apparently rents have risen an average of 40% in Victoria in the lst 12 months that mean ihave to find another $120 for my landlord when i renew the lease in 2 months. Although interest rate are at a 45 year historic low they are still raping us!!!

Can’t afford to buy and soon can’t afford to rent. I hope the Salvo’s aren’t over crowded or we’ll end up on a park bench at this rate.

39 stubbornmule November 19, 2009 at 12:13 pm

lifetimerenter: This is no consolation for you, but based on my contention on the earlier post that rental yields are a key driver of property prices, this increase in rents is likely to continue to support house prices.

40 firsttimebuyer November 29, 2009 at 11:23 pm

I’m a recent first time buyer in Sydney and found this post (and the previous one on the same topic) very interesting – there are so many factors influencing the cost of housing which makes it a pretty fun game to be in.

We have taken a gamble on house prices continuing to rise in line with the trend over that last 20 years, in the hope that we will be able to use the capitol growth from the purchase of the modest bungalow we have just purchased, combined with our on-going saving (now tax free thanks to an offset mortgage), to get us into the family home we will need in a few years time. If prices stay the same then we have lost the fees associated with the purchase, if they rise then we at least share some of the benefit, but if they fall then we will lose out heavily. Time will tell!

A question for the experts though – have there been any studies on the influence of inheritance on the cost of housing? The reason I ask is that I know many people who, on the death of their parents, have subsequently used their inheritance to “trade up” in the property market – my own parents among them some years back.

It seems to me that this could potentially account for the high growth in property prices compared to CPI. I doubt many people would use their inheritance to by large quantities of basket goods, or would just keep the money in the bank. Some may decide to spend on luxuries (holidays, cars, etc) but I suspect the majority invest their inheritance in the property market either by paying down their existing mortgage, buying their first home or by moving up the ladder to a “better” home.

As the majority of inherited money is likely to have come from the property market in the first place (through the sale of the deceased’s home) to my mind this “latent” investment in the property market must surely have a disproportionate inflationary affect on long term residential house prices when compared to other goods. That being the case is it not conceivable that there is no bubble and the underlying performance of the housing market is in fact sustainable far into the future?

Almost certainly there is some huge hole in this logic but I’d certainly be interested to know what it is!

41 Sid December 13, 2009 at 11:22 am

I have put together some of my thoughts in relation to the Australian Property Bubble at the following address (which may be of interest):

http://www.scribd.com/doc/22566921/Australian-Property-Bubble

42 sydneysayer January 9, 2010 at 8:07 pm

Current 30-day bank bill futures are forecasting an RBA cash rate of 5% by year end 2010. (Upside is likely due to stronger inflation coming through and competition increasing in the mortgage market again to bring mortgage rates closer to the rba cash rate.).

This will push the mortgage rates up to 8%-9%.

The resource cycle currently underway is still in its early-mid stages and will ensure that this happens.

Sydney and Melbourne mortgage belts overpriced and will be in mortgage pain. They are average Joe with an average wage in a no growth driven job. Property price increases will not keep up in line with inflation in those areas. “Real Prices” therefore fall in these areas.

Strong property price growth in the regions where there is significant exposure to resources, such as along the Mid-North QLD and mid NSW. Even the coal truck drivers earn a salary of $150k+.

Watch carefully during 2010 as the govts and the number of developers start looking to build more property developments. As they also realise the undersupply of housing in the Australian market and see potential opportunity to make money. These will come online during 2011, 2012. As with any free market, it will bring itself to normalise over time.

Heres a note of interest, Britain had an increase of 5m immigrants arriving and settling in the UK since 1995. And property prices fell 20% there during 2008/09. And here we are in Australia getting excited that a few thousands new immigrants is going to always keep our property market booming!!

More supply, higher interest rates…..an interesting few years ahead to watch out on.

43 stubbornmule January 9, 2010 at 8:19 pm

sydneysayer: it will be interesting to watch the impact of rising mortgage rates on the Australian property market and Sydney in particular.

As for supply, the article “Nailed to the Wall” in today’s Sydney Morning Herald suggests that there is still a long way for Sydney to go to get to an adequate supply of housing, let alone the excess supply that helped lead to the collapse of the US property market. In part the article says of Sydney:

‘‘Currently NSW is supplying just one dwelling for every 4.7 person increase in population. That is by far the lowest level on record, and when you consider the average household size is circa 2.6 people it just doesn’t add up. The Sydney market flattened out from a capital growth point of view around 2003, when more than one dwelling was approved per person. Now it is less than one fifth of that.’’

44 booboo January 14, 2010 at 6:36 pm

firsttimebuyer: I don’t think that many variables makes any market “fun to be in”. However, I am curious on the capital growth allowing upgrading belief. It seems like a logical idea, but large capital growth is the enemy of all outside of investors and retirees. The only way you can benefit is if your current place experiences capital growth, but your “dream home” does not. In fact, with capital growth of BOTH places (greater than your wage growth), the delta in cost between your current domicile and your more expensive dream home will simply grow. Capital growth is merely advantageous in this case vs cash savings or shares as savings are taxed at your marginal rate, and shares are effectively half that if sold after over a year. Upgraders hoping for capital growth are sadly misled.

stubbornmule: The big two effects I’m curious about are the raising interest rates and winding down of the FHOB. Both will take months to play out, but the latest ABS reports have already stated a slow down in home loan growth. Rising mortgage rates in particular will be interesting, as I have often heard commentators (with vested interests) claim that low interest rates were fueling price growth (due to increased ability to service debt) and helped affordability; however, rising interest rates simply lower demand, but do not have a downward affect on prices. Sounds like a case of eating your cake and having it too.

I have long thought that the easy availability and cheapness of credit has helped push house prices to high levels, and rising interest rates increase the cost of money and thus should have a downward effect (especially on the maximum amount offered by banks). The next 6 – 12 months will be interesting.

45 Lefty January 14, 2010 at 9:45 pm

Hi Sean.

I was wondering if you could comment on this article. Check the comments and the links in them as well.

http://www.dailyreckoning.com.au/property-spruikers-claim-australia-suffers-from-a-chronic-housing-shortage/2009/08/24/
I remain unconvinced that there is any actual physical shortage of housing in Australia.

46 Stubborn Mule January 15, 2010 at 9:38 pm

booboo you are absolutely right about capital growth being bad even for some home-owners: I’m constantly surprised by conversations with people looking at buying a bigger house getting excited that the value of their current property has gone up. They somehow maintain the delusion that their house will go up in value while the price of the place they buy next will go down. It seems surprisingly hard for people to appreciate their exposure is to the price difference (delta) and this is most likely to go down only with the overall market, unless there are significant dislocations in prices of where they are and where they are going.

As for the impact of rate hikes on prices, the property market is rather different from markets like the share market and can be “sticky”. If the “true” market price of a house falls, many people simply will not sell and they can continue to convince themselves their property has not fallen in value. The same cannot be said of, say, BHP shares. If the selling of others pushes the BHP share price down, there is no denying the fall in value of my shares (if I had any that is!). So a reasonably plausible scenario is that the market turnover slows and prices simply stagnate for an extended period of time (while this may be a correction of excessive prices, it is not dramatic enough to be described as a bubble bursting). The main thing that can really trigger a collapse, as I argued in the post, is forced sales and while rising interest rates will push delinquencies and foreclosure rates up, we are still a long way from levels seen elsewhere.

Lefty I read that post and many of the comments. I have to say that little I have read on either over or under-supply seems that rigorous or convincing. The most promising line would seem to be the ABS figures quoted in one comment, although the commenter looked at changes since 1981,which is a long period. This may support the idea that there is not an oversupply today, but the rates of construction and population growth more recently may give a better indication of trends in coming years. Perhaps I’ll have a play with the data myself when I get a chance.

47 firsttimebuyer January 15, 2010 at 11:31 pm

stubbornmule, booboo I completely agree with your comments re: capital growth – I’m under no illusion that the capital growth in our current property will somehow buy the next one without any further saving. I’m also perfectly aware that the gap between the value of our current property and the “dream home” is always widening in a buoyant market.

What I do hope we’ve done though is index our existing savings with the property market – if property values do keep increasing in line with the historic trend they will grow faster than any other investment we could have made, in part due to the CGT we would be liable for on the returns (we are top bracket tax payers). Certainly if we had kept our savings in cash and prices keep rising the dream home would always remain a dream as our savings would never keep pace.

By investing in a residential property that we live in, rather than shares or term deposits, we have been able to invest a large sum of borrowed money at essentially no additional cost to ourselves. This is because the interest on our loan is roughly equivalent to the rent we would otherwise be paying (substantially less at the moment), and we need to live somewhere! We simply would not be able to service an equivilant loan on an alternative investment, regardless of whether it would provide a better eventual return.

If property prices do crash it means we’ve made a poor decision to buy now. But in consideration of our long term plans it will actually be better for us if they do… so long as we still have enough money between the equity in our current home (less costs) and our cash savings for a deposit on the “dream home” when the time comes. Obviously it will make us look foolish if that happens, but at the end of the day any investment except cash carries an element of risk. You can’t get everything right in life, only try to make rational decisions based on the information to hand – I won’t be beating myself up forever. And besides, my gut still tells me we did the right thing!

Regarding the comments about the housing surplus/shortage, I am in no way qualified or even informed enough to comment on the market as a whole but I would like to share some specific recent experience.

We have two sets of friends (couples) who have been attempting to rent a property in Sydney recently. Both have good incomes and references from previous tenancies. They’re looking for nothing special, a 2 bed townhouse in one case and 3 beds with a bit of yard in the other, both looking on the North Shore.

Every open house they visit is packed with other couples searching for the same thing.

One has now found a place – by offering 10% (!) more than the asking price after searching for 3 months. The others have been looking for nearly 6 months now and have submitted an application for almost every house they have viewed, even offering 6 months rent in advance and been turned down on every occasion, usually because someone has bid over the advertised rent taking the property out of their price range.

If the market is awash with vacant property why can’t our friends find somewhere to live that they can afford to rent?

When we moved out of our rented townhouse house last year the landlord had let it within an hour of the first viewing…

48 firsttimebuyer January 15, 2010 at 11:53 pm

Sorry, that should of course have read “income tax and/or CGT we would be liable for”…

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