Oz Real Estate and the desperate banks

Firstly we note today that Chris Sayce has caught out the CBA attempting to “fix up” some data before it presented it to overseas investors who they need to fund Australia’s housing addiction.

We also note however they are not alone in their desire to “represent” Australian property in a much kinder way. Yesterday we were sent an e-mail from a reader, Andrew, who was nice enough to supply us with GoldMan Sach’s latest report explaining that there is no Oz housing bubble. This report was referred to in this Business Spectator Article.

Now we know we have heard all of this before , and that GS was telling everyone in the US the same thing while secretly betting against it. We wonder if they are up to the same trick again? Maybe this is a sign to panic?

The report is a very interesting read and has lots of lovely graphs that you would expect to see in a well researched report. It seems genuine enough and has some convincing data to go along with it. There is only one problem….. The content.

Let us have a look.

Firstly the overall premise of the report is that

Australian house prices dynamics do not appear consistent with a speculative bubble, yet they are over valued by approximately 30%.

Ok, so that line alone is a problem for us, but lets move on. The reasons stated that there is not a “bubble” is all of the usual suspects.

  • Housing Shortage
  • Population growth
  • Demographic changes
  • Underlying Demand.

These are not new to anyone whom has read these sorts of reports before, however there are two big points raised by the report that just don’t pass the “sniff” test.

Reason there is no bubble 1 : Housing Undersupply

The reports states

The very broad conclusions of the report are that Australia already faces a chronic housing shortage which is set to worsen over the next 2 years as demographic demand outstrips supply. It is important to distinguish between how many people desire new housing and how many people will demonstrate that demand due to declining housing affordability. We forecast that the number of housing completions will rise 7.5% in 2010 before declining by 5% in 2011 as affordability falls. Should interest rates and house prices stabilise in 2011 then we forecast a large upswing in construction in 2012 and 2013 as the undersupply issues become binding.

They also show a graph proving this point.

Now we have talked about
this before. But lets once again analyse the data. The ABS 2006 census states the following changes in population and household numbers:

2001 AU population: 18,769,249
2006 AU population: 19,855,288

population growth: 1116039

2001 AU dwellings: 7,790,079
2006 AU dwellings: 8,426,559

dwelling growth: 636480

Population change : 5.78%
Houses change : 8.17%

So in 2001 there were 2.409 people per house in the country. In 2006 there were 2.35 people per house. That is correct, the ratio went DOWN !!!

Since then the stats have been

2006-07 Dwellings built 152,071 , Population rises by 329,000
2007-08 Dwellings built 161,292 , Population rises by 389,000
2008-09 Dwellings built 131,882 , Population rises by 460,000

So at the end of 2009 according to the ABS stats there were 8871804 dwellings and a population 21033288 for a ratio of 2.37. The ABS stats show clearly that there was more of a housing shortage in 2001 than there is now. Was there a housing shortage in 2001 ? Well since we can’t remember people camping out in shopping centre carparks because they couldn’t find a house at the turn of the century we are fairly sure there wasn’t, and even if there was a problem (which there wasn’t) it has got better, not worse.

Want more proof? If there was a chronic housing shortage as suggested you would expect to see very low rental vacancy rates in the fastest growing cities. Guess what, you don’t. In fact recently the vacancy rate has been going up. Many of these same points, and others, were mentioned by a Brisbane based property “expert” back in August.

So why, apart from vested interest, are we being told there is an undersupply of houses? and why does this report also talk extensively about it as one of the main drivers as to why we don’t have a bubble in Australia?

Well it is obvious if you take a look at the graph above. The claim is that we aren’t building enough houses because the graph says so, but you have to interpret the graph correctly.

The report says:

Expressing the annual change in the population as a ratio to the number of completions shows that for the 20-year period from 1985 to 2005 this ratio gravitated around 1.6. That is, on average the population needed to increase 240,000 each year to achieve the industry annual average of 150,000 new homes constructed. Or alternatively, for each new person in Australia 60% of a home was constructed.

Well that is fine, if in fact we had 1.6 people per house in Australia, but we don’t. In fact the ABS reports what the current average dwelling occupancy is, it is currently around 2.5 ( we are dubious about this figure, but that is another story). This means that apart from 2009 according to the ABS we have been overbuilding houses since 2001, and from the graph, before that as well.

Funnily enough the report even mentions this fact while trying to prove a different point.

There are 8.9 million homes in 2010 for 8.4 million households. By 2015 the number of households is projected to rise to 9.2 million. By 2020 the number of households is projected to rise to 9.9 million.

So according to those stats there are already 500,000 non-residential houses in Australia and we will only need another million homes to house families over the next 10 years, that is 100,000 per year. How many did we build in 2008-2009 ?? Oh thats right 131,882.

So why would we over-building ? Well if you are a daily reader you will know why, but in case you are not we will let the report tell you.

For an investor with an income sufficient to put them on the top marginal tax rate the combination of negative gearing and depreciation deductions mean that a property investor could currently incur tax losses in excess of $22,000 per year on a $500,000 investment. This dramatically reduces the out-of-pocket expense of
holding the investment property from $548 per week to $126 per week.

From the perspective of wealth accumulation the current -$6,500pa cash flow impact from holding a $500k investment property would seem a sufficient disincentive. However, a 20% rise in house prices equates to a $100,000 capital gain or a total return of $94,500 for an ungeared buyer. The annual returns are much higher when leverage is introduced into the analysis; hence it is not hard to see why during periods of trend growth in house prices highly geared investor housing has been attractive.

Yes that is correct, government supported property speculation has been extremely lucrative over the past decade. If you could afford a house you purchased or built one because the government allowed you to use it as a tax sink. Lots of people wanted to do this and the banks provided the credit so the prices went up. It seems now that people have convinced themselves that this “demand” was population driven, when in fact if anyone bothered to look at the census data it is pretty clear this isn’t the case. There are in fact plenty of houses around, the problem is “affordability” caused by excessive speculation demand and government incentives. When the demand falls, for whatever reason, so will the prices.

Which brings us to our next point.

Point 2: The missing “Boomer Retirement Effect”.

The report spends a lot of time explaining that Australia will be moving shortly into a demographic phase where lots of people will be forming new families and require new houses.

Over the past 15 years there has been an extraordinary skew in the structure of population growth towards those household groups in the wealth accumulation phase of their lifecycle and those too young to matter much for aggregate demand formation. This has masked stagnation in population growth in the age group that drives new home formation.

The key first home buyer age groups are set to enjoy an awakening. In fact, the process has already commenced with the children of the Baby Boomers now entering key household formation age groups. This echo in the population growth data has seen a surge in the population growth rates of the 25-29 age group, which has averaged a 3.7%pa growth rate in the 5 years to 2011. Over the 5 years to 2016 this will translate into 2.7%pa growth rate in the 30-34 age group. This contrasts with growth of 0.3%pa or less for these age groups in the 15 years prior. For those looking for a long awaited pick up in new housing construction and related industries this is a very encouraging observation.

Again they have a nice graph

While we don’t disagree with the statment that there will be growth in demand for housing from formation of families, they seem to have left out the very big problem at the right handside of that graph. You see those 3 soldiers above 65+. Well guess what those people are going to want to do? Lets ask the report:

The familiar migration of the Baby Boomer cohort into retirement is clearly present in the data. The growth rate of those aged 65+ is expected to have grown from 2%pa over the 5 years to 2006 to 3.0%pa in the 5 years to 2011 before peaking at a 4.0%pa growth rate in the 5 years to 2016. From 2010 to 2021 the ABS forecasts the population to have increased by 16.5% or 3.6 million people. However, the share of the population over 65 will rise from 13.7% in 2010 to 17.2%, an increase of 1.4 million.

Hmmm.. And what will be the effect on housing from all those retirees, who have been working the longest and therefore have proportionally the largest investment portfolios?? Lets see what the report says.

……., tweet, tweet … tweet.

Nothing!!. That is right, they have completely neglected to talk about one of the biggest problems housing prices face over the next 10 years. As those 1.4 million boomers retire so do their tax incentives ( you know the ones that are the second most generous in the world ) as they can no longer negative gear. A good proportion of them will want to sell their investments to fund their retirement. Suddenly hundreds of thousands, maybe up to a million, investment houses become retirement funding vehicles and enter the market for sale.

House prices are governed by “stock on the market”, not total stock , we wonder why GS neglected to mention that?

So is there a bubble ? Well as we mentioned at the beginning, Goldman already stated that they believed housing was 30% overvalued even with undersupply and demographics on their side. Take them away and we could only conclude the answer is YES.

Goldman at least got something right in the report.

From a macroeconomic perspective, we believe Australian policymakers may have less than 3 short years before the terms of trade enters a downward phase. The starting point for the correction may be residential and business investment as a share of GDP at highs not seen since 1890. A corrective phase from such lofty heights would risk a deep economic decline and represent a significant policy challenge. Both the RBA and government share the responsibility that the economic prosperity that is enjoyed in the interim is not capitalised in a further escalation in house prices and debt levels.

We believe budget surpluses need to be larger and achieved sooner than currently projected, with realised surpluses banked in a separate sovereign wealth fund designed to smooth the economic impacts of a terms of trade adjustments. From a monetary perspective, with the Australian economy already operating at full capacity, we would advocate the RBA signalling its intent to take interest rates into the restrictive zone through 2010-11 in an attempt to keep debt levels and asset prices in check. We would also recommend the RBA redeploy the tactic of 2003 where it effectively ‘jaw-boned’ the housing market into restraint.

While the RBA has spent much of the past 2 years explaining why house prices and debt levels are less of a concern relative to other countries, at this point of the economic cycle we believe the nation may be better served by it highlighting the risks to Australian households of excessive leverage should house prices fall in concert with a terms of trade adjustment.

Australia needs to stop depending on China to balance its budgets and sort out housing before it kills the economy.

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  1. Outstanding analysis, ED.

    Economists are evidently not scientists, to dispassionately and disinterestedly present all the facts for an as-acurate-as-possible view of the truth. They are rather more like lawyers or politicians: they present just the information that leads to judgment in one particular direction or another.

    It's only people like yourself that balance the equation for the rest of us.

  2. Graphs show that if a price for a market driven commodity has gone drammatically up or down in the past then the same can occur over and over again. In 1989 house prices started to fall and continued to fall for 6 years until some house prices had fallen by 90%.
    Given that type of volatility, we do we think that it cannot occur again?