Melting towards the bottom of the housing cycle

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Recent data suggests that investors are happy to jump back into Australian residential property markets.  Maybe jump is too strong.  Hop might be better.

Perhaps this is due to a search for yield.  Perhaps it is foreign cash seeking a safe harbour. Or perhaps it’s simply time for the Aussie love affair to be rekindled.  Holes are over.  It’s houses turn.

Despite first home buyers being tapped out, having dosed up in property during the 2008-09 FHBG boost period, the critical indicators are showing that the slow melt of Australian property has run most of its course.

With these winds of change in the air maybe it is time to take a step back and look at the long term property cycle itself.  This post is, therefore, my attempt to interpret our point in the residential price cycle based on key pattern that have repeated in previous cycles.

For economists, long term regularity of asset price cycles is an intriguing proposition. Is the 18 year cycle really a good rule of thumb? If so, why don’t investors rationally expect the cycle, and remove it through their anticipatory actions?

One simple answer might be that investors would anticipate the cycle if credit markets would allow it.  But the banks supplying of credit are themselves constrained by previous movements of the market. Thus the interaction of prices and the willingness to supply credit seems to be pretty decent explanation of the peculiar regularity of long term cycles.  Thanks Minksy.

My preferred way to think about the nature of the cycle is in terms of returns from yield compared to capital growth. At the bottom of the cycle equities, including property, are seen as risky places to preserve capital.  During the boom expectations of capital growth return, and equities become the assets to hold despite low yields.

In the past I have used the mortgage rate divided by gross yield as a measure of the relative value of residential property.  The theoretical picture is that the mortgage rate is a good proxy for the yields, net of capital growth, available in the economy generally. Gains above this rate typically arise from capital gains.

So where’s my evidence for the usefulness of this measure? The graph below is an update from a previous post.  With rental growth, falling prices, and falling interest rates for the past five years, this simple measure is showing that now is a good time to buy.

I have also created a second measure – the mortgage payment per dollar of a 30 year loan divided by the yield.  The second measure adjusts for the fact that the cost of buying asset, in addition to the cost of interest, is a higher portion of the total cost at lower interest rates.

HousingBuySellIndicatorApril2013 copy

These is a surprising regularity of a head and shoulders-type pattern – similar tops and bottoms, and a similar period to the cycle, in this case 16 years.  Not too far from the 18 year rule of thumb.  And not too far off the stylised asset price cycle seen so regularly when discussing the latest housing boom.

This aggregated view can be somewhat deceiving since Australian capital city markets do not move in synch.  Sydney and Melbourne have typically led the cycle, with Adelaide, Brisbane and Perth a few years behind.  Details of this pattern are here. Some capital city markets and many regional markets might have a lot of melting still to do.

Other indicators also point to Australia being nearing the bottom of the price cycle on average, with probably just 2-3 years more to run.

First, dwelling turnover is at multi-decade lows. We have bobbed along the bottom for three years now. What is crucial here is that the price cycle usually involves increasing turnover, and higher turnover is more likely than lower from this point forward.


Second, mortgage payments to household incomes should be returning to historical lows.   The two below charts from the RBA cement the idea that the relative affordability of home buying the highest it has been since 2000.

After last month’s interest rate cut, and more expected this year, interest paid as a share of household income should fall quickly below 8% in the next two years.


Third, housing credit growth has been on the decline since the end of the national boom in 2003. However the short periods of increasing rates of growth also produced price gains.  It’s now been ten years since this peak, and a modest turn around looks imminent, especially considering the pattern of the second derivative of housing credit which is surging towards positive territory.


Lastly, falling rents are a signature of periods of increasing prices.  As I wrote two years ago, the next rental price cycle would be accompanied by falling prices.  Which is exactly what has happened since the financial crisis. This might be over for now.


There are essentially two ways to read these pattern in the data.

1. A renewed cycle

A great time to buy in most capital cities was around 1998. This year preceded a boom in Sydney, that cascaded across the country for the next 8 years.  My charts show the cycle at around 16 years, meaning 2014 is predicted to be a good time to buy.  The 18 year rule of thumb is then 2016 – just three years time.

Given the expected resources shock in the second half of this year and early next, I would not be in a rush.  Also it may be wise to get better signals about the direction of international markets, particularly the US before leveraging into Australian housing.  2015-16 is looking to be a relatively good time to buy if you are confident of another cycle.

Just remember, the bottom of the cycle typically coincides with slow economic periods and high unemployment, and it is exactly these factors that will keep prices down for the next couple of years.

2. A long stagnation

Given the weight of private debt, the already low interest rates across most of the developed economies, and a general reluctance for increased public spending to maintain employment and stimulate private investment, could we be heading to a long credit-constrained stagnation that requires major price adjustments in wages, rents, and currencies? The Japanese experience may be telling.

My personal view is actually a blend of these options.

I do think that the bottom of the property price cycle is now just a couple of years away. But there are many reasons to think that in the next boom prices will be far more contained.

  1. A psychological factor to consider is the relatively smooth economic performance experienced in Australia since the financial crisis.  Perhaps this will mean people will be more willing to borrow, and bank more willing to lend.  Or perhaps the memory and lessons from abroad might keep the next credit boom in check. I tend towards lessons learnt and more conservative lending.  However, we still need to consider that mortgage interest rates are likely to fall another 0.5% from this point over the net two years.
  2. A slowdown in foreign demand.  If the safe harbour of the AUD is no longer seen as necessary, this may slow demand for AUD assets.
  3. Demographic headwinds, with asset rich baby-boomer looking to cash in to fund retirement.
  4. Lower inflation generally due to constrained more credit.
  5. RBA now actively monitoring home prices and the threat of precautionary monetary policy tightening

The crucial lesson in all this is that Australian nominal asset prices have been supported by fiscal policy during the financial crisis, ongoing monetary policy adjustments, and foreign investment (including in mining infrastructure), which all supported employment and incomes.

This support allowed a slow melt adjustment since the financial crisis. Home prices have fallen, mortgage rates are down, and rents have increased. This means that buying a home is more affordable compared to renting than it has been for 15 years.

My message, if it wasn’t clear, is that if you have been holding off purchasing a home because of the risk of capital losses, then these risks are probably lower now than at any time in the past decade.  Maybe prices will be a couple of percent lower at the end of next year, but I have a hard time wrapping my mind around downward price movement more severe than a couple more years of the slow melt, or around 3% in nominal terms.  The chances of price gains is also now much higher.

Unfortunately this coming 2 year period is also likely to be economically unstable, with low wage growth and a fragile labour market.  That is the catch with trying to time the residential property cycle – it is a game for players with lots of capital.

Now don’t take this as a thumbs up from me for housing price growth.  High asset prices are not a particularly desirable feature of an economy.  However my strongly held view is that asset prices should not form part of the debate over housing affordability.  It is like having a debate over the affordability if steel by looking at the price of BHP shares.  No, the asset price will be subject to the whims of financial markets, and the affordability of steel can only be observed by looking at the price of steel.  In housing markets, land prices are asset price, and rental prices are the actual market price for housing. And I am glad to see that rents now appear to be falling again.

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  1. We had an open house on the weekend for the last of our properties (2b, 1 car in regional nsw). We were priced (sub 400k) competitively and the place presents well (architect designed reno). 40 groups went through, five offers at the asking price. Two offers at 5k and 10k over the asking, and an offer that we accepted at 10% over the asking. We are seriously in shock. Even with the Reno taken out of the equation, it’s a 30% improvent in the land value since 2009. This is not sustainable.

    According to the agent, every single offer was from an investor. Not a single first home buyer in sight. I’m damn happy to be out of the “market”. Something just isn’t right …

      • No, he’s correct

        my landlady is a Chinese Real Estate salesperson

        she says the market is going crazy with Chinese investors and all of her colleagues are experiencing the same

        they are Chinese investors who don’t even bother to view the property in many cases

        the big pull is the capital gains tax situation and in many cases even if they already have properties they are prepared to sell and skip (that’s her report)

        she said also that many are creating fake companies to front their purchases

        as she said – there are thousands of billionaires and multi-millionaires in China who just want to get their money in something safe – and to most of them the only safe thing is property anywhere except China

        she also told me about one of the property buyers selling a Mercedes 4WD for $6000 simply because he wanted cash and only cash when upgrading to a later model as Chinese only deal in cash and do not want to have their activities scrutinised by the government


      • Yah, I read it again and it does sound like I’m a spruker. My point was that investors appear to be out in force and are driving increases for mo real reason where fhb are sitting on the sidelines. This is not sustainable.

      • dumb_non_economistMEMBER

        Hey Rumple,

        I had a question on the Forum (Property) which no one has answered as yet, on the slow melt. Maybe you could comment?

        I have a question on the slow melt theme. If av income is 70K and the median house is 500K, with incomes increasing by say 4% pa (doubling every 18 yrs) and housing just keeping up with inflation of say 2% pa (median doubling every 35 yrs) it will take 35 yrs to get the income/median ratio to 3.5.

        The slow melt seemed logical, but I would think that’s unlikely for that period of time and therefor (discounting an event that crashes RE) we could be looking at much higher prices as a permanent feature when the economy picks up and buyers revert to normal behaviour.

        What am I missing here or what have I stuffed up?

      • Rumplestatskin


        As I have said many times, price to income is a very poor metric, given that that price is a function of incomes (which determine rent), interest rates, and expectations.

        To me the slow melt is about

        1. Wages growing above the rate of house price growth
        2. In turn, rents rising in line with wages
        3. Interest rates falling
        4. Net cost of owning v renting falling down to historical lows
        5. Rent costs falling slightly compared to incomes as construction picks up

        Nationally we have seen 1, for ten years no (because of the dominance of Sydney in national aggregates).

        We have seen 2. over the past 3 years as construction rates plummeted. This is correcting now (See 5.)

        3. done, with a little more to go.

        4. We are down there now (that’s the first chart). Probably in Sydney, but not quite in other major cities. Perth and Darwin might have some significant price falls ahead.

        And that leaves us at 5.

        Price to income will never fall back to 3.5x (Depending on whose measure you use) unless there is a radical shift in policy to allow deflation and we run out of monetary ammunition.

      • “What am I missing here or what have I stuffed up?”

        Nothing – if you choose your own assumptions then you can come up with any result you like.

        Let’s see if:

        (a) incomes continue to increase at 4%,

        (b) property prices track inflation,

        (c) there is no event to crash real estate (like say, the end of the China boom),

        (d) the economy picks up (assuming that the China boom doesn’t end and our massive private debt levels don’t bring down the economy like they have in some many other places),

        and (e) and buyers revert to their normal behaviour (assuming that they are able, willing and allowed to continue increasing our already world-beating private debt levels).

      • dumb_non_economistMEMBER

        Thanks Rumple,

        AB, it wasn’t so much that is how I see things panning out. Just that if a slow melt (which seems to be the general consensus here) was going to be responsible for a drop in the ratio to a more historical level, then I thought 4/2 was a reasonable assumption (for the fastest slow melt) as I don’t see inflation going lower and incomes going higher. So 35 yrs is a “bloody” looong time for this “correction,” and I don’t see prices falling to any fair degree without some sort of shock.

        Rumple has been kind enough to point out to me that income/prices is as Hungry Beast would say…a little bit bullshit, so I guess against my gut feeling that people won’t continue to pay outlandish amounts, we may be in for a period of far higher housing prices, as much as it goes against how I think it should go. So, maybe Australia is fcuking different.

        Regardless, I will not pay those prices, I’ll continue to rent!

    • “We are seriously in shock”…good to read your honest feelings fwoark, it just goes to show that too many people know the price of everything but not the value,imho.

    • Those thinking prices cannot go up without FHBs are missing the point. Debt speculation is driving the asset market, and we are probably witnessing a shift from M&D speculators with 1 place to determined onshore & offshore speculators that will buy multiple properties.

      The world is awash with cheap money – and it will find any home it thinks is rising and be self-sustaining for a while.

      In the US private equity firms are now buying into real-estate.

      Yes it will blow-up at some point, but that doesn’t help those in australia that are young or asset poor – they are screwed.

  2. what can you say but that we live in a FALSE economy. Prices are ridiculous when compared with rent, any sane analysis suggests a large correction. But we have policy makers the world over who would rather see asset inflation than a return to fundamentals. As a result we have:
    – int rates that are set too low to stimulate borrowing (come on, its got nothing to do with the exchange rate guys!)
    – tax regimes that foster speculation and punish savers
    – immigration policies that support mass import of more and more cheap money
    – govts ready to bail out banks and investors up to their eyes in debt thus distorting natural risk dynamics.
    So what does someone like me with a large amount of cash (60% deposit) do? Choose the lesser of 2 evils thats what. Be prudent and get flayed by low rates and high tax …. or speculate on housing assets that are fundamentally overpriced by at least a factor of 2 but get govt backing, low rates and reduced tax (or none for the family home).

    We live in corrupt times. Civilizations collapse when we are no longer incentivised to make decisions that are good for society as a whole. I truly believe we have reached that point.

    • i’m with you squirrell. I don’t want a 40% albatross round my neck. Not when that’s $400 grand. At this stage of life I’d be happy with a mortgage I can pay off in 5-6 years, not 25. $200k mortgage tops.

    • “We live in corrupt times. Civilizations collapse when we are no longer incentivised to make decisions that are good for society as a whole. I truly believe we have reached that point.”

      Well said.

      • Gonderb, I don’t want to live in the boonies. Or a MacMansion shitbox housing estate. I just don’t want to pay a kings ransom for shitty shack.

        I see a market wildly over-priced. It’s the Emperor’s new clothes all over again. Loads of debt slaves factoring a goldilocks economy, ZIRP, middle class welfare and certain employment into their budgets. Just need one leg pulled out to make it tough, if not near impossible, to service their debt.

        Just as speculators have piled into housing on the back of sinking interest rates and negative gearing (which surely must be quarantined sooner or later), they too might head for the exits when the interest only loan and 95% LVR become a bridge too far in a sour economy.

        I think prices will come back. A lot. I’m prepared to wait. I’d rather earn $20k a year on my savings and compound it than mortgage up to the gills and fork over more than $20k just for interest in a market I see ripe for a tumble.

        Hell, I could be hopelessly wrong. We’ll find out as time goes by. I know I picked the GFC back in 2006. Told many folks who all refused to listen. They said it was all right. What’s to worry about? Well I sold all my shares. Took Super out of shares and into cash, saved a fortune. Sold a run down apartment for what I can only call an obscene number. And laughed all the way to the bank. Funny how quickly people forget where the downside can take them. I’m by nature an optimistic guy. No schadenfreude here. Just a crunching reality check for the pollyannas out there.

      • Yes, I agree with Squirrell too. I am late to this thread, and will say more at the bottom.

      • @mdsee:

        You and I are of the exact same opinion! Can’t pick a single thing I disagree with. So we’re either both sane or insane 😉

        Excellent sub-thread, +100!

  3. something about past performance being no indicator of future performance?

    While we can see the cycle, the fly in your ointment is the unbelievably massive ramp in house prices in real terms, founded on mountains of hard to service debt. That’s the difference between past, present and future. How can it possibly be repeated?

    You really think we’re on a “permanently high plateau” now? Maybe only investors can breathe the rarified air up here now.

    Sounds like crazy talk Rumple

    • I am going to proffer a theory that kind of supports Rumples expectations of ever-rising urban land prices. At the end of the thread.

    • The thing that gets me between Oz and the US (a market I’ve watched since late-2005 to buy in, dodged a bullet there!) is the recourse loans. What happens when the 1.5mil NG’ed “specuvestors” start getting their asses handed to them?

      Recourse loans “should” cause stickier prices, kinda, but much more panic at the beginning (first out the door) which would be far less sticky prices…

      Anyway, this is the big question mark for me; how will recourse loans change the Aussie experience? What other nations have gone through a housing burst with recourse loans? I’d think the Gov steps in and abolishes the recourse ex-post-facto, but who knows?!

  4. russellsmith55

    “However my strongly held view is that asset prices should not form part of the debate over housing affordability. It is like having a debate over the affordability if steel by looking at the price of BHP shares. No, the asset price will be subject to the whims of financial markets, and the affordability of steel can only be observed by looking at the price of steel. In housing markets, land prices are asset price, and rental prices are the actual market price for housing. And I am glad to see that rents now appear to be falling again.”

    Could you please elaborate on this? Considering how the price of land has performed, and the price of the house itself has barely moved in comparison, I’m still uncomfortable with the idea of pretending the excessively high land prices don’t count.

    Also, this wouldn’t apply to all of Australia right? (i.e would you be applying the same opinion for the Melbourne and Hobart markets, or Perth and Darwin after the mining boom is definitively behind us).

    • Rumplestatskin

      By the reasoning here, the payment on a 30 year loan will be around 2.5x the rent.

      So if rents are approximately 20% of incomes, then repayments will be about 50% of incomes. With mortgage rates at about 4.5% that’s around 8x incomes.

      This all rests on some inflation expectations, which I expect to continue for some time. We are still a long way off deflation/Japan-style long stagnation.

      • You do need to disaggregate the cost of land to really see what is going on. I will say more at the bottom of the thread. This is monstrous rent-seeking.

      • If I’m reading this correctly… you’re saying that owning will be 2.5x (two and a half times) the cost of renting? And we’re talking same timeframes here (1 months rent = 1 months mortgage repayment)?

        Plus all the maintenance costs (or is this included in the 2.5x)? With how much of a down payment, 10%? 20%? (more lost opportunity in deposit interest, and therefore higher still).

        I don’t mean to attack you, just cannot see that I’ve understood this correctly…

  5. I could see a bottom to the downturn within the next few years, but I would be surprised if the downside was limited to “a couple of percent”.

  6. Rumple – what do you expect foreign buyers to do if our dollar falls significantly, and how would you see that play out against overseas investors who have held property here for some years, who may be concerned about future currency losses.

    IE. do you expect foreign buyers to outweigh foreign sellers or vice versa?

    • Good question Peter.

      One suspects we’ll get more Asian buyers as the AU$ drops and China slows down as it restructures and from crimping the shadow banking system (and maybe the real one too).

      The ones stuck with a devalued property (in AU$ terms) will, for the most part, suck it up. Did they buy for wealth protection or a bolt hole? I say bolt hole.

      We could see two very different dynamics come into play. Major metros driven up by investors (local and foreign). Everywhere else deflating as our economy stumbles off the mining cliff.

      All bets are off if we get dollar driven inflation. I’d look to let the market take the hit from the over-leveraged and under-employed and then go shopping for a desperate seller.

      • Thanks for your POV mdsee. that’s what I expect as well, but I look back at what happened when the Japanese buyers were out in force in the eighties, they had to sell at significant losses because they had a property bust in Japan, so o/s events do matter to our market given the number of Asian buyers, and of course Asia is a damn big place that spreads across a number of economies.

        There is plenty of possibility for a surprise either way that we “didn’t see coming”

      • we wont necessarily get more buyers. If it drops its cheaper for sure, but it heightens worry that it will get even cheaper as currency continues to drop. All the spin at the moment is that AUD is overvalued and finally is starting to deflate, wouldnt you be better putting your money in the US?? But whatever happens, it wont be rational decisions affecting outcomes, otherwise how did we get here in the first place???

      • You have it back to front.

        Asian owners will be trapped by a falling dollar and will not sell.

        Prospective Asian buyers will dry up as the dollar falls.

        They’re not idiots.

      • @H&H

        not sure I get your point, if dollar fall, prospective buyers will be able to get two houses for the price of one, isn’t it ?

        And the # of existing Asian investors is probably inconsequential compared to the potential pool that could invest here.

        but we are yet too see a significant drop of the AUD, it still not the most likely scenario.

      • Yes H&H they are not idiots, and while $AUD is falling they will not buy, but if they see exchange rate stabilisation and the opportunity to buy a stable asset at a reduced price they just might come back faster than we anticipate, but it will all depend on how their own economy is travelling, and how politically stable their future looks.

        Far too many moving parts to call IMHO.

        I’m tossing a coin right now.

    • Rumplestatskin

      “Do you expect foreign buyers to outweigh foreign sellers or vice versa?”

      Compared to now, a little. Say there are now 10 foreign buyers for every 2 sellers, for a net 8 new foreign buyers. Maybe that net figure will drop to 5. Foreign purchases of domestic assets is a long run trend that won’t simply switch off – just adjust a little to short-term conditions.

  7. @PF
    It s quite likely we are only at the beginning of this investment/diverstment phase by Chinese’s and as our dollar get cheaper our properties/assets are becoming a bargain ( for them).

    • Dam, perhaps you can explain something that I don’t understand.

      Why are these (presumably) sophisticated and financially literate wealthy Chinese investors likely to choose to diversify to a country that:

      * Has some of the highest house prices in the world
      * Has one of the most over-valued currencies in the world
      * Has close to the highest private debt levels in the world (and is hence at least at risk of an asset price collapse)
      * Is the most leveraged country in the world to the country that they are trying to diversify away from
      * Is physically isolated from most of the world

      If I was a wealthy Chinese investor, Australia would be close to the last place that I’d be diversifying my wealth to.

      • Strategic value != fair value 😉

        our property laws are extremely valuable ( and residency as well, if invest more than 5mil).

        What the alternative, invest on Chinese stocks ? or Chinese condo ?

        Some just want to preserve their already acquired wealth, Australia is not the worst place to buy.

      • Anecdotal evidence – i have some friends who are mainland Chinese. They all want to get out of China and buy anywhere except China.

        Generally they all say that the government is corrupt and they fear that the government will just seize their assets (cash/property/whatever).

        There is also citizenship. Australia is close to China and a great place for FIFO people. And buying a house here makes it easier for citizenship.

        Not everyone invests in houses just because of yield, growth, or other figures and facts.

      • “What the alternative, invest on Chinese stocks ? or Chinese condo ?”

        No, how about buying property anywhere else in the world?

      • “Australia is close to China and a great place for FIFO people.”

        According to my quick Google research, London is quicker flight from Beijing than Sydney, LA is close to the same duration, and New York is slightly longer.

        Australia isn’t really that close to China (physically anyway).

    • That’s not a bubble, it’s a plateau. A spruiker told me. Out with your chequebook you greater fool, before you get crushed in the stampede

  8. By the way Rumples great article and I like the points for the debate – I am looking forward to seeing Leith’s reply after reading his report in the Member Pavilion in the Forum this morning.

    I am off with flu hence I get to be on the site during normal hours! 😉

    Thanks to all the crew at MB.


    • “She said she and her husband, who bought the house with friends, planned to renovate and on-sell.”

      • Indeed velocity, I can read between your lines, cheers.
        Oh to be young and so hip like Zanita and Daniel..I think this is the demographic that watches all those reno style TV shows.
        So the current expected “realistic” price was 650k and they paid 800k plus say 32k stamp duty. Lets say a good renovation plus selling costs at about 200k (these dudes don’t look like tradies and we gotta think Sydney tradie rates). Not including holding costs for say 6-12 months before they on-sell.
        Then there most be at least 4 individuals as joint owners….jeez I can’t be bothered typing anymore.. I wonder what one million dollars stands for these days??

  9. Hmmm but what to do as a future FHB, appreciate this analysis and the evidence does point to a 2015 buy point. Also happy to keep saving.

    But whilst interest rates continue to drop, the temptation for yield chase increases. Yet the conditions mentioned (near term economic uncertainty) means the usual catch-22 of balancing risk/reward when investing seems exacerbated!

  10. Just one question Cameron. Did you predict and were you on the record to predict, the GFC as an economist?

    • Rumplestatskin

      Nope. I only have my own record of property speculation in the last cycle (from 2002-2007) in Brisbane and other QLD regional towns. Admittedly the buy in timing was luck, but the sell out was not.

      Also, I was working at a large residential property developer in 06-07 and got out of there before they came crashing down.

      Just remember, if your strategy is the long run accumulation of assets it is best to buy when no one wants them.

      I guess my question to you is what criteria would you need to satisfy to believe that residential property might be a worthy investment?

      • Rumplestatskin

        Ok Patrician, let’s run you numbers

        Say, prices do fall 30%. By my first chart we will see the yield/payment ratio fall to 1. Meaning that it cost the same to buy (and pay off, not just the interest) a home as to rent.

        There would have to be entrenched expectations of deflation for this to make any sense, and given that the RBA has a mandated inflation target of 2-3%, and plenty of ammunition, I can’t see how we could get these expectations. They only alternative explanation for prices to fall that far is that domestic credit channels and foreign demand simply dry up. The would need to be serious fear about some economic calamity for that to happen, along with radically high unemployment.

        I can’t see it happening. And it has never happened before.

      • “Nope. I only have my own record of property speculation in the last cycle (from 2002-2007)”

        So you owned over the “sell cycle” as per your mortgage rate / gross yield chart and still profited handsomely? Wouldn’t that go some way to dispelling it as a useful timing tool?

      • Rumplestatskin


        As I said, the timing of the cycles in each capital and regional centre is quite different, and Sydney dominates the aggregate.

      • Rumplestatskin, could a fall in property prices of 30% also be accompanied by a fall in rental prices, thus avoiding a yield/payment ratio of 1? In some circumstances, wouldn’t this be likely? As the ratio approaches 1, renters should switch to buying thus decreasing rental demand and forcing rents down. Could you end up with a downward spiral (most likely in a bust/recession scenario)?


      • Rumplestatskin


        Yes, that would have to be the case. But think about the macroeconomic conditions that would lead to falling rents. We would really have systemic deflation – not just low inflation arising from the high dollar and low tradables inflation.

        The RBA would drop rates to zero in that case. They would have to. Essentially we would be reliving the financial crisis all by ourselves, with absolutely jammed up credit markets. Government would stimulate, regardless of the political nonsense and promises being discussed right now.

        I guess H&H sees the mining bust as a trigger for some kind of domestic economic upheaval. I see the falling dollar rescuing demand, monetary policy doing the same, and a moderate labour market adjustment. The next two years won’t see a property boom, they will see this new adjustment wash through the economy. And during this phase investing in residential property will be very attractive on many metrics.

      • When you treat it like any other investment decision, risk and yield. At the moment it is mad as batpoo to invest into residential IMO.

  11. This is probably the most bullish property article I’ve ever seen on MB.

    I sure hope we’re not at the start of another cycle, because property is already too damn unaffordable to buy!

  12. I find this article very difficult to reconcile with David LS’s view of the Aust economy that private investment is embarking upon the beginning of a major decline which will hit GDP and the AUD very hard. Moreover, Australia has ammased one of the highest level’s of private debt worldwide, having not experienced a recession for 20 years. Unemployment has only one way to go, the TOT boost to income is fading and the AUD is telling us that the markets are starting to get sceptical about our economy’s near future.
    In light of this, I cant see our heavily leveraged real estate market delivering solid returns any time soon. I am more of the view that we are one of the last economies to experience the end of a debt supercycle – because of our economy’s over exposure to commodities markets. If this is the case, then all generic ‘business-cycle’ based analysis goes out the window because the response to the looming economic slowdown will be unlike the response to your run of the mill business cycle trough.
    I’d like to know David’s view on this.

  13. As a financial adviser, I would estimate that 4 out of 5 of my baby boomer clients plan to downsize in the next 5 years. This is going to put a lot of pressure on the market. It is difficult to estimate how it will affect the market and putting a percentage figure on where the market will go is almost impossible. No one knows.

    On most metrics, house prices are not cheap and I would expect that they return slightly less than inflation over the next 5 to 10 years.

    I choose to rent because the mathematics work out better if house prices dont rise at a greater rate than inflation.

    Houses and apartments up to the $700,000 range are likely to be supported by the baby boomers downsizing and SMSF’s borring to invest. Above this is more risky.

    The top end of the housing market has nothing to do with the fundamentals of the lower to mid end because people buy with smaller amounts of their wealth money and rarely borrow.

    “Be fearful when others are greedy and greedy when others are fearful.” Warren Buffett

    I bought two houses in the US last year when it was right at the bottom and there was enormous amounts of fear.

    There is still an enormous amount of greed in Australian property markets and whilst this remains, I will be fearful.

  14. Thanks Rumple. I don’t actually agree with your conclusions but it makes such a pleasant change to read a bullish property article that isn’t an insult to even an average intelligence.

    • I agree. Rumples has provided the strongest possible foil to test out arguments re supply of land etc. I am all the more convinced I am right after having come up against the strongest possible arguments. There are some terribly thick people out there who support relentless urban growth containment. It is rare to find one as intelligent as Rumples – but he is still wrong.

  15. SweeperMEMBER

    I have to say, I think your scenario – that housing is at the bottom of the cycle – is extremely unlikely.
    The period from the late 1990’s to 2007 was an unprecedented one off (globally) and is a poor guide IMO, to what is likely to happen in the future.

    Between the late 1990s and 2007, 2 structural forces drove house prices higher not just here, but everywhere:

    1. Fall in real interest rate: the real rate had fallen from 7% in 1980’s to 5% in 1990’s and then to 2% in 2000’s – by 2005 long-real interest rates were at record lows. This was mainly due to China’s policy of holding down the Yuan and in the process dumping a bucket-load of capital on to the rest of the world. This trend like decline in real interest rate drove up virtually all asset prices relative to income (especially land).

    2. Household misperception and over-confidence about future income growth. This can be traced back to the advent of inflation targeting in early 1990’s. Overtime, by stabilizing at low levels actual and expected inflation, greater stability led households to over-borrow and over-consume as it appeared less likely that the CB would ever step in and inflict a recession as they had always done in the past. Mervyn King calls this the nice (non-inflationary consistently expansionary) decade.

    Only one of these forces is still in play (and for a very different reason). The real rate of interest is still low (actually negative). But this is because most of the high income world is in a mini-depression. And it remains in a mini-depression because the 2nd structural force no longer exists. Households are no-longer confident about future income growth (which is demonstrated by a post-GFC increase in savings rates) because recessions are now a real possibility. And even worse, far from being CB inflicted, they are outside the control of the CB.

    Unless you can get structural force 2 to return – which is impossible unless you can wipe out peoples memory of what has happened to the world post 2007 – there is absolutely no way you can get a repeat of the period 1998 to 2007.

    Despite appearances to the contrary, Australian households are no longer confident about future income growth either. This is also demonstrated by an increase in the savings rate post GFC. The only reason this hasn’t translated into weaker actual income growth today (through a feedback from weaker current spending and borrowing), is because the ToT has kept income growth elevated. In other words, The ToT are the *only* reason why the end of structural force 2, did not pull the curtains on the housing boom here as it did everywhere else. A bet on Australian housing is a bet on the ToT.

  16. There are so many historical examples of house price cyclical volatility to go by; who knows which Aussie will follow?

    20 year slow melt like Japan?

    Rapid crash like Ireland or Spain or California/Arizona/Nevada/Florida? (And crazy new bubble starting now in the case of CA/AZ/NV).

    Relentless housing unaffordability underpinned by relentless shortage of houses, with cyclical price busts nevertheless always smaller than the booms – like the UK for the last 50 years? Note the consequences of serious long term economic underperformance and rising social instability accompanying this path. At some stage the whole thing has to collapse through the sheer structural sabotage of the rent-seeking – this might be happening to the UK economy now.

    I pick that Aussie will go like the UK, with perhaps a greater initial price crash than typical UK ones – and then the urban planners will react to strangle supply altogether to “prevent further bubbles”. Yes, they really are this stupid. This has been the reaction in Ireland.

    Florida is not included in the renewed price bubble now underway in LA and Phoenix and Vegas, because Florida abolished statewide “Smart Growth” mandates – the truly “smart” thing to do. Aussie COULD do the same but I am not holding my breath. It would require Tony Abbott to be smarter on this issue than John Howard – who I am told shut down initiatives for reform on the part of of Peter Costello and other deputies, based on the excellent work of Alan Moran. A tragic, tragic, tragic missed opportunity.

  17. Rumplestatskin provides some amazing number-crunching at times but he has one significant blind spot about the way urban land markets work, or can work, and the distortions introduced by prescriptive urban planning. He sees the prices of houses as always “determined by fundamentals”; i.e. “what people are prepared to pay for them”; completely ignoring that with regulatory distortion of “supply”, the urban land market behaves not just like an essential “cost of living” commodity in which there is an oligopoly of supply, but like a speculative commodity like gold. The price is not even being determined by “what ordinary people are prepared to pay for a necessity”, it is being determined by what SPECULATORS are prepared to pay. It is as if there was not just an oligopoly in the supply of bread and milk, but speculators gaming the supply of them as well. We wouldn’t stand for this in bread and milk, so why do we stand for it in housing?

  18. In the UK, there has never been a significant rapid bust in prices of houses, and there has never been a “slow melt”. There has been a relentless trend to worse and worse unaffordability, with the price inflations during the boom phases exceeding the deflations during the bust phases.

    What underpins this, is relentless undersupply of land for urban development. It is relentless just for population growth, let alone people’s desires for more space as incomes rise. What the analyses of “the price of housing” conceals, is the obscene inflation in the price of land per square foot. While “house price median multiples” have been ratcheting inexorably upwards, the size of sections in new developments has been shrinking, AND more and more people are excluded, period, from the part of the housing market from which median multiples are calculated.

    I pick Aussie as capable of following this path for a while. The UK has had London’s global finance income as a primary source of income propping its economy up. If this was undermined for any reason, (Tobin taxes? outsourcing or automation of finance sector functions?) the UK economy would be toast. You can’t have this kind of rent-seeking strangling the real economy indefinitely. UK GDP is 20% – 40% lower than it might have been as a consequence. The UK, given the Poms capability for innovation and the universality of the English language, should have been a manufacturing powerhouse to match Germany, and with at least one Silicon Valley.

    Google “LSE The Best Laid Plans or Another Fine Mess?” for a very illuminating PPT by Alan W Evans.

    So there is evidence on which to base a theory that Aussie could have a long “new normal” of very high house price median multiples, with relatively small cyclical volatility in the prices, and space being traded off in new developments, and by young households and immigrants “crowding”, and by an increasing proportion of the population excluded completely from the market for actual “houses”. This does not make it morally right, and it is all the more disgraceful that the underlying racket enabled by urban planning, is tolerated.

    Meanwhile the “economic rent” incorporated in every square foot of land rises to the benefit of the large-property-holding rentier class. The bubble bunnies are small fry. It is the interests who have had large holdings of urban land long since, who are absolutely creaming it on their rents – like the 4 families of the descendants of the original “London Dukes” and other grand old land holders.

    Note the study by Cheshire and Hilber on office rents in the UK, Europe, and the USA – virtually EVERY city in the UK is higher than Paris and most European cities, which in turn are almost all higher than Manhattan….!

    But Rumplestatskin will tell us this is nothing to do with regulatory distortions, it is just “what people are prepared to pay” in the UK.

    • No surprise that I agree with you and share your pessimism.

      There are some flickers of hope however.

      In many respects we have witnessed a perfect storm in terms of housing supply over the last 30 years.

      Primitive and simplistic notions of user pay resulting in front loaded costs.

      Fears of urban landscapes being turned into modernist pebblecrete horror shows.

      Technocratic modernist town planning obsessions rather than organic community development.

      Anti automobile / fossil fuel/ greens rejection of sprawling cities

      Compliant and paid off media without semblence of independence

      Confused and economically illiterate ‘progressives’ cutting of the developers to nose and spiting the low income earners.

      Debt boom like no other in recorded history.

      Change is inevitable and people are starting to wake up.

      • Edit failed

        No surprise that I agree with you and share your pessimism.

        There are some flickers of hope however.

        In many respects we have witnessed a perfect storm in terms of housing supply and prices over the last 30 years.

        Primitive and simplistic notions of user pay resulting in front loaded costs.

        Fears of urban landscapes being turned into modernist pebblecrete horror shows.

        Technocratic modernist town planning obsessions rather than organic community development allowing people choice in where and how they choose to live.

        Anti automobile / fossil fuel/ greens rejection of sprawling cities

        Compliant and paid off media without semblence of independence

        Confused and economically illiterate ‘progressives’ gleefully cutting off developer’s noses and in doing so spiting the face of low income earners.

        Debt boom like no other in recorded history.

        Change is inevitable and people are starting to wake up to the horrendous and unnecessary cost of this combination of ideological obsessions, phobias and fads.

      • I think this was probably helped by the Thatcher sell-off of public housing to its occupants, which sort of increased supply in the real, “private”, housing market. But it was a one-off – and the critics of the scheme who agonised that “the poor” would all end up NOT owning their own houses anyway in the long term, with the sold-off “public” stock ending up in the hands of higher income quartiles, were never going to be proved wrong unless the Town and Country Planning system was reformed. Thatcher’s single sin of omission was not attending to this, and unfortunately this was a significant legacy-eroding omission.

  19. Now, there is some truth in the “what people are prepared to pay” theory. It used to apply to virtually everything in the world. Food. Clothing. Some people went without altogether. Most people got barely enough. “Economic rent” was also a norm. There is a direct connection between people “paying what they are prepared to”, or rather, “what they have to”, and the existence of economic rent.

    What eliminated economic rent in food and clothing? The lowering of transport costs to insignificant levels in real terms, and “trade” no longer limited to regions of close proximity, but rather to the superabundant quantities of land for producing the raw materials and genuine competition between all parties including land vendors. No more “economic rent” being extracted by the owners of the wheat-growing land or the wool-producing sheep-farming land within 60 miles of a city as described in those neat Van Thunen “land rent curves”.

    What we see in contrast, in a world where economic rent is eliminated in food and clothing and all manner of goods, is “consumer surplus” everywhere you look. We buy bread, we buy milk, we buy a woolen garment, at far below the price we would pay if the price was determined by “what we HAD to pay”, accompanied by the extraction of economic rent by a lucky rentier class.

    Now there is absolutely no rational economic reason that housing cannot have economic rent eliminated from its cost, and instead to have “consumer surplus”, just as with food, clothing, TV’s, cars, bicycles, whatever. Matt Ridley actually says the following on page 25 of “The Rational Optimist” (after discussing the falling cost of most items in the modern age):

    “……Housing, too, is itching to get cheaper, but for confused reasons governments go to great lengths to prevent it. Where it took sixteen weeks to earn the price of 100 square feet of housing in 1956, now it takes fourteen weeks and the housing is of better quality. But given the ease with which modern machinery can assemble a house, the price should have come down much faster than that. Governments prevent this by, first, using planning or zoning laws to restrict supply (especially in Britain); second, using the tax system to encourage mortgage borrowing (in the United States at least – no longer in Britain); and third, doing all they can to stop property prices falling after a bubble. The effect of these measures is to make life harder for those who do not yet have a house and massively reward those who do. To remedy this, governments then have to enforce the building of more affordable housing, or subsidise mortgage lending to the poor……”

    But there ARE housing markets where economic rent is eliminated and consumer surplus maximised. This is why the median-multiple-3 cities in the Demographia Reports, have MUCH LARGER sections, larger houses, more modern housing stock on average, higher quality, more mod-cons; and far greater democratisation of home ownership. There really is this massive a disconnect. It is like people in some cities in the developed world are still paying “what they have to” to get bread and milk and a woolen vest, while elsewhere people are buying pies and cakes and designer-label clothing and TV’s.

    I repeat: why do we tolerate it with housing? The effect of low real transport costs and indeed low real infrastructure costs, does not have to be forgone for housing, just as we would not accept it being foregone in food and clothing. This whole thing is a colossal loss of reason that has all too easily played into the hands of the rentier property investor classes.

    • While the desire to keep the game going remains strong it is becoming harder and harder.

      Unless further significant increases in household debt are tolerated (and even Luci Ellis will eventually accept there are limits) further growth in prices are now largely limited to income increases and the future for Australian incomes following the end of the mining boom does not appear promising.

      And that is the best case and relies on no change to the highly constipated approach to housing supply. It is doubtful that this will continue with the virulence of the last 40 years especially when state governments will be desperate for some engine of economic activity.

      Clearly, rapid population growth is the final straw being grabbed but the politics of that will become increasingly difficult as economic activity slows.

      The credit card is maxed out just as the overtime and shift bonuses are drying up.

  20. Cam,

    Well reasoned article, thanks.

    And thanks to MB for providing an article that argues (well) for the “other side”, even if I disagree axiomatically, somewhat.


  21. Note the study by Cheshire and Hilber on office rents in the UK, Europe, and the USA – virtually EVERY city in the UK is higher than Paris and most European cities, which in turn are almost all higher than Manhattan….!

    The power-elite in any city are probably concerned mostly with the fact that REGULATIONS can deliver them HERE AND NOW, far fatter unearned increments than centuries of growth towards even a Manhattan-style local economy. Why would any big property owner in any UK city where the rents are higher than Manhattan anyway, care about letting the regulatory/planning brakes off the local economy, when THEIR returns on investment will be REDUCED thereby, pretty much forever?

    The architects and planners generally do not have a clue about the economics and the perverse incentives and the vested interests. They just like it to look good on paper and in the “artists impression”. (Unless they are all smarter than they act, and do understand what side their bread is buttered on – but I don’t think so).

    • True, but the big property owners are a minority.

      What has kept them in the game is that the much larger and left of centre groups have been sucked into thinking that being opposed to ‘sprawl’ and redevelopment and intensification (voluntary in response to demand) is a costless exercise.

      Up until recently too many ‘progressive’ and low and middle income earners have been ignorant of the extent to which they have been shooting themselves and their children in the foot – ie hip pocket.

      A few who are cottoning on and wish to hold fast to their policy preferences (anti-sprawl hyper-preservation of ye olde) call for zero population growth. Which is at least consistent albeit extreme.

      The sooner more people understand that they are the authors of their own and their children’s misfortune the sooner there will be a faster policy response towards allowing housing supply to quickly respond to demand at the lowest possible cost consistent with minimum requirements for safety.

  22. Mason Gaffney, 1964:

    “……As the German economic historians relate, the monopolistic city can exploit its customers. The city exploits its customers by stunting its own development, limiting the number of creaking doors and sagging gates through which its customers may go for supplies and services.

    There is also exploitation within the city. Employers, merchants, and assorted rent-collectors are generally happy with policies that keep out untrained interlopers who might have alien ideas about competing for labor, tenants, and customers, and in general keeping the natives restful in their compounds.

    Growth containment policies have an instinctive fascination for anyone whose interest is to limit competition. There are many groups which would like to limit competition, of course. But cities tend to fall most strongly under the sway of those who stand to gain or lose most by municipal decisions, and those whose assets are irrevocably committed to the city, that is, the landowners. The rest of the citizens are ‘by comparison mere transients, outsiders and climbers whose organization and influence is seldom commensurate with their numbers.

    To the dominant landowning oligarchy, few limitations on competition commend themselves with quite the same force of logic as limitations on the entry of new lands into urban use. It is therefore no accident that negative containment is the most respectable and salable kind of planning in many quarters. It harmonizes all too mellifluously with the interest of a dominant class. But from the viewpoint of social economy, of other interest groups, of the general welfare, of the region, state, and nation, and even of most urban landowners in their roles as workers and capitalists, negative containment is an instrument of monopoly exploitation……”