Property risk highest in a long time


MB contributor, Rumpletstatskin, wrote an interesting post on the Australia property cycle this morning. In it he mused that:

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.

Cameron argues his post well but I vigorously disagree with these conclusions.

Australian property prices are not affordable on any spectrum that looks beyond the current cycle. Indeed, they remain at nose-bleed levels on any historical comparison.

Yet, prices have held at these high levels for over a decade and there is no saying that they won’t continue to do so. Throughout the GFC and afterwards I argued that the time of reckoning for the Australian housing bubble was not yet at hand. This was based largely upon the assumption that the nation had lots of firepower left in monetary and fiscal policy that would protect the downside. And so it turned out to be.

But each successive challenge has sapped these supports and insurance policies. Monetary policy is at 2.75% and probably has, at best, 1% of cuts left before it is exhausted. Fiscal policy too has limits now that the Budget guarantees bank borrowings. Not to mention the political paralysis preventing spending. We will never see another post-GFC stimulus program.

Most importantly, these limitations are apparent as the Australian economy enters a very serious challenge in the form of declining mining investment.  In its editorial this morning the AFR wrote:

If Professor Garnaut is right, Chinese steel use per capita – the great driver of Australia’s resources boom – may not grow much further. He believes Australian resource investment will slide from 8 per cent of gross domestic product to just 2 per cent, effectively taking out about two years’ worth of national economic growth. This is already showing up in a string of profit warnings from mining services companies and an emerging slump in profitability in coal.

Think about that a moment.  6% of Australian GDP disappearing over the next three years before we even start to grow. This is the same forecast currently projected by ANZ and Goldman Sachs. It must be taken very seriously.

If this comes to pass, then it will be very difficult for Australia to avoid a recession and property bust of some kind.  There will be very big falls in the dollar and they will protect Australian property prices to an extent. The fall will trap Asian investors already in the market but it will also deter future investors as currency risk becomes the new reality.

But the fall in the dollar is also going to hit consumers, much more quickly than it is going to benefit tradable sectors. Consumers will see purchasing power eroded as high inflation in oil and all imported goods overwhelms income growth. This will keep confidence under the cosh.

More to the point, a 6% draw down in business investment will hit the labour market hard and potentially trigger forced selling in property markets. Perth and Darwin especially are going to be at risk of property busts as the many project labourers on our major mining projects flood back into town with nothing to do. Not to mention the trouble we’ll see in the many sundry industries that have benefited from the mining boom. Brisbane is at risk of this dynamic too but has already corrected sharply so has less downside.

These factors, along with a generalised stalling in income growth, have the potential to feed bad loans back into the banking system. The majors can absorb serious losses. But how serious? And how much credit rationing would it take to pop the grossly oversupplied  Melbourne and Canberra property markets, the latter afflicted with big job losses from a new government as well? Sydney is strong but only so long as credit keeps flowing.

There are of course arguments about high immigration, underlying demand, under supply and rising rents to support the market. And they will play some part. But none of these will matter in the circumstances I’m describing. If there are not enough jobs then people will move in together. Shortage will turn to surplus.

Cameron’s argument that the property cycle could be approaching a turning point will hold if these turn out to be normal times. A moderate retrenchment in mining investment will allow time to rebalance the economy so long as the dollar falls. Even so, things will seem abnormal. Inflation be high and property prices may rise in nominal terms but not so much in real.

But that is far from certain, indeed, may not even be the base case.

I am not saying any of this will happen. But if the mining investment cliff turns out to be precipitous in the next two years then the risk of a property shakeout is higher than at any time I can remember.

David Llewellyn-Smith
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  1. The Patrician

    Some good points there HnH

    2 key ones for me

    1. Forced sales – we haven’t really seen it yet at wholesale or retail level yet but when it comes real sales competition could come quickly. The disposal decisions at Stockland, Mirvac, PEET, Lend Lease et al are crucial.

    2. Immigration – the demand tap has been at full throttle unchecked for nearly 2 years and new sales are still at record lows. If this is backed off the demand consequences could be significant. The HIA recognise this in their recent election hitlist.

    • The englobo land disposals by the REIT’s is a fascinating sub-plot to The Great Australian Land Bubble, Patrician.

      If realization sales reveal a new, lower price for raw land (the stuff is rarely traded), then they should mark-to-market their continuing holdings. An independent valuation is going to trash balance sheets.

      I’m with Leith on the risks here. This is a fabulous time to buy Detroit or Columbus Ohio or Japan ex-Tokyo.

      Perth at the end of a mining investment boom?

      Melbourne at the end of a construction boom?

      Western Sydney ever?

      Adelaide is in a coma. Brisbane is underwater.

      Keep saving, Homesteaders!

      Don’t Buy Now!

      • It’s never a good time to buy Japan ex Tokyo. I did because I live here and can’t rent the kind of place I bought. But I’ll be in negative equity for the life of the loan because the value of the building depreciates to zero faster than the 30 years it takes to pay it off, and the land value is negligible (AUD$30,000 and still dropping 20 years after the peak). Can’t complain about the $130 a week repayments, though.

      • What has happened in Japan is just incredible.

        What is it about the Japanese that they alone seem to have just left Property speculation alone after the first significant cyclical experience?

        They’re piling right back into it right now in LA and other parts of CA; and in Phoenix and Vegas. The Poms have NEVER learned, and have a repeat cycle around every 16 years almost without fail. I wonder when the next Irish house price bubble will happen? I wonder how many episodes of cyclical volatility Aussie will have?

      • Conspicuos consumption in Australia is driven towards housing. In Japan it isn’t.
        For example, there are people who will shop at Bruce’s Bargain duds for clothes, never eat out and shop at Aldi, yet will have the flashy new house with the plasma screen and the leather lounge- because that is the consumption that impotant here- people talk about the house stuff not their prada bags.
        In Japan it is the reverse- $6,000 on a brand new outfit, yet live in a teeny tiny basic unit. There is not quite the tradition of home entertainment there, so people are less likely to see your hovel, they judge consumption on other criteria.
        This is reflected in the furnishings in Japan as well- they tend towards the simple and less overwhekming- fewer leather lounges, more functional sofas.

      • DC, “The englobo land disposals by the REIT’s is a fascinating sub-plot to The Great Australian Land Bubble”.

        From working within the commercial and industrial industry, large greenfield land sales in Sydney West have been few, primarily because the current landholder is not realising the true ‘reduced’ value of their land.

        Developers are not prepared to pay the higher prices to develop the land for industrial use if the market rental rates have not increased. Not to mention 6 to 9 month lease incentives being offered to the tenant and Governments contribution burdens adding to the cost.

        Currently however with the demand for blue chip long term leased properties with stable yields being increasingly in demand from super/trust funds globally, (not to mention borrowed at a cheaper than ever rate) this is compressing cap rates, increasing the value of the property, which is good ‘now’ for the property owner and the developer, as the fund is prepared to pay the developer more for the property.

        Depending on the rate of demand increasing, will determine if the developer is prepared to pay more for that greenfield piece of land, or in my opinion, more likely increase the incentives to attract the tenant which is the rarer piece of the model.

        A long way to go before the incentives in the market are removed and placing pressure on the rent rate, particularly with increased employment lands in the pipeline adding to the supply side. All good for the tenant.

    • “Immigration the demand tap has been running full throttle for nearly 2 years”

      Permanent immigration, including households or families likely to buy, like always has increased incrementally, and make up less than half of net overseas migration NOM and includes spouses, dependents etc..

      Temporary visitors, most unlikely to buy houses, have been driving the NOM, or as everyone likes to describe it “immigration”.

      There are those within the latter e.g. parents of long term students who will buy apartments etc., but no data has yet surfaced to show evidence that Chinese, foreigner buyers etc. have been significant and are directly responsible for driving market vs “Australians”.

  2. JacksonMEMBER

    Have to agree that Perth is at serious risk. Certain inner city suburbs around me that are the domain of the over-extended had a ridiculous number of “for sale” signs up during GFC1, and they’re starting to appear again.

  3. I can’t ever remember a time when buying property seemed like an easy decision without risk, especially for a FTB.

    People point to a time when interest rates were 17% and say that was a great time to buy because price were low, but no one knew that rates would shortly fall, and the risk at the time of purchase was very real.

    The House used in the Herengracht Index in Amsterdam went on trends that lasted up to 70 years at times, how does a mortal with a mortal lifespan factor that into their financial calculations. Buying a bargain at 85 years of age is no compensation for the years lost.

    Unless you are getting an absolute bargain, buying a house always appears high risk.

    • I disagree that “buying housing always appears high risk”.

      Quite the opposite.

      Australians (at least for the last 30 years) have always presumed you can’t lose with property. “It always goes up”. “Safe as houses.”

      It has always been doctrine that you should buy a house as soon as you can, and anyone who doesn’t is a mug.

      Yes, some degree of risk has always been present.

      But never as much risk as now.

      • That’s actually not true. I tend to buy what everyone else passes over at a time when others won’t touch it, and those times come and go in cycles. Most people feel the risk when they buy even if they don’t have that on display.

        Ice cool buyers are few and far between.

      • Certainly Peter, nerves on the part of the buyer are always present.

        But I’m talking about objective risk.

        I agree with the main post – objective risk is far higher than normal at present, for good reasons.

    • I bought my first house in 1993. IIRC house prices were depressed, interest rates were low, and the worst of the recession had passed. It seemed like a pretty good time to buy, and indeed it was.

  4. Well … I agree that Perth and Darwin are susceptible to a property bust, but I reckon Sydney (in particular) will hold up and may even see some growth. Does credit rationing matter when there’s so much foreign money flowing into the Emerald City?

    • P.S. Its really great to see Macro Business contributors having a full-on barney in public. I can’t imagine Gotti and Kohler doing similar over at BS.

  5. Demographically Australia’s population is yet to hit peak private debt. Japan reached that level in the early 90s and US hit it in 2007. Australia is approaching it. Once it is reached private deleveraging kicks in and demand for housing falls. That is when real prices will nose dive.

    At some point aging debt holders realise principals have to be repaid. When that occurs en-masse the scales tip to falling house prices as speculators try to unload. Aged thinking they hold a nest egg with their property will find it hard to unload at what they believe is realistic price. Then they are faced with the costs of downsizing.

    • 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 under the sheer weight of the rent-seeking.

      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.

      • Yes, you might have missed this in the past, why do you ask?

        But if Aussie had actually had affordable housing – perhaps due to sensible reforms during the Howard era – I reckon I’d have been over there long ago. I am not proud of NZ. Maybe we will get the housing market reforms right at long last.

      • Because only Kiwis refer to Australia as “Aussie”, a fact they seem completely unaware of.

  6. What affect will the falling AUD have on leveraged foreign property speculators? Probably not a good one?

  7. Robert Sherlock

    Compare Gladstone Qld to Freeport Tx, in the news recently because they are the center of the shift from Australia to USA of LNG.

    Freeport(45k) average household income is almost half that of Gladstone(80k).

    Average house price in Freeport is 70k in Gladstone it is $470,000.

    • Yeah, and check out how fast some of these towns in TX GROW when something is HAPPENING economically in their region, WITHOUT house prices going “unaffordable” by any measure.

      • BTW, they grow not just with the influx of workers for a specific sector, but trickle-down sectors spring up like mushrooms, something like 7 times as many trickle-down jobs are created as the primary ones, and you pretty much end up with a permanent self-sustaining new city.

  8. Someone up above on a skinny thread praised the way MB writers like Rumplestatskin and H&H and UE disagree in public – I agree.

    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?

    • Agreed, really impressive to see intelligent, reasoned, and perhaps most importantly, civil debate.

      For me, this is the kicker, and what it all comes down to: “Cameron’s argument that the property cycle could be approaching a turning point will hold if these turn out to be normal times.”

      Ultimately, if we get a “soft” landing, so to speak, then in a couple of years it could well be a good time to buy. However, if things turn out to be much worse (and there is some evidence of that), then probably not.

  9. So many punters think that Howard and Costello made them rich. And it’s true, some were seriously enriched by the rise in the property market and access to credit. But millions of others now find their welfare is entirely bound to motion in one of the world’s most expensive, most illiquid and most vulnerable commodity markets – Australian property.

    But let’s look on the bright side. There will be a recession in property. Actually, there will be a calamity in property. But the cost of this to the budget will eventually become so great that reform of negative gearing will become irresistible.

    So the coming dissipation of the Millenium Housing Bubble, Parts A and B, will bring about budgetary reform. That can’t be entirely bad.

  10. From Cam’s post:
    “Rumplestatskin May 20, 2013 at 4:58 pm 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.”

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

    Plus all the maintenance costs (or was this included in the 2.5x, not likely) and how much of a down payment, 10%? 20%? (more lost opportunity in deposit interest, and therefore higher still). So this all likely adds up to beyond his 2.5x rent…

    Who…? How…? What…?

    1 + 1 = 5 it seems.

    • russellsmith55

      Why the hell would you buy when its 30%-of-your-income cheaper to rent? And what kinds of yields will that result in?

      • shhhhHHHH!!!!!

        You’ll scare the sheeple! 😉

        AND that extra 30% doesn’t include maintenance of the property, rates (in ACT, we just pay the water bill as a dirty dirty renter) nor the lost interest on any down payment you put into the property… so MORE than 50%, probably closer to 60%!