Is the housing bubble about to pop?

Specufestor spirits are certainly under assault, as the AFR noted over the weekend:

Property investors could be forgiven for thinking this week that the universe, particularly the financial universe, is out to get them. And they would be right. Runaway property prices in Melbourne and Sydney and a spike in lending to investors have regulators concerned about financial stability, the level of household debt and the impact of a market collapse on savers, many of whom seem to think that house and apartment prices only go in one direction. Banks, meanwhile, are scrambling to abide by lending restrictions imposed on them by the Australian Prudential Regulation Authority.

…”I think people should be leaning towards other asset classes. History tells us those sorts of runs [in house prices] don’t go on forever,” adds AMP Capital head of investment strategy Shane Oliver.

Oliver’s starting point is that the low yields on Sydney and Melbourne properties imply those markets are overvalued. Rental yields on units are about 2.5 per cent, while on houses the figure is less than 1 per cent. “Effectively this means that property is trading on a high price earnings multiple,” says Oliver. Add to poor valuations the prospect of higher rates on investment mortgages and tighter lending restrictions and the market could be in for a “pullback” in 2019, Oliver predicts.

“Australian shares look reasonably attractive,” argues Oliver, noting that long-term returns for property and equites are similar, but that “the starting point for property is far less attractive”.
Oliver points out that the local market has underperformed significantly since the mining boom, but the losing streak appears to be coming to an end and it offers a gross yield of about 5.5 per cent. Meanwhile global growth is improving and interest rates are expected to rise only slowly. On a local currency basis, Oliver suggests having a 50:50 allocation between local and international equities in constant currency terms. However, given the potential for a fall in the value of the Australian dollar as US interest rates rise, Oliver says “people might want to weight their portfolio to global shares on an unhedged basis”.

…Savvy investors who do want exposure, or more exposure, to residential property should consider the Perth and Darwin markets, suggests Oliver, where prices are close to the bottom.

Perth fell 30% in real terms for well over a decade after the last mining boom in the seventies (we’ve a special report coming out on it next week). Darwin is going to return to being a stagnant backwater once Inpex is done.

Let’s sum up:

  • RBA jawboning is a negative and whether or not APRA actually openly cuts the investor loan speed limit seems a little moot today. The banks are moving anyway and that has to be a serious blow to specufestor spirits as they are singled out for rate hikes of 30-40bps versus owner-occupiers of 5-8%. The other major banks are obviously going to follow. If they move far enough then the RBA will cut again so it’s not a one way bet on slowing prices.
  • The raft of experts calling the top is no doubt negative at the margin but not especially so. Obsessive property conversation bullish and bearish is just a part of the bubble.
  • Poor yields and cosmic prices hasn’t stopped anyone so far but I guess it will at some point. Sentiment indicators are all over the place but are certainly more suggestive of a top than a bottom.
  • Labor’s negative gearing curbs give us the clearest date for the crash. It’ll win in two years time and reform property tax concessions likely six moths later so late 2019 is a brick wall for specufestors. Whether in advance they charge in to get their last ditch tax giveaway, or out to avoid the subsequent bust, I have no idea.
  • State governments are also messing around at the margins boosting and curtailing demand and supply but there is no obvious net gain or loss. Do-nothing Malcolm appears more likely than not to pretend to do something while putting a rocket under demand. First home buyers may be lured in for one final burst right at the peak.
  • The Chinese bid is already down a lot and won’t come back up except for those rich enough to dodge the Chinese capital flight rules.
  • Supply is booming and the economy is weak.
  • Immigration is going to fall sooner rather than later as One Nation destroys the Coalition.

There’s no clear picture here for specufestor spirits. They are certainly under pressure and that will increase but the reserves of denial are deep. It could break or it could sail on.

What we can say for certain about specufestors is that:

  • they are caught in a raging tulip-style bubble;
  • authorities are worried about household debt enough to put a lid on it at the margin but are terrified of popping it;
  • official interest rates will not rise, and will fall given half a chance (the exception to this could be some kind of fiscally-led hand-off from specufestors to FHBs);
  • political risk is soaring and is baked-in for 2019 and
  • the global cycle is nowhere near as strong as it appears and will come under a lot of pressure around or before early 2019 as the Trump boom goes bust. Commodity prices will fall a long way before then.

My base case remains unchanged. I don’t see property going bust until we get to the next global shock. Even then it will ebb and flow with political desperation. Remember that this is not a market. It is a public/private partnership in asset inflation and that must break for it to fall sustainably.

But that does not change the risks nor allocations. Property remains a sell if you see it as an investment because:

  • valuations are terrifying;
  • the embedded risk in investor demand is real;
  • soaring political risk is real and a policy error is quite possible;
  • the global environment remains high risk for the bubble given its external exposure;
  • monetary policy is at the verge of exhaustion;
  • fiscal policy is close behind it;
  • the immigration lever has turned toxic;
  • it is an extremely leveraged and illiquid asset class, and
  • now is the time to cash in and hedge the bust by getting your money out of the country while the AUD is high.

Sell!

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