Link to part 1: http://www.somersoft.com/forums/showthread.php?t=52058
Link to part 2: http://www.somersoft.com/forums/showthread.php?t=52061
An analysis of the Australian Property Market
Part 3: Why the gloomers are wrong!
The doom and gloom crowd frequently make spurious assertions regarding the Australian property market. In particular they like to make up reasons why an imminent crash is inevitable. This article aims to address and correct their most common claims.
False claim number 1: ‘House prices will revert to historic price vs income trends’
The gloomers often claim that property prices have diverged from fundamentals and must revert to historical price vs income ratios. This argument is clearly nonsense. What they fail to recognise is that the fundamentals have changed, and therefore the trend has changed. House prices won’t revert to historical price vs income trends for the following reasons:
- More women in the workforce means dual incomes going toward housing is now the norm.
- Financial deregulation, product innovation and competition make finance available to a wider range of borrowers.
- Lower interest rates and reduced financial institution's margins on housing loans improve debt serviceability.
- New incentives such as negative gearing, capital gains tax advantages, SMSF can now invest directly in property etc.
Of course, along the way there will be property cycles, booms and busts, but the house price to income ratio will never revert back to past historical trends.
False claim number 2: ‘There is no shortage of houses in Australia’
Another frequent doomsayer claim is that the critical housing shortage recognised by the RBA, media, major banks, government, HIA, real estate industry, and all property analysts and commentators is actually an illusion. They claim that Australia has a massive number of empty houses that will somehow flood the market at some point in the future when interest rates or unemployment levels get too high. This is of course rubbish – the percentage of empty houses in Australia has barely changed in 30 years as shown below.
Year Occupied Empty %Empty
1976 4162064 431200 9.4%
1981 4691425 469742 9.1%
1986 5285571 543539 9.3%
1991 5765021 597582 9.4%
1996 6496072 679165 9.5%
2001 7072202 717877 9.2%
2006 7596183 830376 9.9%
Some gloomers even go so far as to suggest that many property ‘speculators’ are hoarding empty houses while claiming negative gearing deductions. This would of course be completely illegal, and in any case does not make sense from a business perspective, since the investor would be losing rental income while risking severe penalties if caught by the ATO.
Australia has always had empty houses, and an excess of bedrooms in occupied houses, however these empty houses are not necessarily available for sale or rent. And they are not necessarily located in places where people want to live. A house is marked empty if it is unoccupied on census night. Many people are on holiday, out with friends, travelling etc. on census night, so their houses are counted as ‘empty’. This does not mean that the house will shortly become available for rent or sale.
Remote coastal towns always have a large number of empty holiday homes and high vacancy rates, but that doesn't help all the people who work and need to live in Sydney or Brisbane. On census night, there may have been plenty of empty villas in Thredbo and empty houseboats on the Hawkesbury, but again, not much use to the majority of the population who live and work in our cities.
As for the empty bedrooms... well, Australians want empty bedrooms in their houses. We're used to them, and we're not going to start inviting people to share our houses and bedrooms unless forced to by extremely adverse conditions.
High prices and low rental vacancy rates are a symptom of shortage. We see these symptoms across Australia.
False claim number 3: ‘I see very few homeless people in Australia. How can there be a shortage? Where is everybody living then?’
The number of persons per dwelling in Australia dropped from 2.97 in 1991 to 2.76 in 2001 and to 2.74 in 2006. So after falling considerably over a decade, this metric has basically flat-lined from 2001. Australians are now bunching up in existing dwellings rather than continuing the trend of forming new households. Why? Because we don't have enough houses to allow people to continue spreading out at the rate they desire.
Construction is currently down and rents are rising strongly in all cities. The Australian population grew by 390,000 people or 1.84 per cent in the past year. This is the largest number added to the population ever.
We can't just keep bunching up into the existing housing stock forever. The government is beginning to recognise this, hence their plan to build 100,000 new 'affordable' houses. But that is a drop in the ocean - we need many more. They will leave that up to the private sector to build (i.e. property investors and private developers).
Unless we develop new stock, we cannot possibly hope to appropriately house the growing population. So where are all these people who contribute to the pent up underlying demand actually living right now? They are:
- Bunched up in existing houses.
- Sleeping on friends sofas.
- Living in caravan parks and campsites (caravan parks in Australia are overflowing).
- Staying with parents for longer then they desire.
- Hotels, motels, backpacker hostels, guest houses.
- Crisis shelter, homeless centres and public housing.
- A small number of people are living on the streets.
False claim number 4: ‘I have a lot of pent up demand for a Ferrari, but I can’t afford one so my pent up demand is irrelevant, just like pent up demand for housing is irrelevant.’
This is a very common misunderstanding from the gloomers. What they fail to understand is that a Ferrari is a highly discretionary luxury item, while a home is a basic necessity. You can't really compare them like this. If a person cannot afford a Ferrari then they have the option of buying a cheap second hand car, or a bicycle, or walking. On the other hand there is no real alternative to living in a house. Shelter is a basic need. If a person is priced out of a particular housing market then they will do one of the following:
- Move further out, to a less desirable suburb.
- Buy a smaller house or unit instead.
- Make use of a shared equity arrangement or partner with another buyer.
- Leave the country.
Unless they choose the last option, then their demand on the Australian property market still exists. This underlying pent up demand doesn't just disappear. Everybody needs to live in a house.
It would be fine to compare a Ferrari with a luxury waterfront mansion, or to compare ‘transport’ in general with ‘shelter’ in general. But to compare ‘Ferrari’ with ‘shelter’ is just ridiculous. One is a highly discretionary luxury item. The other is a basic necessity.
False claim number 5: ‘Australia’s debt to GDP ratio is at 160%. This is unsustainable - the ratio can’t possibly get any higher and must collapse.’
Credit growing faster than GDP is not necessarily a problem. GDP is income received each and every year, while credit is an expense that is only paid once. It makes more sense to either chart GDP against the interest on the debt, or to chart total debt against total assets.
GDP is not really comparable to total credit. If my income rises by $100 and my total debt rises by $110 then even at an interest rate of 10% pa, I’m still ahead by $89 (100 - (0.1 x 110)), even though my total debt has increased at a faster rate than my income. The same analogy applies to Australia’s Credit vs GDP ratio.
Although the interest on the total credit must be paid every year, much of this interest is owed to other Australians, so to some degree we are paying the interest to ourselves. From the perspective of the overall economy, debts are not just negative assets. They simply represent a pledge to transfer funds from one person to another at some future point in time. They are as much an asset to the lender as they are a liability to the borrower.
In short, Australia’s credit vs GDP ratio is not necessarily a problem. Many countries have a much higher credit vs GDP ratio than Australia. The ratio is over 300% for some countries. There is no reason why our ratio can’t continue to grow. Here is an interesting comment from the RBA on Australia’s debt situation.
Has the expansion of household credit run its course? Will it reverse? We cannot know the answer to these questions with any certainty, but my guess is that the democratisation of finance which has underpinned this rise in household debt probably has not yet run its course. In the past, the lack of access to credit had resulted in Australian household sector finances being very conservative. Even as recently as the 1960s, the overall gearing of the household sector (taking account of all household debt and all household assets) was only about 5 per cent – that is, households owned 95 per cent of their assets, including houses, outright. This meant that the household sector had significant untapped capacity to service debt and large unencumbered holdings of assets to use as collateral for borrowings. Financial institutions recognised this and found ways to allow households to utilise this capacity. The increase in debt in recent years has lifted the ratio of household debt to assets to 17½ per cent (Graph 6)3. I don’t think anybody knows what the sustainable level of gearing is for the household sector in aggregate, but given that there are still large sections of the household sector with no debt, it is likely to be higher than current levels.
False claim number 6: ‘Many economists have said that property values in Australia will fall by 40%’
The only public figure who is claiming that property prices will fall by 40% is Steve Keen, an associate professor from a Western Sydney university. Mr Keen has not actually based this 40% figure on any real data, but rather has suggested that because this is approximately how much prices fell in Japan, 40% sounds good for Australia too.
Originally Posted by Steve Keen
Japan also had a bubble economy in the 1980s, and its house prices have since fallen 42% in real terms, and more in nominal terms since consumer prices have fallen over the 90s and 00s courtesy of Japan's long-running Depression. That's the reason I give a 40% figure for a price decline in the press: our bubble was larger than Japan's in general (though much smaller than Tokyo's), and a fall of that magnitude would seem a good ball park estimate even though it would take a greater fall to restore the median house price to median income ratio to 3, which is Demographia's estimate of the peak level for affordability.
It seems strange to compare Australia to the Japan experience, when there are so many differences between the property markets in each country. It does not make sense to expect the same outcome from different inputs.
The other notable identity who gained some notoriety in 2008 for his claim of a 40% fall was an internet blogger known as Edward Karan. Karan asserted that property prices in Australia would fall by 40% over two years, starting from the ‘tipping point’ of Q1 2008. With only 8 months to go until his deadline, and prices down only 3% (and rising again), it is obvious why we no longer hear from Edward Karan in the media.
For prices to drop by 40% we would need to see massive levels of forced sales. Unless you are a forced seller, why on earth would you sell for a 40% loss? For prices to fall by 40% there needs to be no buyers at 5% down... no buyers at 10% down... no buyers at 15% down. However there are plenty of buyers ready to jump in right now (even before any significant falls) and even more would be ready to jump in at 10% down. Most people simply want a house to live in and will buy when they can afford it. Many can afford it right now. Property investors are already seeing many cashflow positive opportunities due to the historically low interest rates. There is simply no mechanism by which prices can fall 40% in the current environment.
If I live in a street with 200 houses, and even if two of those houses were forced sales to lucky buyers for a 40% discount, while 10 others sold for a 5% discount (because those vendors didn't need to sell, and the buyers were willing to buy at 5% down), then my valuation would come in at a 5% reduction. For median prices to fall by 40%, then 40% down sales need to become the norm, not the exception. This means massive levels of forced sales. This simply will not happen, especially with the government and major banks agreeing to payment holidays for the unemployed.
False claim number 7: ‘Australian house prices are the highest in the world’
This is another factually incorrect statement, generally based on the Demographia survey. The Demographia survey has been thoroughly debunked due to its massive flaws. It uses a very basic measure of 'affordability' - i.e. median house price to median income. This is an extremely blunt tool. Demographia compares house price to income ratios across various countries, however there is no reason why house price to income ratios would even be consistent across different countries, because there are substantial differences between the housing markets in each country. The survey fails to consider the following factors:
- Disposable/discretionary income
- Employment rate
- General cost of living
- Interest rates
- Rental yield
- Availability of public housing
- Marginal tax rates
- Mortgage default rates (Australian defaults are way below UK and USA default rates)
- Tax incentives such as negative gearing, FHOG, CGT reductions
- Land/Block size
- Dwelling size and quality
- Proximity to transport and infrastructure
- Currency exchange rates
- Economic and political stability
- Home ownership rates
- Urbanisation (much higher in Australia than in US, UK or Japan)
- Population growth - Australia (1.84%), compared to USA (0.9%), UK (0.4%) and Japan (negative)
- Demographics (it is ironic that a survey called Demographia ignores demographics!)
Of course, no survey is perfect and no survey can possibly hope to account for all these factors. Our best option is to examine as many different surveys as possible, each of which may address several of these factors, and this will provide a better general impression of comparative affordability in each country, rather than looking at just one survey in isolation.
Regarding the 'demographic' failings of the Demographia survey, take for example its assertion that a certain 'sea-change' town in Australia is particularly unaffordable. Demographia bases this on the median house price to medium income in that town. What they fail to consider is that the median income there is largely irrelevant, because much of the population are cashed-up retirees (no income) who have saved up for their whole lives and purchased a nice big beach house, often with very low borrowings. Sure, these beach houses may be unaffordable for a first home buyer who lives there and works in the local supermarket, but that's not the primary demographic driving prices that town. In reality, the Demographia survey is comparing apples with oranges.
Another key issue with Demographia is that it only compares Australia with five other countries, yet the gloomers proceed to claim that Australia is the 'most expensive country in the world'. The survey conveniently ignores all the many cities around the world with much higher house prices than Australia. For example Moscow, Tokyo, Oslo, Seoul, Hong Kong, Geneva, Zurich, Milan, Paris, Singapore, Monaco. Here are some alternative studies:
World's Top 10 Priciest Cities To Own A Home
Sydney - Not in the top 10
GlobalProperty Most Expensive Cities 2008 (apartment price per sqm):
Sydney - Number 13
Mercer Most Expensive Cities (cost of living, including housing)
Sydney - Number 21
CityMayors Expensive Cities
Sydney - Number 24
Knight Frank Survey (prime residential property)
Sydney - Number 8
Overseas Property Mall Survey
Aneki (most expensive countries to live in)
Australia - Not shown in the top 20
Most expensive countries in the world
Australia - Not on the list
Most expensive rental markets
Australia - Not on the list
False claim number 8: ‘Australian house prices are unaffordable’
The majority of Australians are well ahead on their loan repayments. Less than 1% of borrowers are 90 days in arrears on loan repayments. The RBA has demonstrated that 25-40 year olds today have more disposable income left over after buying a 30th percentile house than at any time in the past. Clearly the majority of Australians are not finding property unaffordable.
False claim number 9: ‘Australian house prices will crash when unemployment rises’
The unemployment rate has been at historic lows and could not realistically do anything other than rise. Obviously there will be job losses across Australia over the medium term, however house prices have boomed through much higher unemployment levels in previous years. The people most impacted by a rise in unemployment tend to be those who do not own a home anyway, and those who do own a home will be covered by the mortgage payment holiday recently announced by the government and major banks.
False claim number 10: ‘Nigel Stapledon’s data shows that real house prices in Australia were flat thoughout the 1800s and early to mid 1900s’
Stapledon's work has been largely discredited. Nobody was actually collecting Australian median house price statistics in the 1800s and early 1900s. Stapledon’s methodology for collecting the statistics is described in his thesis at the link below.
Stapledon collected the data by visiting the library and reading one old Sydney newspaper for one day of each year from the 1800s. Then he looked at the advertised price of properties for sale in that paper. Then he extrapolated this out to create an Australia-wide house price index. He based the whole thing on a handful of advertised sale prices in one newspaper from one city on one day of each year, and somehow arrived at a house price index for Australia. He preformed no compositional adjustment and failed to recognise that one city in Australia may be booming while another is stagnant. In addition, Stapledon's measure of inflation in the 1800s bears no semblance to anything we would call CPI today, never mind the fact that houses were purchased using a completely different currency in the 1800s. Stapledon's data is meaningless when analysed critically.
False claim number 11: ‘House prices in Sydney have peaked and cannot possibly get any higher in real terms’
Five years ago, Sydney house prices were 20% higher in real terms. There is no reason why they cannot get that high again or higher. There is no known limit to house prices. Prices in cities such as Moscow, Tokyo, Oslo, Seoul, Hong Kong, Geneva, Zurich, Milan, Paris, Singapore and Monaco are already much higher than prices in Sydney.
False claim number 12: ‘No subprime in Australia? Ha! I saw an 18 year old on Today Tonight with no job, seven kids and twelve investment properties.’
Of course there are isolated instances where lenders have provided finance to people who are unlikely to be able to service their loans over the long term. But these are exceptions. As a rule, Australian lenders have taken far fewer risks than their US and UK counterparts.
False claim number 13: ‘Fundamental supply and demand, population growth etc is irrelevant. Availability of credit is the only factor responsible for house price growth.’
In 2007, house prices in Melbourne rose by over 20% while prices in Sydney rose by only 8%. Did Melbourne have twice the amount of credit available? No. Prices were driven by supply and demand, not availability of credit. Credit is equally available throughout Australia, but house prices do not rise by equal amounts in each city.
False claim number 14: ‘Interest rates were cut in the UK and USA. It didn’t save their markets and it won’t save the Australian market.’
The UK and US did not start to slash their official rates until after house prices were already falling sharply, and in any case the official rate cuts were generally not passed on to the borrowers to the same extent as they were in Australia.
False claim number 15: ‘The UK and USA had high population growth. It didn’t save their markets and it won’t save the Australian market.’
Annual population growth in the UK is actually very low at 0.4%. The figure is 0.9% for the USA. This is much lower than the Australian growth rate of 1.84%.
Link to part 1: http://www.somersoft.com/forums/showthread.php?t=52058
Link to part 2: http://www.somersoft.com/forums/showthread.php?t=52061