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Housing bubble fears: property prices could fall 10 to 20 per cent

Date

Christopher Joye

Analysis

Widening gap: Housing prices have outpaced wage growth over the past 12 months.

Widening gap: Housing prices have outpaced wage growth over the past 12 months. Photo: Fiona Morris

The $4 trillion Australian housing market is now overvalued by at least 10 per cent. Every day, valuations get more stretched. Indeed, Australia is just months away from having the most expensive residential property market in history.

Anyone with exposure to the banks, which account for one-third of the sharemarket's value, or to housing, should be focused on two questions.

The Melbourne market has jumped by 15 per cent over the past 12 months.

The Melbourne market has jumped by 15 per cent over the past 12 months. Photo: Jessica Shapiro

When will a bona fide bubble emerge and how steep are the price falls likely to be when borrowing costs are normalised?

After calling a housing recovery at the start of 2013, we warned that the Reserve Bank of Australia's decision to slash its cash rate to a record 2.5 per cent low in August – opening the door to never-before-seen 4.8 per cent mortgage rates – would fuel double-digit house price inflation that risked blowing a destabilising bubble.

At the time, we argued the housing market was already "priced for perfection" – home values could not afford to outstrip incomes for any sustained period. Our worry was that if national prices expanded at, say, a 10 per cent annualised pace for six to 12 months, or more than triple wages growth, Aussie homes could become dearer than fundamentals warranted.

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So it has proved. Australian dwelling prices have jumped more than 10 per cent over the year to March 2014. In Sydney and Melbourne, which make up 55 per cent of the metropolitan population, home values leapt by 15 per cent and 11 per cent, respectively. Yet disposable incomes per capita only rose by 1.7 per cent over 2013.

According to a valuation benchmark regularly cited by the RBA – Australian house prices divided by family incomes – the asset class is three months from piercing the valuation peaks touched in June 2006 and June 2010. After both episodes, home values fell: by 6.1 per cent in 2008 and 6.6 per cent in 20011-12 according to RP Data.

The high-water marks set in 2006 and 2010 for the ratio of average dwelling prices divided by average disposable incomes per family is 4.5 times. When this newspaper started sounding alarm bells last year the ratio was 4.1 times. Taking the latest price data and assuming recent income growth rates, we get a price-income ratio of 4.4 times as at end March 2014. That is, 1.7 per cent off the peaks. Valuations are already 10 per cent above the average since 2000 and 20 per cent beyond than the benchmark since 1993.

The RBA is expected to leave the cash rate unchanged tomorrow.

The RBA is expected to leave the cash rate unchanged tomorrow. Photo: Rob Homer

 

Speculative activity on the rise

And there's no evidence the boom is abating. In 2014, national auction clearance rates have consistently punched above 70 per cent – echoing the 2009 ebullience induced by low rates and the government's first time buyers' bonus. Speculative investment activity, boosted by self-managed super funds, is also on the rise. The RBA observed last week: "the share of households favouring real estate [as their wisest place for savings] has risen to a level approaching the early 2000s property boom".

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Notwithstanding ultra-low borrowing costs, the proportion of people nominating "paying down debt" as the best thing to do with their savings is back at pre-global financial crisis levels. In contrast to the first-time buyer craze in 2009, the current boom looks more like 2002-03. Investors make up the largest share of new loan approvals in Sydney since that time. The proportion of owner-occupiers using "interest-only" loans has crept up to over one-quarter, and buyers with deposits less than 10 per cent of their property's value make up a remarkably high 15 per cent of all loan approvals (after slumping to almost 10 per cent in the GFC).

While sticking to its line that there's nothing to worry about, the RBA conceded this week that "there are indications some lenders are using less conservative serviceability assessments . . . and signs of an increase in high-LVR lending among some institutions".

Acknowledging a burgeoning bubble is awkward for the RBA given the conflicts between its monetary policy objective, which requires super-low rates, and its "financial stability" mandate, which is tasked with preventing imbalances, like destructive bubbles, being induced by abnormally cheap money. The governor has also questioned the merits of "macro-prudential" policy, which are tools that limit lending, suggesting rate hikes might be the best tonic. To get the discounted variable mortgage rate back to normal, which is around 6.6 per cent, the RBA would have to lift borrower repayments by 30 per cent. If inflation becomes an issue like it was in 2007, home owners could face variable rates over 8 per cent. Either of these outcomes would likely induce significant price corrections as buyers cut expectations of capital gains, which are being biased upwards by current experience. When prices do start sliding, it is not inconceivable that we could see unprecedented 10 to 20 per cent losses across the board.

This has ramifications for home owners and investors in the banks, which are, on average, leveraged 25 times and only need a circa 5 per cent fall in the value of the assets held on their balance sheets – 60 per cent of which are home loans – to have their equity capital wiped out. My message is: buyers beware.

Christopher Joye writes a blog for AFR.com. You can find it here

317 comments

  • These kinds of articles are what drive these situations to happen. If there is a housing market over valued it has to be Sydney, so maybe not casting all of Australia with the one brush is the way to go?

    Commenter
    Rosie
    Date and time
    March 31, 2014, 9:57AM
    • Reasons house prices will fall:
      1. Interest rates will soon rise from current historic lows (per forward rates and most experts)
      2. Private investment falls off a cliff over next 24 months (end of mining construction boom)
      3. Economy is weak with unemployment rising (manufacturing etc uncompetitive)
      4. Continued fears of global credit crunch due to unsustainable debt / fake growth from stimulus
      5. Tough budgets / spending cuts needed to reign in the deficit
      6. Iron ore and coal prices have plummeted, meaning lower taxes, profits, investment, jobs
      7. Flood of new apartments etc in East Coast capitals
      8. Amongst the highest and most unaffordable house prices in the world

      Reasons house prices will keep rising:
      - Please suggest reasons???

      Commenter
      James
      Date and time
      March 31, 2014, 10:37AM
    • Actually Sydney has been undervalued for years, on many different measures, and is now only just starting to play catchup.

      Commenter
      Adrian
      Date and time
      March 31, 2014, 10:43AM
    • The crash might be much closer than your think. Last week there was the first bank run in China as locals started panicking - they understand how precarious the China property bubble is and how much financial leverage is in play.

      Mainstream media suppressed it but google it (here's a piece from reputable news agency Reuters)
      http://www.reuters.com/article/2014/03/26/us-china-banking-idUSBREA2P02H20140326

      It was small, localised, contained and well managed by Govt. But the real thing could be catastrophic in every sense of the word. And anxiety levels are rising - a bonfire now soaked in fuel.

      Careful going into this with too much debt.

      Commenter
      James
      Date and time
      March 31, 2014, 10:46AM
    • It's the usual articles, lobby groups, vested interest, poor government policy, poor bank practices, misguided RE agents, inaccurate & grossly misleading data that leads us to where we are today.
      Because we have had all the rot, we now cannot expose some light & truth?
      Remove negative gearing ... stop rewarding debt ... let's see what happens?

      Commenter
      Yuppy
      Location
      Yuppy Ville
      Date and time
      March 31, 2014, 10:49AM
    • Houses are 4.5x wages for one reason and one reason only: banks are happy to lend you 4.5x your wages to buy the house. It follows that prices are likely to fall only when credit conditions tighten. Whether it's a bubble or not is beside the point, prices will only fall when some economic or regulatory catalyst compels banks to not lend as much. With the banks rolling in profits, I'm sure they are only too happy to take on riskier loans at the moment.

      Commenter
      Clueless
      Date and time
      March 31, 2014, 10:58AM
    • 7.) Unscrupulous banks are lending 90% of purchase price.

      Commenter
      Glove Puppet
      Location
      Left Field
      Date and time
      March 31, 2014, 10:58AM
    • hahaha Adrian nice counter ... :D
      Can you enlighten us to those measures please?
      It's not the mug punter measure is it?
      Or the ignorant petulant belief of ever increasing profits .... or is it the one where people actually believe all the lobby groups, RE agents & inaccurate RE data?
      But I think Adrian is onto something James ..... how many more punters can get suckered in & trapped before the RBA decides to push rates back up again.
      Sounds a little like the game of snakes & ladders .... how much speculation & false hope can you have ... then when you hit the ladder how far back down the board are you going to go?
      Only you can decide your fate ... or you could let excessive debt decide it for you.

      Commenter
      Yuppy
      Location
      Yuppy Ville
      Date and time
      March 31, 2014, 11:00AM
    • Todays article: the world is going to end.
      Tomorrows article: the market is unstoppable.

      BUT HOW WILL I GET RICH WITH MIXED INFORMATION?

      Commenter
      Nick
      Location
      Sydderney
      Date and time
      March 31, 2014, 11:00AM
    • @James

      9. Massive wages bubble.

      Commenter
      JohnBB
      Date and time
      March 31, 2014, 11:02AM

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