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Deflating speculation on the property bubble

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David Potts

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In Debt We Trust

This is the documentary that predicted the financial crisis. It shows how the mall replaced the factory as America's dominant economic engine and how big banks and credit card companies buy the US Congress and drive consumers into what a former major bank economist calls modern serfdom. Americans and their government owe trillions in consumer debt and the national debt, a large amount of it to big banks and billions to Communist China.

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Home prices will halve over the next few years, says the only forecaster to have predicted both the record sharemarket run to 2007 as well as the subsequent GFC. And that was in 1993.

More recently, he also predicted the property collapse in the US, selling his Florida home at the peak in 2005 and renting ever since.

He's predicting a second big drop in the US and Australia's first, which, in four years, could turn McMansions into ghost houses.

Bearer of bad tidings . . . economic forecaster Harry Dent in Sydney.

Bearer of bad tidings . . . economic forecaster Harry Dent in Sydney. Photo: Domino Postiglione

Harry Dent, who runs the US-based forecaster HS Dent Foundation, isn't alone in predicting property prices will collapse.

US experts do seem gobsmacked by our prices, understandable when theirs were down 18.9 per cent at one point - and that's an average, so some houses did far worse - which is a bigger slump than during the Great Depression.

No wonder our banks have produced special housing price studies for their roadshows in the US. The gist is, what are you worried about?

Out of town ... rather than live in western Sydney, first-home buyer Samantha Saunders decided to commute from Green Point.

Out of town ... rather than live in western Sydney, first-home buyer Samantha Saunders decided to commute from Green Point. Photo: Simon Alekna

Plenty, it seems.

The world's most successful fund manager, Jeremy Grantham of GMO, said on a visit earlier this year that Australian property was a bubble about to burst, though later recanted slightly to suggest it might deflate slowly rather than pop.

But there are also local economists, still a minority, who say the same.

Associate professor Steve Keen had to walk from Canberra to Mount Kosciuszko after losing a bet with another economist, Rory Robertson, that prices would drop 40 per cent from their peak.

The chief economist at AMP Capital Investors, Shane Oliver, says prices are "way overvalued", though not in a bubble. They need to correct by about 25 per cent but there are alternatives to a crash, such as a slow meltdown - or should that be a fast cool down? - or no movement for years as inflation, like termites, wrecks the foundations.

While the IMF and The Economist also say Australian housing is overvalued, Dent is unique in basing his forecast on what he sees as a global phenomenon of deflation.

That also gives consolation of a sort to home owners - eventually the banks will have to write down the size and value of their mortgages, so your repayments will be slashed.

Far-fetched perhaps, but more persuasive is how he takes the very arguments used against a price collapse as evidence for it's inevitability.

So how good is he? No forecaster is perfect and one of his two clangers was saying in 1999 that the Dow would reach 32,000 by now.

It's only just pulled itself above 11,000 again. While he was hopelessly out on the destination, he got the direction right, including the detour of the tech-wreck correction, when his contemporaries were extremely bearish.

The other miscall, a prominent feature of his book The Great Depression Ahead: How to Prosper in the Debt Crisis of 2010-2012, was that Wall Street would "fall to between 2300 and 4500 by late 2010". Mind you, he has the perfect excuse and uses it. He didn't know the US Federal Reserve would hit the money printing press, which is only delaying, he says, the inevitable.

And so a new book to be published next month, The Great Crash Ahead, pushes this out to 2012-14. The depression, by the way, is still there but won't be as bad as the 1930s.

So where is he coming from?

Dent says the economy - and, let's face it, our well-being - is driven by 40-year demographic trends, or the "spending wave", and the 80-year technological or "new economy" cycle. The cycle du jour is the rise of the baby boomers, reinforced by a huge credit expansion in the '90s, which pushed up property prices for decades.

They bought homes and raised kids but, having reached retirement and become empty-nesters, are selling and looking for something smaller.

The baby boomer demographic was worldwide, except it started earlier in Japan and we all know what happened there: property prices have been shrinking on and off since 1990.

For Dent, this is a preview of what's in store for the US and Australia.

"Prices will drop 50 per cent maybe. Not as much as the US but it'll be closer than you think, because you had a bigger bubble," he says, comparing the Australian boom to California's.

"At the top of the boom, Sydney and Melbourne were very similar to Los Angeles and San Francisco but they've dropped substantially. Now Sydney is the most expensive in the world outside China when you compare home prices to income. This is a global real estate credit bubble as the baby boomer generation put pressure on real estate around the world, especially in places where [land] was scarce. Interest rates were the lowest in a lifetime."

Now, as he puts it, "bubbles are popping in different places and not at the same time".

Dent's bubble view is not shared by mainstream economists or housing industry-based analysts who argue that, unlike the US, Australia has a chronic undersupply of housing.

The estimates (read "guesses") of a shortage range up to 200,000 dwellings. The trouble is nobody really knows and, in any case, those calculations are based on a higher rate of immigration than we're experiencing.

There's no denying that rising rents and tight vacancies prove there's an undersupply, though not necessarily a chronic one.

Besides, the average household is getting bigger, after a century of decline, reducing the need for more supply.

"If Australian homeowners continue to make greater use of their large dwellings, then it is clear that estimates of housing undersupply will need to be substantially revised," Craig James, chief economist at CommSec, says.

Any arguments justifying high property prices only become fodder for Dent. The more reasons there are, the more proof we're in a bubble.

"These created the bubble in the first place,'' he says. ''But young people can no longer afford to buy a house. And your demographics are a bit stronger here because of immigration and that's why your boom has held up better. But you still have baby boomers passing their peak spending and immigration is starting to slow. I think immigration will drop and baby boomers are ageing. You won't get hit as hard but your real estate is way more overvalued than in the US."

Also we "have higher interest rates and higher housing costs so people here are paying a much higher percentage of their income on mortgages".

While Dent's argument assumes this is a bubble and so, at some point, it must burst, that seems unlikely while unemployment remains low.

Besides, the banks say most homeowners are ahead in their mortgage repayments, so it's not as if there's any pressure to sell.

Frankly, there are vested interest on both sides. Dent can sell more books, while banks and developers can't afford property prices to collapse. There's always denial when bubbles build because they usually begin for good reasons. The trouble is they are carried on their own momentum, inflated by ever-increasing borrowing and speculation.

Dent needs a bubble first. Property might be "way overvalued" but AMP Capital's Oliver says there's "little sign of the excesses that characterise a bubble: housing credit has been soft, investors have been sidelined, buyers have been restrained and lending standards have not deteriorated".

Still, one thing everybody agrees on is that property in Australia is expensive - something has to give.

It has to fall but how far is the question.

And how fast.

In the future, small will be beautiful

RATHER than live in a McMansion in outer Sydney, first-home buyer Samantha Saunders and husband Harry have gone a step further, putting a deposit on a house in Green Point, an hour's drive north of Sydney.

"Sydney prices were a bit out of our reach," Samantha says, and the places they could afford were too far out with no amenities.

In any case, they didn't fancy a five-bedroom giant that took up the whole block, commonly known as a McMansion.

Samantha is eligible for a first-home buyer grant and their broker, Mark Bambagiotti of Mortgage Choice, signed them up with Bankwest on an interest rate of 6.95 per cent.

Although the couple don't plan to have children, Samantha says "I like to have a backyard. They take up most of the block. Where can you hang your washing out?"

It might be roomy but a McMansion can also be claustrophobic.

"They reach out to the boundary and your lounge can be right next to somebody else's," Samantha says.

Although the Saunders have made a lifestyle decision, it could prove a good move financially as well.

Higher petrol prices, along with rising electricity and water bills, not to mention the cost of owning a large house, and the near necessity of maintaining two cars are dangerous for your wealth.

Worse, powerful demographic trends will tell against McMansions.

Baby boomers are downsizing and young people can't afford big houses. They probably aren't keen on living out in the sticks anyway.

"The only people who buy McMansions are in their late 30s and early 40s,'' says leading financial forecaster Harry Dent, who predicts property prices will drop by up to 50 per cent in the next two to four years. ''The next young generation won't be in that stage for 20 years. Ageing baby boomers are going to want smaller houses and young new families will want smaller houses. Nobody wants big houses, so they're going to tank the most."

This demographic tsunami is likely to turn McMansions into ghost houses in a few years, or at least slash their value.

"We tell older people to downsize now and to younger couples: 'Don't buy. I know you're 30 years old and you've got two kids and you want to buy a house but wait two or three years and let this deleveraging work out. You'll pay half the price and have a lower interest rate in three years,'" Dent says.

New homes being built are already shrinking - before they're built, that is - to reduce their cost. In a recent presentation, Stockland told analysts the size of its three-bedroom house had shrunk 25 per cent since 2007.

Four years ago, Stockland sold one McMansion for every two three-bedroom houses. That's dropped to one McMansion for every 17 three-bedders sold.

Yet Australia still builds the biggest houses in the world, according to a CommSec-commissioned study by the Australian Bureau of Statistics.

"It also helps explain why homes in Australia cost more,'' says the chief economist at CommSec, Craig James. ''Not only are they bigger but, arguably, the standard is also higher than in other parts of the globe."

42 comments

  • Yawn....

    SO the bubble will bust and we'll all be rooned...

    Depends on your schtick mate but if the house price falls it is still a house and you can still live in it...

    This is Australia, house prices never fall and we're different...

    is there any other hackneyed view I have missed...

    stop negatively gearing and everything will be all right, prices will be set by people needing houses not speculators...

    zzzzz

    Commenter
    Hmmm
    Location
    Sydney
    Date and time
    September 19, 2011, 10:25AM
    • Despite the growing number of award winning individuals who are predicting a bloodbath in the Australian property market, we still seem to think that we're different, that they're wrong and our market will forever rise. We are the laughing stock of the world, with prices so high and delusion running so deep. They say if it walks like a duck, and it quacks like a duck, its a duck. We say, no, its not a duck, its a rhinoceros. Like I said. Laughing stock. Sell now if you're in trouble or reasonably expect to experience financial strain in the future, and if you don't own, for heavens sake wait, prices are falling by the week. The bloodbath has only just begun.

      Commenter
      FONZ OBE
      Date and time
      September 19, 2011, 10:29AM
      • It seems it will take a long time until the US centricity of 'global analysis' will collapse, like a thought bubble.

        Hope Harry Dent has a pleasant holiday in Australia - the weather forecast for the next few days is not too bad.

        Commenter
        Life-long-learner of Sydney
        Date and time
        September 19, 2011, 10:41AM
        • Here we go again.. McMansions in the firing line, I am still not sure what is the definition, however due to the derogatory nature of the term , it relates to any home with a block over 500 square metres with more than 3 bedrooms. The price correction predicted would not apply of course to those little semis in the inner ring that command ridiculous prices.. these are the ones that are most exposed to a severe correction due to the 'must have' lemming attitude that has driven those properties to absurd levels.

          Commenter
          you said it!
          Date and time
          September 19, 2011, 10:42AM
          • Craig James is at it again. It's laughable.

            One reason for the price of Aussie house is that the build quality is so high?!

            Mmmm. Where do I start with that?

            How about this. No it's not.

            The quality of a typical Aussie house or block of units is, in a word (or two) pretty dire. I've lived in the UK and Germany and I can tell you that Mr James and the rest who make this claim have absolutely nothing, zero, ziltch to base their claim on whatsoever.

            I have this, it's only anecdotal, but it's more than they have. Whenever family, friends, work colleagues etc etc have visited over the years, they have pointed to major building issues in the places that we've lived in - poor quality fittings, finishes, workmanship, leaks, etc etc.

            If Craig James is going to say that the general quality of Aussie housing is better than other places let him offer some evidence of it.

            Commenter
            PP
            Location
            Bondi
            Date and time
            September 19, 2011, 10:52AM
            • Hmmmm...

              I totally agree Australia has a serious housing bubble, created by a combination of tax incentives (negative gearing, stamp duty, CGT discounts), government interference and psychology, but recognising that is not at all the same as picking the burst.

              As Friedmann (I think?) once said, the market can stay irrational longer than you can say solvent.

              A bubble only visibly bursts with collapsing prices when owners sell. Now that might happen with vacant dwellings (around 10% of total last time they were counted), but this is only a subset of the market.

              More generally, even if people have wildly overpaid (and overborrowed) for their homes, they don't really have much alternative to simply sitting there and paying the mortgage - you have to live somewhere.

              Even if they can't repay the debt, once there are enough such people, it's actually not in the interests of the lender to kick them out and sell. Given the collapse in retail, this is where I suspect we might be heading. Down that path, it's entirely possible that we wind up with apparently stagnant prices (ie not collapsing), but a whole lot of un / under-employed borrowers in properties that the banks won't foreclose on, for fear of triggering a collapse.

              What then? I really don't know.

              Commenter
              DaveC
              Location
              Sydney
              Date and time
              September 19, 2011, 11:04AM
              • If house prices stay flat for another five years (after the 10-20% drop of a year or two ago), that will amount to a 50% price cut. Meanwhile if nothing is selling there will be no new stock built. As soon as the economy recovers one would expect an almighty boom in prices and frantic development. So here we go again ...

                Commenter
                bg
                Date and time
                September 19, 2011, 11:06AM
                • It may be a bubble or not, prices have already come down by at least 15-20% (considering COL). so another 20% drop, which is likely before end of 2012, Steve Keen will win.

                  Commenter
                  Home
                  Location
                  Melbourne
                  Date and time
                  September 19, 2011, 11:14AM
                  • I agree with PP from Bondi,

                    "It also helps explain why homes in Australia cost more,'' says the chief economist at CommSec, Craig James. ''Not only are they bigger but, arguably, the standard is also higher than in other parts of the globe."

                    A wholly unsubstantiated and unbelievable claim.

                    British born and bred, I can assure you building standards in Australia are a joke. Foundations consist of a slab of concrete (9 inches in depth), in the UK 1-2 metre footings are standard foundation rules. First floor buildings are structurally built on breeze blocks and not wooden supports. Windows and doors actually fit the house, are designed for heat retention and by default these days are double glazed. When interviewing people, please begin to challenge them on the crap they utter.

                    Commenter
                    Joe
                    Location
                    Geelong
                    Date and time
                    September 19, 2011, 11:15AM
                    • "Not only are they bigger but, arguably, the standard is also higher than in other parts of the globe."

                      Where does this misconception come from? Compared to Albania maybe Aussie houses are great quality but compared to the rest of the developed world Aussie houses are of poorer quality no doubt.

                      Commenter
                      MD
                      Location
                      Sydney
                      Date and time
                      September 19, 2011, 11:24AM

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