Australian property bubble

The Australian property bubble is an observation that real estate prices in Australia appear to be greatly inflated (when compared to most other developed economies, when compared to the long-term historical average, when compared to rental yields, and when compared to average income), and that this may constitute a real estate bubble. Broadly, Australian property prices rose quickly between 1997 and 2004, and were flat or fell very slightly between 2004 and 2008. Since 2009, prices have risen sharply, and this has continued into 2010. This behaviour, in contrast to many other countries during and after the current global financial crisis, has led to concerns about housing affordability, as well as concerns that Australian property may be experiencing an economic bubble.

Factors increasing demand and decreasing supply

In a free market, all prices are the result of an equilibrium between supply and demand. For prices to rise, it would indicate supply has fallen and/or that demand has risen. In the case of Australian property, both have occurred:

• Historically low interest rates from 2008 onwards, decreasing costs and increasing borrowing capacity, thus increasing demand.
• High immigration from 2007 onwards, increasing demand.
• Limited government release of new land, reducing supply.
• Government grants and incentives and taxes, almost all of which increase demand and/or favor existing home owners (such as the first home owner's grant, stamp duty exemptions on new construction, negative gearing on investment property, the lower rate of capital gains tax on investment property as compared to non-speculative income, and the special tax-free status given to capital gains on the primary place of residence).
• Limited stock - anecdotally, there appear to be lower levels of existing property sales in 2009/2010 as compared to previous years, reducing supply.

Indicators of an Asset Bubble

Demographia International Housing Affordability Survey

File:House price vs CPI vs Cost of construction.pdf

Australian Land Inflation as a function of House prices, CPI and Cost of construction. Source RBA

Based on the correlation of median house price divided by gross annual median household income, Australia (with 22 of the 62 severely unaffordable markets) has topped 2010 Demographia ‘International Housing Affordability Survey'. Severely unaffordable markets were considered to ones where price to income ratio was over 5.1. The other podium place-getters in the survey were the UK (silver) and USA (bronze).

Current home buyers face the fact that they are now likely to be twice as indebted as previous generations of home owners as "the average house price in the capital cities is now equivalent to over seven years of average earnings; up from three in the 1950s to the early 1980s."

Despite a number of inquiries and reports , little headway has been made by policy makers in addressing the myriad of causes underlying the current asset bubble.

The Demographia survey cited “urban consolidation” as one of the main causes for this situation. The “first part of this high-density strategy is to artificially strangle the land supply” evidenced by “Residential land release in Sydney . . reduced from an historic average of 10,000 lots per year to less than 2,000 (in 2007)..”

Citing HIA data, the same report stated that “Construction costs of a standardized house rose only 4 percent relative to inflation between 1973 and 2006 in the major capital cities. The price of the land for building has risen nearly 400 percent over the same period, inflation adjusted. This indicates that 98 percent of the increased cost was in the land, not construction.” (See Figure 1)

However, other factors besides land supply can be seen to impact on housing affordability, including irresponsible lending practices, tax policy, public perception of real estate as sure bet, reduction in interest rates, and immigration levels. It is a matrix of factors that has effectively inflated property prices and so logically any solution to unaffordable housing will need to address all factors simultaneously.

Safe as houses - a global comparison by The Economist

An interactive chart ‘Safe as Houses’ (The Economist online Dec 2009) gives a clear comparison of house-price data over time and how overvalued some markets have become.

IMF warns of housing bubble

In 2003, the IMF gave a prescience warning that “housing bubbles in Australia, England, Ireland and the United States” would “burst”. The IMF again warned in 2009 that Australian house prices were overinflated by between 5 and 15 percent. Since that warning, prices have climbed another "10 per cent" in 2009 according to reports.
As of February 2010, Australia has thus far proven to be the only exception to the 'bursting property bubble phenonema'. However, as in the case of the bursting of the Japanese asset price bubble (land and share market), deflation starts gradually, but once started, has a momentum all its own.

First Home Ownership Inquiry

In same year the government recognised that housing unaffordability was becoming an issue and initiated a Productivity Commission Inquiry Report titled ‘First Home Ownership’ with its findings released in 2004. The government’s response to the report was dismissive of some of the more critical recommendations. The commission’s finding that “general taxation arrangements [capital gains tax, negative gearing, capital works deductions and depreciation provisions] have lent impetus to the recent surge in investment in rental housing and consequent house price increases" elicited the response that “There is no conclusive evidence that the tax system has had a significant impact on house prices.”

Investment or Speculation

Real estate promoters, financial advisors and landlords believed that investment in property, based on the promise of capital growth, was a guaranteed road to riches. However, this phenomena was described in 2004 as speculation by the then Treasurer, who told Australians: "Work for a living and we’ll tax you at close to 50 cents in the dollar; speculate and we’ll only take 25 cents. Not only that but, as a special deal - while stocks last - we’ll pay half your speculating costs." The 'Investor Lending Ratio' chart shows that the bulk of investment has been channeled into existing property in the ratio of about 11 to 1 (existing to new build). The irony of the situation is that the exponential growth of debt has in reality created little, either in terms of new homes or employment for the building industry. The growth in property debt shows up in GDP but is not indicative of any real production or productivity, rather it simply points at increased consumption.

2008 Senate Select Committee on Housing Affordability in Australia

By 2008, with housing affordability worsening, another study was commissioned – the 2008 Senate Select Committee on Housing Affordability in Australia.

The report stated that "the average house price in the capital cities is now equivalent to over seven years of average earnings; up from three in the 1950s to the early 1980s." This trend of irrational exuberance towards property debt reversed in early 2009 as evidenced by a sharp price drop in the top end prices of the market. However, entry level prices for homes continued to rise due to an increase in the First Home Buyers Boost ($21,000 for new build and $14,000 for existing homes) and sharp drop in interest rate.

This increase in First Home Buyer's Grant (FHB Grant), sometimes referred to as the 'First Home Vendors Grant' , has “cost the Government about $200 million, but has inflated property prices by close to $3 billion.” However, questions exist over the wisdom of encouraging “marginal buyers to enter the market at this stage of the cycle (just ahead of a sharp rise in unemployment and with interest rates so low)” as Australia risks "creating a sub-prime underbelly in our own housing market.

Overvalued by 25% - IMF report

In April 2008 the International Monetary Fund (IMF) argued that Australia’s property market was the fourth most overvalued in the world, being close to 25% higher than could be explained by changes in underlying fundamentals. Other analysts argued that the rise in property prices was explained by peculiarities of the tax system. The 2004 report 'First Home Ownership' recommended, inter alia, a tax review. Australia's Future Tax System Review is currently addressing this and other issues.

Global credit squeeze

A slight decline in home prices in 2008, combined with a marked fall in property sales in the second half of 2008, supported claims of price deflation. However, in March 2009, the Hedonic Property Index showed Sydney and Melbourne were the key drivers of a rebound in property prices. At the same time, Australian Bureau of Statistics (ABS) showed a decrease of 6.7% in established house prices for the year." Analysis by some commentators attribute this data contradiction to the fact that commercial research includes the sales of units in its index whereas the ABS does not include this sales data.
One housing value index found that property boomed in 2009 with “robust gains in Sydney (+11.6% for year) and Melbourne (+17.0% for year).”
However, another report discredited this data finding “Average house prices have been overstated by up to 18 per cent”

Exponential growth of private debt

From 1994 to 2009 Australian private debt to GDP ratio grew from about 80% to 160%. The surge in debt was related to the easing of lending standards, favourable tax treatment (e.g., the absence of capital gains tax on principal residences, negative gearing and capital gains tax discount on investment properties 1999); the First Home Buyers Grant; increase in household incomes, and housing supply lagging demand, amongst others. Some of these factors added especially to the borrowing power of investors. To ignite the property bubble all that was required was funding. Financial institutions took up the challenge and debt growth soon averaged 15% per annum compounding (1998–2009). During the same period national economic growth was less than 3% with debt stripped out.

RBA outlines why extra debt failed to alleviate housing shortage

The Reserve Bank of Australia (RBA) outlined reasons for “contradictory evidence" that property investment is high "yet there seems to be a shortage of dwellings”[11] , namely, that:
1. real expenditure on new dwelling built is 60% higher than 15 years ago;
2. a high proportion of investment is for alterations and additions;
3. a higher proportion of new houses built are simply replacing existing houses that have been demolished;
4. a large proportion of investment has gone into holiday homes or second homes.
It was also noted that this capital allocation came at the expense of other areas of the economy which necessarily received a falling share of GDP.

Decade of land inflation outstrips CPI by 8:1

Between 1998 and 2008 inflation was about 36% yet property prices inflated by more than 300% in all capital cities except Melbourne (up 280%) and Sydney (up 180%).
This difference can be explained by understanding how the Consumer Price Index (CPI) is actually calculated, as certain expenditures are not sourced from the ABS Household Expenditure Survey:
"6.24 . . For the purposes of the CPI, the land component needs to be excluded from expenditure on housing."
The RBA, tasked with making policy decisions that aim to achieve low and stable inflation over the medium term, uses the CPI data provided by the ABS. This data ignores the inflation (or deflation) in the economy that is caused by land price movements. The lack of any negative feedback mechanism to address the effect of extreme fluctuations in land price tends to exacerbate the boom or bust cycle in property prices.

Diverting capital away from the rest of the economy

File:Lending - Commercial vs OO vs Investor - Housing debt taking all the oxygen.pdf

Excessive lending for housing comes at the cost of other sectors of the economy. Source RBA and ABS

Housing as an asset class has absorbed excessive resources but “confers minimal economic benefits” according to one recent article. The head of business banking at the NAB warned of excessive lending to the residential housing sector, at the expense of businesses stating that “a banking system which allocated capital away from the most productive areas of the economy — business — is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end, bad for Australia.”

Selling the message

Another factor in the surge in house prices and rush to invest in particular, were the active promotion within the real estate seminar industry and mainstream popularisation of home renovation as a form of wealth creation. It was almost as if a get rich quick scheme with no risk had been discovered. Numerous lifestyle programs extolled the virtue of property investing. The factoid that property doubles in value every 7 to 10 years became a self evident fact - up until the Global Financial Crisis put a brake on easy credit.

Relaxation of foreign investment rules

In December 2008, the federal government introduced legislation relaxing rules for foreign buyers of Australian property that was declared to exacerbate “Australia’s housing shortage and prolongs an asset bubble. According to FIRB (Foreign Investment Review Board) data released last month, foreign investment in Australian real estate shot up by more than 30% this year (2009) to $20.4 billion.” The rule change on foreign ownership could be seen to have the potential to increase the stock of housing in Australia. However, one agent canvassed said that “[overseas investors] buy them to land bank, not to rent them out. The houses just sit vacant because they are after capital growth.”

Intervention in support of prices post-GFC

By October 2009, it appeared that the pricing of homes was exacerbated by actions taken in October 2008 to address the GFC . Housing was identified as an asset class worth shoring up against the type of deleveraging seen in the stockmarket. To this end, the government increased assistance given to first home buyers as part of its "multibillion dollar sandbag against the rising global tide of fear and loathing" its $10.4 billion Economic Security Strategy. For a relatively new Australian government "facing the biggest global financial crisis since the Great Depression, falling house prices had become . . . public enemy number one, not high house prices."

Established house prices and other charts

The RBA provides a useful Chart Pack for ‘Established House Prices’ and ‘Household Debt and Interest’ which is illustrative of historical trends.

High and rising rates of Mortgage Stress

• Feb 2010: After only 3 quarter percent interest rate increases off 50 year lows, 45% of new first home buyers are in mortgage stress and/or defaulting on their loans.
• With rising interest rates, stricter lending standards and reduced government grants, surveys shows that buyers are giving up the chase indefinitely as property has become completely unaffordable.
• As interest rates rise, events mirror the sub prime collapse in America.

Vacancy Rates

In March 2010 the Sydney Property Market's vacancy rate fell to 0.53% from a high of 2% in August, 2009.

Timeline

1998 to 2008: real net national disposable incomes increased significantly (2.8% a year on average from about $32,000 to about $42,000 per year). Other factors throughout this period include: rise in the number of two-income households, relaxation of lending standards, active promotion of real estate as the best investment, population growth creating demand that was not matched by supply, planning and land release issues and a tax system that was skewed in favour of property investors.

1999: Capital Gains Tax was discounted from 100 to 50 percent (for property held at least one year), while 100 percent of costs remained deductible.

2000: The collapse of the Dot Com Bubble saw many investors switch to real estate. At the same time the RBA lowered interest rates (year 2000 to 2002). The First Home Owners Grant was also introduced and was set at $7,000 for established homes, $14,000 for newly built homes.

2003: The government, in seeking to address rapidly rising property prices, set up a Productivity Commission Inquiry.

2004: The Productivity Commission Inquiry on 'First Home Ownership' published its findings (No. 28, 31 March 2004). It identified several factors that had contributed to the rapid increase in real estate prices, including overall fairness of the tax system, lending regulations, lower interest rates and planning issues.

2008: With housing affordability at an all time low, a Senate Select Committee on Housing Affordability was established. Its final report included dozens of recommendations.

2009: October 1 - FHB Grant begins to be rolled back to its original level. A UNSW City Futures Research Centre director said "the boost has resulted in inflated prices" and had created "a bit of a mini-bubble". A senior economist of Housing Industry Association (HIA) said "the boost may have encouraged some buyers into the market but it has made housing affordability worse".

2009: Mid October - Unemployment surprisingly drops to 5.7%. In a move that shocks the world, including highly indebted first home buyers, the RBA increases interest rates by 0.25%, and flags further rises in the future. Australia's big four banks indicate they will have to increase interest rates above and beyond official rate rises set by the RBA due to higher international funding costs. Another rate rise of 0.25% was announced on Melbourne Cup day in November 2009, followed by another rate rise of 0.25% in December 2009.

2009: November - Bouyed by the falling interest rates and the FHB Boost "Australian capital city house prices . . climbed an average 10 per cent" in 2009. Melbourne lead "the nation's house price boom, with values up 14.9 per cent in the 10 months to the end of October to an average of $481,247."

2009: December - The reporting of real estate price data was brought into question by one source, stating that "AVERAGE house prices have been overstated by up to 18 per cent by the real estate industry, official statistics show. In September the average house price quoted by the Real Estate Institute of Victoria was $67,000 higher than the official figure, based on preliminary valuer-general data obtained by the Herald Sun."

2010: January - The removal of the first home buyers boost combined with previous interest rate rises to reduce mortgage applications by 21.2% . First-home buyers accounted for only 13.1 per cent of new loan applications in December, whereas nine months previously they were at 28.1 per cent.

2010: 07 January - the Economist used the term "bubble' to warn that Australian prices had effectively raced ahead of reasonable rental yields when it stated "In the American housing market . . homes are priced at around fair value on the basis of rental yields, but they are overvalued by almost . . 50% in Australia, Hong Kong and Spain."

See also

• Real estate bubble
• The world housing bubble
  • British property bubble
  • Indian property bubble
  • Irish property bubble
  • Japanese asset price bubble
  • Romanian property bubble
  • Spanish property bubble
• House price index

External links

• HIA Housing Report A quarterly review of the recent trends in house prices and housing affordability