Australian property bubble

The Australian property bubble is an observation that real estate prices in Australia appear to be inflated (when compared to some 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 have been rising in real terms for over 60 years, rose quickly between 1997 and 2003, since when they have stayed constant in income terms to the present, 2010.

A CHART FOR SPECULATORS: House Price Index - Prices go up until they don't (source ABS, RBA, whocrashedtheeconomy)

Making a meal of borrowers Asset value as a function of total debt to disposable income has roughly halved in last 20 years. Source RBA

House Price Index and CPI. Source ABS

General Overview

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.

In recent years there have been two Inquiries aimed specifically at addressing housing affordability and the demand/supply imbalance.

Recent commissioned studies

2004 Productivity Commission Inquiry Report - First Home Ownership

2008 A good house is hard to find: Housing affordability in Australia

Also, in 2010, a comprehensive review of the Australian Tax System was undertaken, with a number of recommendations regarding the tax treatment of housing and investment in housing:

Australia's 2010 Future Tax System Review (Henry Taxreview)

An additional resource is the Executive Summary of the RBA's submission to the First Home Ownership Inquiry . It spells out in black and white the reasons why real estate prices have become extraordinarily out of kilter in relation to long term average valuations (cost versus incomes).

The degree to which prices have trended away from any sensible valuation and can now be deemed a poor investment on the basis of rental yield was demonstrated recently by (on-line) ‘The Economist’.

Latest valuation – 61.1% overvalued – The Economist

Chart 1: Australia, the least likely destination for investment - House price value comparison based on rent yield - source data The Economist

July 2010, The Economist’s most recently created ’House-price indicators’ table offers a sobering reminder how over-priced real estate is in Australia. In a list of 20 countries (Asia, US and European markets), Australia was noted as being 61.1% overvalued on long run average of price-to-rents ratios. It was also noted that:

More concerning, however, is our analysis of “fair value” in housing, which is based on comparing the current ratio of house prices to rents with its long-term average.

By this measure Australian property is the most overvalued of any of the 20 countries we track.

As can be seen in Chart 1 'House price value comparison based on rent yield', Japan, Germany, Switzerland and the US are the countries surveyed that offer value for money in terms of rental yield.

Main observation – property bubble is no accident

As noted above, there is array of factors that have played into the rapid rise in property prices in the last 10 years. A study of these intertwining factors reveals that none are accidental in nature. Each factor is the outcome of some deliberate policy decision, made by either lending institutions, various government entities (Federal, State and Local) or special interest groups such as landbankers. Add to this mix the lack of any real scrutiny by media representatives and the picture is almost complete.

In other words, the over-inflated real estate price phenomenon aka 'property bubble' is by design one hundred percent deliberate.

The question as to why this has been allowed to occur has yet to be definitely answered.

Twice the debt, half the fun

Today, home buyers face twice the debt of previous generations in securing a home. This was noted in the 'Housing Affordability in Australia - Good house is hard to find' Report:

"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."

The findings of this Senate Select Committee report were released in 2008. However, the submission and analysis phase of the report occurred during the lead-up to the 2007 General Election. The public were by this stage keenly aware that housing affordability was a problem to be solved - by whichever party won the election.

The following cartoon displays the prevailing sentiment of the day:

• I feel a housing crisis coming on . .

House prices surveys

Australia, a 'severely unaffordable market' - Demographia study

Chart 2: Melbourne House & Wages 1965-2010

Based on correlation of median house price divided by gross annual median household income, Australia topped the 2010 Demographia 'International Housing Affordability Survey' in terms of being a severely unaffordable market - a market where price to income ratio was over 5.1. Runners-up in this 'competition' were the UK and USA. The Demographia study compared prices in Australia, Canada, Ireland, New Zealand, the United Kingdom and the United States only.

An example showing the rise of cost relative to incomes for the Melbourne market can be seen at right: Chart 2: Melbourne House & Wages 1965 - 2010.

It should be noted that other surveys are available (Other surveys and studies) but that some have been designed to compare prices for luxury markets catering to high income earners. As such, these surveys are not representative of any deeper market trend within any one country. Also, readers should be aware of surveys conducted during a period when “currency fluctuations” created “a strong impact on the comparative cost of expatriate housing” (for US workers). For example, surveys from the year 2008 would have seen the Australian dollar join company with the Polish zloty, and Mexican peso as a currency that “lost more than 30 percent in value against the dollar (US)”

Other surveys and studies

However, the Demographia survey only compares Australia with five other countries and uses a very blunt measure of affordability (i.e. house price to gross income) and does not consider various other important factors such as disposable/discretionary income, credit availability, tax incentives, comparative dwelling size/quality, etc.

Many other cities have much higher house prices than those in Sydney (Australia's most expensive city), however relative to incomes and in real terms Australia remains the most expensive. Several alternative studies are included below. Most of these studies and figures have been commissioned and generated by vested interests and are therefore should be disregarded as unreliable and biased. They also completely disregard other relevant facts such as geographic location, population size, wealth of the population and percentage of borrowing to house price.

Numbeo: House Price to Household Disposable Income Ratio London 15x, Singapore 14x, Tokyo 12x, New York 8x, Dublin 8x, Sydney 7x

GlobalProperty Most Expensive Cities 2009 (apartment price per sqm) Sydney - Number 28

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 Average home values for select family dwellings - Tokyo $786K, Sydney $683K

World's Top 10 Priciest Cities To Own A Home Sydney - not in the top 10

Aneki (most expensive countries to live in) Australia - Not in top 20

Most expensive rental markets

Thoughts on urban consolidation

Chart 3: Surge in house prices and underlying debt

The Demographia survey cited "urban consolidation" as one of the main causes for this situation and that:
"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."

This is clearly shown in Chart 3 'Surge in house prices and underlying debt' with a noticeable spike after tax policy changes to Capital Gains Tax provisions (1999). At the time the Australian Council of Social Services (ACOSS) had “considered that the changes would fuel speculative property investment” and some saw the changes as “A green light for tax avoidance”.

Whatever the interpretation of the rationale for the changes, the effect has been profound in terms of the surge in both real estate prices and underlying debt.

Even the RBA Governor has questioned the incongruous fate befallen Australia (in terms of housing affordability):
"How is it that in a country this big in area and this small in numbers of people we can't manage to make the marginal price of a dwelling lower than it is? It seems to me quite high."

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, immigration levels and the 2008 foreign investment rule changes for temporary visa holders.

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.

A number of well resourced Inquiries have been conducted into housing related issues in recent years.

Inquiries

2004 First Home Ownership Inquiry

By 2002 the government recognised that housing unaffordability was becoming an issue and initiated a Productivity Commission Inquiry Report titled 'First Home Ownership'. The government's response to the report was generally quite dismissive of the 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."

However, popular commentary of the day (2002–03) highlighted the view that the tax system and RBA actions were central to any argument concerning the bubble, as shown in these cartoons:

• Do ya reckon this housing bubble is our fault?
• RBA Reserve Bank housing boom bubble gum
• Housing Bubble
• Treasury uses B word

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.

2010 Taxreview - AFTS Review admits to tax system bias but cautions on reform

'Australia's Future Tax System' (AFTS) review, more commonly known as the 'Henry Tax Review', made a number of recommendations that would have impacted on the housing market, including:

• Introduction of land tax "on all land . . removing disincentives for institutional investment in rental property";
• that "transfer taxes on property should be reduced, and ultimately removed";
• a move to "more neutral personal income tax treatment of private residential rental investment . . through a 40 per cent discount on all net residential rental income and losses, and capital gains."

However, the AFTS review, while admitting that there are "significant biases that the tax system introduces into the housing market" found that a "range of other policies are likely to have a more significant impact on housing supply than tax settings." These other policies involve changes to stamp duty, land tax and "interest rates and land release policies".

In summary though, the AFTS review issued caution on reforms. "Reforms that could promote the more responsive supply of housing will present serious choices for both the Australian people and their governments. Most starkly, 'improving' housing affordability for purchasers involves policies that cause house prices to be lower or grow more slowly than the community would otherwise expect. While this will benefit those who gain access to housing, it will affect the wealth of the majority of home owning Australians."

In the months leading up to the release of the Henry Taxreview, and with the status quo at stake, one cartoon captured the fear of anticipation:

• Henry tax review unexploded bomb

The Taxreview was expected to include a radical overhaul of the tax treatment of the family home and to shake-up other areas of taxation such as land tax, negative gearing and fringe benefits tax.
As can be seen in the cartoon linked below, the government's response to the 138 recommendations of the Taxreview accepted few changes. Recommendations aimed at improving the regressive impost of aspects of the tax system are 'framed' out of the picture. However, ‘negative gearing’ and ‘fringe benefits’ can be seen ‘hiding’ below the 'frame':

• The Big Picture

2010 Government response to the AFTS recommendations

In regard to recommendations of changes to tax policy that might impact the housing market, the government response was pointed. The Government advised "that it will not implement the following policies at any stage" (excerpt of list):

• Include the family home in means tests (see Rec 88c)
• Introduce land tax on the family home – this is a state tax and thus an issue for the states (see Rec 52 & 53)
• Reduce the CGT discount, apply a discount to negative gearing deductions, or change grandfathering arrangements for CGT (see Rec 14 & 17c)

For the housing market and how the tax system relates to it, the government response was a decree that the status quo should be upheld.

Systemic tax advantage offered to investors was one of the main findings of both the 2004 Productivity Commission 'First Home Ownership' report and the 2008 Senate Select 'A good house is hard to find' report (see recommendation 4.2). Two years after the 2008 Senate Select report was released, this facet of the tax system, its "overall fairness", is a question mark.

If distortions in the tax system figured so prominently in earlier inquiries into the housing market, 'How has this issue resolved itself without changes to tax policy' is a question yet to be answered.

Taxreview's 'too hard basket' and upside down welfare

Heralded as a comprehensive overhaul of Australia's taxation system, the 2010 Henry Review (AFTS) "fell on deaf ears with only two and a half measures out of 138 recommendations being accepted by the government." The recommendations of the Taxreview sought to "broaden the tax base to areas deemed untouchable until now (ie means-testing the family home) but cut inequitable and inefficient housing tax breaks like negative gearing and a generous capital gains tax regime."

The finding, that the CGT regime was overly generous, had a kind of Groundhog day ring to it, as shown by this cartoon from 2002:

• Housing boom could be targeted by capital gains tax

Although the Henry Report "identified some of the worst forms of welfare for the wealthy within our tax system" the "under-cover, upside-down welfare system" has been virtually left unchanged. "Australia's uniquely generous treatment of negative gearing is also a major contributor to our unenviable leadership of the world in unaffordable housing and household debt. . . limitless exemptions from capital gains tax, land tax and the pension assets test which are enjoyed by owner-occupied housing provide a huge tax shelter for wealthy people and their heirs."

Implementation of the Taxreview recommendations on negative gearing and CGT:
"would also have cut back the ability of high-income earners to avoid paying income tax by investing in loss-making property, while upping the bill on their capital gains a little." One Housing commentator said "it makes sense to dilute the attractiveness of negative gearing" as it "inevitably puts house prices up because what happens is you get investors competing with first homebuyers . . Essentially what happens today is that taxpayers subsidise investors. We subsidise them when interest rates go up by the tune of their marginal tax rate, which might be as much as 48 cents in the dollar . . It's a regime that encourages investors to make losses which is inevitably picked up by the taxpayer. Then taxpayers subsidise the capital gains."

Investment or Speculation

Invasion of the speculators, egged on by the tax system

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 end result is that the bulk of investment (93%) has been channeled into existing property rather than new construction (see Chart 4 below).

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. The effect on the economy of consumption caused by an overly leveraged residential property sector (approx 140% from total of 155% debt to income) shows up in a List of countries by Current Account Balance (CAB). Australia can be found 'struggling' with its chronic CAB near the bottom of the list along with other highly indebted 'consumer' nations.

One commentator highlighted the overkill in expenditure associated with residential property (particularly second-hand homes) versus productive enterprise:

With the exception of providing shelter, housing provides minimal benefits to the economy (after the initial construction), unlike business and capital investment, which further technological improvement and create lasting employment. Lending money to fund an over-priced property sector is even worse, wasting precious capital on an asset that is far removed from its intrinsic value. That capital could, and should, be used on in its most efficient manner — over-paying for housing is certainly not efficient.

Self-managed super funds trump the bidding

Within this realm of generous tax deductions, it is those individuals and entities operating from with a superannuation environment that trump all other comers.
This is highlighted in an article titled ‘A big black hole in investment’ (excerpts):

“Bubbles are endemic in the housing market. In any auction to buy a property, a well-funded self-managed super fund trustee, with generous tax advantages provided by the Government, will almost always trump a young couple bidding for their first home. This goes some way to explaining the continuing irrational rise in property prices and the housing affordability crisis in Australia. But this is a fool's paradise! Not all of these properties can be realised at a profit in the future, unless we find a way to export McMansions to China (or dramatically raise the population?).”

Using tax advantage to buy second-hand homes rather than build new

Chart 4: Investors are now 15 times more likely to use tax deductions to bid up the price of existing homes rather than build new.

As pointed out by the RBA in its Executive Summary to the First Home Ownership Inquiry (point 22)

"taxation treatment in Australia is more favourable to investors than is the case in other countries."

Despite such 'favourable-to-investors' tax treatment, very little 'investment' has flowed into new construction. Amongst other possibilities, this reflects either the low skill level of amateur investors (averse to taking on the task of construction) or, in the case of seasoned and professional developers, that the tax advantage associated with purchase of existing dwellings offers the path of least resistance to maximum profit. Consequently, construction barely gets a look in.

The result of this over-generous treatment of investors is shown in Chart 4, where a surge in debt for second-hand property is seen from about 2000 onwards. This was coincident with the changes to Capital Gains Tax, wherein a 50% discount was approved. Conversely, loans for construction have basically flat-lined now for over 20 years. There is currently only about 7% of investment loan dollars allocated to new construction (Feb 2010). As a comparison, the ratio of lending (existing to new) to investors in Jan 2000 was 5:1, today it is about 15:1.

In an environment where immigration has recently been dramatically increased to double the world average (2.1%), the consequences on property prices and rents of under-building are obvious. This is why the oft-quoted refrain from within the real estate industry, that Australian prices will remain high and even increase, has some factual and credible basis.

'Would be helpful' if demand resulted in 'extra homes for occupation'

Demand, created by a combination of under-building and rapidly increasing population can have no other effect than to exert upwards pressure on nominal prices (in the absence of credit controls). This point was brought into focus by Head of Financial Stability at RBA, Luci Ellis who said "in the current episode . . more of the extra demand is . . because of the extra population growth" and that "banks must maintain lending standards to prevent a surge in house prices . . from turning into a bubble".

On the issue of allocation or destination of debt, few would disagree with the RBA spokesperson who also said that "it would be helpful if more of that demand could be accommodated with extra homes for occupation, instead of by higher prices".

However, many amateur investors consider their purchase of second-hand dwellings as a valid contribution to provision of housing stock, and compared to landbanking entities, it is.

March of the Speculators

In what must be a world first and indicative of a trend of property ownership possibly becoming the almost exclusive domain of investors, it was noted that in Victoria (Aug 2010): “For the first time, lending to property investors in Victoria outstripped borrowing by people wanting to purchase existing homes”. Economist Saul Eslake said: “Investors were generally in a stronger financial position than first-home buyers and able to take advantage of tax breaks such as negative gearing” and that he did not “think we are going to see great price falls in Melbourne.” Another analyst, Property Planning Australia director Mark Armstrong, said “the growth in lending to investors did not equate to speculation in the property market”.

However, rental yields as shown in Chart 1 'House price value comparison based on rent yield' are anthemia to making a profit based on the investment principle of income generated. According to the Economist (July 2010) Australia homes are 61 per cent overpriced on the basis of rental yield. This is hardly a buy signal for anyone looking for income stream. It appears that the attraction to real estate is still premised on the belief in a guarantee of capital gains and that a speculative mindset is still in the ascendancy.

Debt accelerants – Interest-only Loans

Easy credit and a tax system designed to reward optimistic borrowing (e.g. negative gearing and CGT discount) have encouraged investors into ever larger mortgages.
The vehicle of choice for transport into the highest leveraging of debt is Interest-only loans.

Traditionally these loans were available for a limited period (say 5–10years). Designed to cover only the interest payable on a loan, these products allow larger debts to be engaged. At the end of the period of the loan, the borrower still owes the full amount borrowed. The plan is simple in that the borrower hopes that a substantial capital gain results at the final sales point (over and above outgoings and interest repayments).

In most cases, there is no intention on the part of the borrower to own a particular property, so this product can be thought of as purely a speculative tool to capture upswing periods in property booms. As one major lender points out: “This loan is ideal for people who are borrowing for investment purposes.”

First Home Buyers – the last wave of ‘investors’?

In May 2010, a new interest-only loan product was mooted as a solution for those seeking entry to the RE market.
The product is reported to cut repayments on a $300,000 mortgage by $5000 a year.

“Homebuyers are to be offered never-ending mortgages in a bid to overcome Australia's affordability crisis” said one lender, the lender advising that it “is preparing to sell loans that have no fixed term and no requirement to repay any capital along the way. . . . Repayments would be kept to a minimum, allowing borrowers to benefit from capital growth in their property.”

This plan, aimed at getting new entrants into the housing market (read FHB), makes a number of loose assumptions:

• that capital growth is guaranteed and the buyer will book a decent capital gain;
• that easier access to credit will not feed into higher prices;
• that interest rates are stable;
• that homebuyers, at some future point in time, will be able to purchase a property with what remains of their ‘capital gains’ after the lender takes their entitlement.

This latest incarnation of interest-only loans, a loan that is ‘ideal’ for ‘investment purposes’, is one now suddenly recommended to a wider client base of ‘homebuyers’ (read FHB).
Many FHBs, lacking historical knowledge of RE market ups and downs, are treated as little more than grist for the mill in a push to build of a larger pyramid or empire of debt for lenders.
Using FHBs as 'investors', foot-soldiers for expanding mortgage markets, is one last logical step in a process that is best described as the 'March of Speculation'.

Goldman Sachs on the attraction of leveraged returns and tax minimisation

In August 2010, Investment Bank Goldman Sachs (GS) highlighted the overly generous tax treatment of investors, declaring in a report that:

“house prices are 25 to 35 per cent overvalued, based on a measure of affordability that takes house prices, income, lending criteria and mortgage rates into account” and that “residential property investors have been attracted to the housing market by high historical leveraged returns and tax minimisation, and that action in these areas could stem the rise in prices. . . With the exception of the Netherlands, Australia has the most tax advantageous arrangements for investing in housing in the developed world"

The reference to “tax minimisation” and “tax advantageous arrangements for investing in housing” mentioned in the GS report resonates with findings of various government-initiated reports ('First Home Ownership' Report, 'A good house is hard to find' Report, and the 2010 Henry Taxreview mentioned above).

Playing with the ego: Fanning desire and mocking 'delusion'

Another factor in the surge in house prices and rush to invest in particular, is 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, fanning the winds of desire. The factoid that property doubled in value every 7 to 10 years was often trotted out as some kind of self-evident fact. However, this virtual reality has been brought into question by the Global Financial Crisis and the resultant brake applied to easy credit.

One show however has recently highlighted the danger of holding the lazy assumption that property only ever increases in price. 'Selling Houses Australia' mocks vendors who have "failed to offload" their properties and in a "series of humiliations" robs investors of their "delusion". Battered "with independent valuations which come in much lower than expected" investors are offered "dire warnings about the peril of property" and are "paraded through much nicer homes which are on the market for the same price."

Debt, CPI and interest rates

Exponential growth of private debt compared to CPI

Chart 5: Australian Household Debt to Disposable Income – total versus housing. Source RBA

Chart 6: Cash Rates and Total Lending to Owner occupiers and Investors. Source ABS, RBA 2010

From 1994 to 2009 Australian private debt to GDP ratio grew from about 80% to 160%. The surge in debt was related to, amongst others things, the easing of lending standards, favourable tax treatment of housing (e.g., the absence of capital gains tax on principal residences, negative gearing availability for second-hand homes and Capital Gains Tax discount (50%) on investment properties after 1999), the First Home Buyers Grant, and increase in household incomes.

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.

As can be seen in the Chart 5, total household debt as a percentage of disposable income was about 45% in 1990 and 155% in 2009. In the same period, housing debt to disposable income increased from about 35% to 140%. During the same period of time the CPI increased by 62.7%, far less than the 344 - 400% increases in debt to disposable income noted above in the total and housing debt respectivley.

Decade of land price 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."

However, as anyone who is paying off a mortgage is well aware, a large portion of a any property debt is attributable to the 'land component' of the loaned amount.

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.

Interest rates rises fail to dent price surge

As can be seen in the Chart 6 'Cash Rates and Total Lending', the incremental rate rises (Apr 2002 to Apr 2008) failed to halt escalating debt which, in the main, was channeled into bidding up the price of existing property. This is shown in Chart 4 'Investor Lending – New construction vs Existing property', where it is evident that about $93 out of every $100 in loans finds its way into mortgages for second-hand real estate (as at Feb 2010).

Interest rate cuts and 'Economic Stimulus Strategy' used to prevent price falls

What eventually jolted the market into some kind of reality, be it briefly, was an external shock. This took the form of the global credit squeeze accompanying the GFC. However, the subsequent Australian government intervention, the $10.4B 'Economic Stimulus Strategy' (Oct 2008), somewhat alleviated the situation facing lenders (credit squeeze averted).

The key stimulus within the 'Economic Stimulus Strategy', in terms of protecting property prices, was the increase of the First Home Buyers' Grant. Slashing of Central bank interest rates also played a part in maintaining prices.

Warnings

IMF on housing bubble

In 2003, the IMF, with some foresight, warned that "housing bubbles in Australia, England, Ireland and the United States" would "burst".

Again in April 2008 the 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.

As evidenced by the Japanese asset price bubble, the bursting of credit bubbles can have long term effects on an economy. The most recent nation to experience the bursting of its housing bubble is Ireland, where following a “decade-long property boom which imploded spectacularly in 2007 . . Irish property prices have halved”. and will cost the Irish Central Bank about €34bn to rescue.

2010 'The Economist' estimates house prices overvalued by 56%

April 2010, The Economist house price indicators estimated Australian house prices were the most overpriced in the world, at 56.1% overpriced (against long-run average of price to rents ratio).

According to a RP Data-Rismark, the nationwide median home price rose to $455,000 in Feb 2010 (this is about x 6.8 median household income assuming a median household income of $66,820).

2010 Midst of an unsustainable bubble - 50pc overvalued?

According to Edward Chancellor, a US-based investment strategist and financial author:
"Australia is in the midst of an unsustainable housing bubble that could burst at any time" and that "house prices are more than 50 per cent above their fair value -- a once in 40-year event."

Describing Australia's banking system as a "cartel" he said "luck rather than skill had allowed the Australian economy to fare better in the global financial crisis than other developed economies."

However, some economists, including one senior economist with the Commonwealth Bank disagreed with this assessment, stating that Australia did not have the high unemployment levels of the US or UK and that there was "an extremely low" rate of late debt payments. Readers were also reminded that there will still be "an undersupply of dwellings in the next few years, not an oversupply", primarily due to high population growth. The possibility that Australia would be subject to a house price implosion was dismissed as "ridiculous" by the Commonwealth Bank economist.

2010 It’s not a bubble, just overvalued

In a somewhat cryptic message to the Australian public, Investment Bank Goldman Sachs (GS) reported (Aug 2010):

Australian housing is not in a speculative bubble but could be up to 35 per cent overvalued . . . warning that an abrupt and sustained decline in the terms of trade over the next few years could act as a catalyst in deflating house prices across the country. The report says Australian house price dynamics do not appear consistent with a speculative bubble, noting there is a "very big difference between a speculative bubble and a period of overvaluation.

One inference that can be drawn from the GS statements are that while RE prices may not fall precipitously (there is no bubble to burst) it is possible there will be a period of sustained pricing atrophy. Such a period of price stagnation, should one occur, could balance out any current overvaluation.

Treasury Brief for Incoming Government

Following the 2010 elections, the incoming government was provided with a Treasury Brief which highlighted the risk to the economy of domestic debt (mainly residential mortgages) sourced externally: A key risk for the Australian economy is our reliance on short-term external debt . . Highly indebted households, together with high dwelling prices, further heighten the vulnerability of the economy to shocks. While household finances are in good shape overall, and arrears rates and other financial stress measures remain much lower than in the early 1990s, households are more exposed than previously to adverse shocks.

Mixed messages on household debt levels

2010 RBA issues caution

With the background context of sovereign debt events unfolding in Europe (Greece’s public debt relative to GDP singled out during the speech), the RBA chief issued a note of caution during a business presentation. The Governor noted that “potential vulnerabilities need to be addressed in good times. . . Australia does not have a problem with public debt . . Nor . . a problem with corporate debt” but rather that “ the big rise in debt in the past couple of decades has been in the household sector.”

In part the speech was clearly aimed at moderating the on-going infatuation with debt as related to housing. In a time when investors appear smitten by 'unrestrained-debt-equals-maximum-tax-deduction' syndrome and home-owners have come to believe the mantra that 'my-home-is-an-ATM', the Governor added that this does not “mean it would be wise for that build-up in household leverage to continue unabated over the years ahead” and that “further big increases in indebtedness could increase . . vulnerability to shocks”.

The RBA received some positive feedback for “withdrawing low interest rates without sending the economy into reverse”, however, it was noted that the “question for both sides of politics is: Will they do their part in withdrawing the tax system's bias towards bricks and mortar to reduce the risk of households getting caught with too much debt when another global recession comes?” That vital question remains in the public domain: Will enough be done by policy makers "to wean households off the fool's gold of capital gain" at a time when capital gains is looking anything but guaranteed?

RBA Deputy unconcerned about household debt

Although Tax Office figures showed a record 1.2 million investors . . . spent more money on their rental properties than they earned in 2007-08 and that one in every 10 taxpayers owned negatively geared property, RBA Deputy Governor recently told a conference that he was unconcerned about household debt, noting that since 2006 it had stayed steady relative to disposable income.

It is true that total household debt to disposable income for the last 4 years has been stable at about 155% (Chart3 - Debt to Disposable Income). However, this ratio has climbed steeply over the last 20 years, up from about 45% (1990) to the current 155% for a greater than 300% increase in household indebtedness (Chart 5).

RBA outlines why extra debt failed to alleviate housing shortage

The Reserve Bank of Australia (RBA) outlined reasons for the "contradictory evidence" that property investment is high, "yet there seems to be a shortage of dwellings", namely, that:

• real expenditure on new dwelling built is 60% higher than 15 years ago;
• a high proportion of investment is for alterations and additions;
• a higher proportion of new houses built are simply replacing existing houses that have been demolished;
• 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.

Intervention in support of prices post-GFC

By October 2009, it appeared that the pricing of homes was being inflated by actions taken in October 2008 (inclusive of FIRB foreign investment rule changes) aimed at addressing the fallout from 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" in 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."

Foreign Investment in residental property

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 add to "Australia's housing shortage" and prolong "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."

Reversion of foreign investment rules

In April 2010, the government, faced with "a growing crescendo of complaints and reports of massive buying by Chinese investors" announced amendments to policies to:

"ensure that foreign non-residents can only invest in Australian real estate if that investment adds to the housing stock, and that investments by temporary residents in established properties are only for their use whilst they live in Australia."

Under the rules, temporary residents and foreign students will be:

• Screened by the Foreign Investment Review Board to determine if they will be allowed to buy a property.
• Forced to sell property when they leave Australia.
• Punished if they do not sell by a government-ordered sale plus confiscation of any capital gain.
• Required to build on vacant land within two years of purchase to stop "land banking".

Failure to do this would also lead to a government-ordered sale.

Collateral damage

Diverting capital away from the rest of the economy

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."

This observation that the stable functioning of the broader economy is jepoardised by excess lending for speculative activity in the property market is not new, as shown by this 2002 cartoon:

• Reserve bank tries to hit King Kong housing boom without colateral damage

Buying high - what risk and what alternative?

Some commentators have used humour to put the high cost of home ownership into perspective. In an article titled 'Time for a realty check?' (excerpts below), renting is depicted as being a sound alternative to buying into property during the midst of a bubble: A house, a house, my kingdom for a house . . .

Kids? Check. Job that kills me softly? Check. What's missing here - the last piece of the Great Australian Dream? The castle, of course. Mate, you've got to have a castle.

Affordable housing for all? No, the government's job is to waft a petrol-soaked towel at the First Homeowner's Grant-negative gearing-fuelled bonfire and say "take a look at that beaut".

In any event, it's not the lack of property that keeps me up night. It's the thought that, if I buy in so high, I'll become one of those crashing real estate bores who arranges their social life around RBA announcements, cheerleading the bubble from the sidelines.

"What do we want? Even more tax breaks for property owners! When do we want it? Before the end of the financial year! And what about the rest of Gen X and Gen Y? Screw them sideways over a builder's jig . . ." Bah, that ain't living. I think I might just give this one a miss for now. I'm fairly confident I can lead a perfectly satisfying existence without ever owning digs. Instead, I'm going to spend a little quality time with the kids. Maybe take in some Monopoly.

Demise of owner occupier as market segment

The Victorian trend mentioned above, March of Speculators, the trend of "investors" gambling on guaranteed capital gains has come at the cost of diminished home sales to owner occupiers. If this trend were to be reflected in other states, it would spell the demise of home ownership in general in Australia over the long term. The final result for the economy, in terms of the access to 'shelter', is that it could essentially degenerate into a two-class system - one class of renters and another class of speculators/investors, with an ever diminishing owner occupier class in between.

The tax system is in no little way responsible for this trend. The government, in its responses to date, has proven protective of the status quo and simply dismissive of many of the recommendations offered by various housing affordability and tax studies commissioned on its behalf. As a result, the real economy blankly faces the challenge of providing one of the most basic of social infrastructures - the provision of affordable housing. Increasing the amount of debt buyers/developers can walk into (via increased home buyer grants or open-ended tax deductions such as negative gearing or developer friendly schemes such as NRAS) has not improved stability or affordability in the housing sector of the economy.

Making a meal of borrowers

Chart 7. Asset value as a function of total debt to disposable income. Source B21 RBA

While historical dollar value is most commonly referenced facet of the property market, there is another way of looking at the real estate equation. One graphic (Chart 7) epitomises the illusion that focussing only price of an asset does not give the full story. The price of residential property must necessarily be a function of disposable income, and these two entities, income and realistically achievable debt potential, are inextricably linked.

Chart 7 shows that the actual value of total household assets, (expressed as a function of disposable income) has more than halved between 1988 and 2010. With the percentage of debt (for housing) to dsposable income having actually increased fourfold in 20 years (in 1990 it was about 32% and in 2010 about 139%), this is not a ringing endorsement for ever increasing debt loads.
The table below shows selective data from 1990 to 2010 for total debt to disposable income versus total assets to disposable income extracted to create Chart 7.

Selective months (March)	% Total Debt to disposable income	% Housing debt to disposable income	% Assets to disposable income	Asset value as function of total debt - expressed as a ratio
1990	44.7	32.2	462.3	10.3 : 1
1995	65.1	54.2	515.5	7.9 : 1
2000	92.3	76.9	609.3	6.6 : 1
2005	144.2	124.5	737.9	5.1 : 1
2010	157.3	139.5	754	4.8 : 1

This decline in relative asset value to debt engaged is an indictment of the banking/financial system's ability to manipulate borrowers. The finance industry has used both home owners and investors to plough residential mortgage fields using easy credit. The yield for the finance industry is rich in interest repayments but the harvest for borrowers, especially recent ones is poor indeed, with relatively less return for greater levels of debt.

Another way of describing this trend is that the finance industry is making a meal of borrowers.

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 spending more than 30% of their income on mortgage repayments, a figure than some believe constitutes 'mortgage stress', however the number of people default on their loans remains extremely low, at well under 1%.
• With rising interest rates, stricter lending standards and reduced government grants, some surveys claim that some buyers are giving up the chase indefinitely as property has become completely unaffordable to them.
• However, despite rising interest rates, events do not in any way mirror the sub prime collapse in America.

Vacancy rates and rental stress

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

The rental impact is even more stark for some groups, where for example in Sydney, there is "one affordable and available dwelling for every 15 very low income households."

As noted in the Senate Select Committee 2008 report 'A good house is hard to find', "current supply of rental housing is severely inadequate (chapter 10). Vacancy rates are at record lows". The report recommended that the NRAS aim at a 50 % increase (an extra 50,000 dwellings) to the notional target by 2012.

Price trends since April 2010

April 2010: "Home values flat in April as heat comes out of Australia’s housing market" and "Housing markets outside the capital cities record no growth in 2010". Brisbane fell 1.2% in April which equates to 14.4% fall per annum if the trend were to continue. Perth fell 0.9% in April, and Darwin 0.3%. A rise in interest rates, the end of government stimulus and general notion that housing prices are too high (as noted in above warnings), has led to these slight falls in the house prices. Also, on 5 June an article appeared in The Australian Business section, stating that some hedge funds, who chose not to be named, are selling their stakes in major Australian banks because '...sentiment towards the Australian banks had soured because of doubts that the strength in the national property market would be sustained.' These major hedge funds are also shorting the banks. However, on a year on year basis the picture is seen to be different.

Timeline

1987: Negative gearing is reintroduced by the Keating government.

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 RBA cash rate peaks at 6.25%. The collapse of the Dot Com Bubble sees many investors switch to real estate. The RBA lowers interest rates until mid-2002.

2001: July - The Federal government introduces the First Home Owners Grant of $7,000 for established homes, and $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: A Senate Select Committee on Housing Affordability was established. Its final report 'A good house is hard to find' included dozens of recommendations.

2008: March - The RBA cash rate peaks at 7.25%.

2008: October - The First Home Owners Grant Boost is introduced, which came on top of the existing First Home Owners Grant. The stimulus consisted of an extra $14000 available to first home owners buying or building a new home, as well as an extra $7000 made available for established homes. First Home Saver Accounts are also introduced, where the Federal Government will contribute up to $850 per annum towards savings for a deposit to purchase housing.

2008: December - In the frenzy of activity that followed the GFC, FIRB rules were relaxed allowing temporary visa holders including students, to more easily buy up 'second-hand dwellings'. Changes did not require notification of sales be made to the FIRB and the $300,000 cap on price was removed.

2009: April - The RBA cash rate bottoms at 3.00% in reaction to GFC.

2009: October - 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".

Economy strengthens, unemployment drops to 5.7%. With global backdrop of falling interest rates, the RBA surprises markets and borrowers with it first increase of 0.25% to the cash rate.

2009: November - Buoyed by the sharp fall in interest rates (7.25 to 3.00% post-GFC) and the increased FHB Boost "capital city house prices . . climbed average 10 per cent" in 2009. Melbourne led the "house price boom, with values up 14.9 per cent in the 10 months . . to an average of $481,247."

2009: December - Reporting of RE data was questioned by one source: "AVERAGE house prices have been overstated by up to 18 per cent by the real estate industry . . . 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 . . "

2010: January - The removal of First Home Owners Grant Boost, combined with gradually rising interest rates, reduced 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.

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."

2010 March: ABS declares that house prices "soared 20 per cent in the 12 months to March" - a rate that was described as the "fastest ever recorded" in Australian history. The Head of Australian economics at National Australia Bank admits "This is a shocker".

2010: April - Rules on foreign investment in real estate introduced in 2008 are scrapped. Temporary residents required to sell their Australian property when they leave Australia. Also, for the first time, the FIRB is given the means to ensure that the laws are enforced.

2010: May - 'Australia's Future Tax System' (AFTS) Review (aka 'Henry Taxreview') makes the light of day with a number of recommendations on policies that could affect the housing market.

The government responds to the AFTS review findings with a report 'Stronger, Fairer, Simpler: A Tax Plan for our Future'.

RBA Cash rate is raised to 4.5%. Rates for major banks now vary between about 7.2% and 7.5%.

2010: September - Irresponsible lenders (like Mortgage House) return to reckless practices and bring back 105% loans to further inflate the bubble. http://www.news.com.au/money/property/lenders-throwing-cash-at-buyers/story-e6frfmd0-1225918973988

Many analysts accused Commonwealth Bank of "self-serving rhetoric" in downplaying the threat of a housing bubble. http://www.theaustralian.com.au/business/industry-sectors/analyst-blasts-cba-for-denying-home-bubble/story-e6frg96f-1225919848419

Useful resources and charts

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

'Safe as Houses'- an interactive chart from The Economist (online Dec 2009) gives a global comparison of house-price data.

RBA inflation calculator

Government's Economic Stimulus Report (Oct 2009 - includes FHB Grant in Table 2.2: Itemised Expenditure by Package)

See also

• Home ownership in Australia
• Australian Dream

General:

• Real estate bubble
• House price index

International:

• British property bubble
• Indian property bubble
• Irish property bubble
• Japanese asset price bubble
• Romanian property bubble
• Spanish property bubble
• US housing bubble

External links

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