The fate of the property bubble
As one of the most important asset classes for Australians, the fate of our residential property market affects much of our economy – from bank profitability to broader growth. Recent media articles have debated whether the Australian property market is in ‘bubble’ territory, however few commentators are unbiased.
The economic historian, Charles Kindleberger identifies four signs of bubbles in his book: Manias, Panics, and Crashes: A History of Financial Crises1. Exploring these four aspects provides a framework to cut through the media and real estate agent hype and analyse market fundamentals.
1. High levels of debt
Australia has the highest level of household debt in the world at 123 per cent of GDP2 and we keep borrowing. The majority of that debt is mortgage financing, with 40 per cent of new mortgage loans interest-only3. Some will argue that absolute debt levels are not a useful measure of a bubble given mortgage rates are low and that a household income-to-interest ratio or a measure of servicing cost is more important. This argument misses the point that was so strongly made in the corporate world during the global financial crisis: debt needs to be repaid, not just serviced.
2. Extreme valuations
There are a number of different measures that can be used to illustrate valuation. Price-to-rent balances the forces of financing and speculation (price) against the force of the economy (rent, driven by wages and population). In Sydney and Melbourne for example, these ratios, expressed as a yield (the ratio's inverse) are at around three per cent4 – half the long run average according to the International Monetary Fund5, and this allows little for the frictional costs of property ownership (i.e. stamp duty, agent fees, maintenance). With the economy growing but wages and employment stagnant, rent rises are slow, which indicates reliance on capital gain for a return. That should ring alarm bells.
3. Cheap money
Interest rates have never been so low. We could stop there, but there are other measures worth noting. Ease of obtaining mortgage finance, high loan-to-value and loan-to-income sizing are all in effect delivering money at prices and to people otherwise not feasible (and possibly not sensible). Banks may talk about ‘internal controls’ but anecdotally we all have hair raising stories about the inexperience of senior management running a particular bank’s mortgage businesses, the cousin in “x” who hasn’t had a regular job for years who’s just got a mortgage for “y”, the string of apartments bought on the strength of a parental guarantee then leveraged, and the misalignment of interests between brokers and mortgage lenders.
4. A convincing narrative as to why the situation will continue
This is what you are already reading in most newspapers. It is enticing, even logical, but are we hearing what we want to hear given residential property is likely a large piece of our net worth?
Will the bubble burst?
With the Australian property market in bubble territory on a number of measures, the question is will the bubble burst, deflate, or can the economy inflate around it?
Kindleberger tells us that bubbles burst when money gets expensive. Aren’t Australian rates “lower for longer” kicking that can down the road? We shouldn’t just look to the level of interest rates and the Reserve Bank for “expensive”. A mortgage gets expensive if you lose your job, if lenders tighten lending criteria or increase margins, or if a tax break is removed –none of which are mutually exclusive.
Australia’s residential property market is not by any means homogenous. It pays to look very closely at the specific geography and asset type. However, it is still true to say our economy is heavily reliant on property as a whole, on house building to fuel growth, on banks stocks in our pension funds and on land taxes for the NSW government. That so many vested interests are dependent on the current situation continuing, and so much of our net worth at stake, leads to an uneasy situation. It is unreasonable to suggest we should sell our homes, but diversifying the balance of our worth away from assets reliant on Australian residential property is the least that should be considered.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.