Australlia:No evidence of a property bubble? Not quite


The ABA’s (Australilan Bank association) own definition of a residential property bubble surely indicates that Australia currently has one. There’s no getting around the fact that our real estate is abnormally expensive, writes Michael Janda.

Contrary to the headlines, an Australian Bankers’ Association (ABA) report released today doesn’t rule out a property bubble.

Yes, the press release says the report finds there is “no evidence of a property bubble”.

However, read the 33 page report to its end and you will find a far less certain conclusion:

There is insufficient evidence to conclude that house prices are unsustainably overvalued or that Australia is currently experiencing a speculative ‘bubble’.

Within this broad observation there are regional variations, with more intense activity in Sydney and, to a lesser extent, Brisbane and Melbourne.

To me there’s a big difference between “insufficient evidence” and “no evidence”.

Insufficient evidence may get you off criminal charges that have to be proved beyond a reasonable doubt, but it doesn’t prove you didn’t do the crime.

Unlike the press release and the media coverage of it, the ABA’s report is far less certain of Australia’s housing market stability.

Perhaps this is because, however hard its author(s) tried to spin the evidence, however selective they were with data and dates, it is impossible to argue that Australia’s residential real estate market is anything but abnormally expensive, both historically and internationally.

The ABA argues that Bank for International Settlements data show Australian dwelling price growth has been in line with several other markets since 2008.

What about before 2008? The BIS data shows just how exceptional Australian home price growth has been, with the second highest increase after Norway.

However, Australia has had strong income growth over much of that period, particularly through the 1990s and early 2000s, which is why you need to compare price growth to other measures to see if there might be a bubble.

On the key price-to-income measure, Sydney is around its early to mid-2000s peak of approximately 6.5 and Australia is over four, and that’s from data that’s already at least six months old and assumes each household has 1.65 typical incomes.

Australia’s household debt-to-income ratio at 152.8 is a smidgeon off its September 2006 record, due to a pay down in personal debts since the GFC, but the housing debt to income ratio has powered to a record high of 139.

Another key measure of bubbles is the ratio between the price of an asset and the income it can generate.

This is the so-called PE (price-earnings) ratio on the share market. In the property market, it is the gross rental yield.

A recent IMF study put Australia fifth on the level of prices relative to rents among 27 OECD countries examined, a finding echoed by the BIS which found our ratio to be 50 per cent above its historical average, while 20 per cent was its threshold to start ringing alarm bells.

In Australia’s two biggest property markets, that rental yield has often been below the ‘risk free’ rate of return from Commonwealth Government bonds, and the ABA notes that bond yields have fallen even further than rental returns in recent years.

“For significant periods, the risk free return has been higher than the rental yields on housing. Under this scenario it would only make financial sense to purchase dwellings as an investment to rent if there were expectations of capital gains on housing,” the ABA notes on page five of its report.

Firstly, this shows the policy flaws in Australian housing – negative gearing, compounded by the capital gains tax discount – that allow people to invest in assets that have negative real net income returns purely in the hope of capital gains.

Secondly, as the ABA itself states on the very next page of its report:

In the context of residential property, a bubble occurs when buyers push up the prices of properties based on their assumptions that the value of those properties will continue to rise into the future. As such, they are not purchasing the properties primarily as shelter or as income producing assets but are betting on strong future asset price appreciation to generate a return.

On the ABA’s own definition of a residential property bubble, surely they are acknowledging that Australia has one.

The same apparent incongruity of analysis and conclusion applies to the ABA’s comparison of Australian price-to-rent ratios with other countries.

The author(s) compare us to a range of countries, and conclude that we’re lower than some and in line with others. The problem is the narrow choice of comparison countries, all of which the IMF, BIS and Economist magazine have concluded are massively overvalued.

Thus, comparing Australia’s price-to-rent ratios to Belgium, Canada, Hong Kong, New Zealand and Singapore and saying they aren’t that high is like comparing James Packer to Bill Gates and Warren Buffet and concluding that Packer isn’t very rich.

The bank report acknowledges as much in less colourful terms:

Having said that, there is no getting away from the fact that Australian houses are expensive relative to the investment returns that can be generated. Current rates of return may be economically viable only if expectations of further price gains are fulfilled.

The ABA rolls out other arguments commonly used to deny the existence of a housing bubble. One is the apparently solid lending standards of Australia’s banks:

The RBA has confirmed that banks have not relaxed their lending standards, concluding that “mortgage lending standards remain firmer than in the years leading up to the financial crisis”.

As with the international comparisons, choosing to compare current lending standards favourably with the laissez fare period leading up to (and that led to) the financial crisis is somewhat akin to saying a smoker has kicked the habit because they only smoke half a pack a day instead of a whole one.

While recent data do show a fall in the proportion of loans that have a deposit of less than 10 per cent, they show a rise in the proportion of loans with deposits of less than 20 per cent.

It seems that laying down only 10 per cent of the purchase price and taking out lender’s mortgage insurance has become the new safety benchmark, rather than the old preference for a 20-per-cent-plus deposit in most cases.

Investors have also been accessing interest only loans in greater numbers – probably to take fullest advantage of negative gearing – which are also a riskier form of lending.

The ABA go on to argue that the housing market is safe because:

The value of household assets is much greater than the value of household debt so that on average households have a positive net worth.

But that’s only because house prices have risen so much. If they start falling sharply the proportion of people with negative equity will rise steeply.

For example, someone who took out a margin loan on Macquarie Group shares would have looked totally fine in 2007 when they were worth well over $90, but their financial position would have looked catastrophic in 2009 when those shares fell below $20.

House prices are highly unlikely to fall by anywhere near that magnitude, but you get the idea.

The ABA, as has the Reserve Bank, also points to people being ahead on their mortgage repayments.

As of June 2013 (the latest data available) households were, on average, 21 months ahead of their scheduled repayments, which equates to approximately 14 per cent of outstanding mortgage balances.

The existence of such a large buffer implies that borrowers, on average, are well placed financially to withstand an increase in interest rates or other event that may cause increased financial pressure.

But averages can cover up significant divergence. It is quite likely there are many households years ahead of their minimum mortgage repayments, using offset accounts to pay off their loan quickly and minimise their interest bill, while many others are only just keeping up.

It would only take a few per cent of households with mortgages to fall behind and default to cause financial carnage for the banks, and pull Australia into a nasty recession.

As a parting shot, the ABA also talks up the positives of Australia’s house price inflation, something policymakers such as the RBA are also inclined to do:

Property price appreciation has been a key driver of wealth creation for many Australians. This has been especially true during surges in prices such as in the late 1980s and the early years of the 2000s.

But this is a zero-sum game. The wealth created for existing property owners comes at the expense of the next round of buyers. In this respect, soaring housing markets do exhibit features of a Ponzi scheme.

Unlike rising share prices that often reflect innovation, technological advances and other productivity enhancements boosting corporate profits, rising land prices (the vast bulk of rising dwelling prices) simply reflect the scarcity of well-placed land and strong demand (which can be real accommodation demand and/or speculation).

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