It’s no secret I am forecasting price declines (or prolonged stagnation) in the Australian residential property market. The intricacies of this topic have led many to the conclusion that the government won’t let that happen - there are simple too many people going to lose in the short run, even if we may all benefit in the long run. While I agree that the government may not let this happen (although foreign ownership rules are being tightened up again), and may produce an arsenal of economic weapons we haven’t even though of yet, I disagree that there are more losers than winners from a significant housing price correction.
The mainstream ‘more losers than winners’ message is aptly summarised in this article:
The only people who would rejoice in a house price slump, it seems, are the young and aspirational. As Willem Buiter put it in his 2008 paper for the National Bureau of Economic Research, 'Housing Wealth Isn't Wealth', “…the young and all those planning to trade up in the housing market are made better off by a decline in house prices. The old and all those planning to trade down in the housing market will be worse off.”
This view is wrong.
Why are the elderly and those planning to trade down in the housing market worse off? If the elderly are planning to sell their home to fund retirement they may be (on paper at least since they never realised their capital gain) worse off. If they plan to leave their home as inheritance for the children, the children are equally well off. If they plan to sell to leave money for the children they are also equally well off, as the children now face lower housing costs with the lower inheritance.
Those trading down in the market may lose if the price gradient (the percentage difference between two different quality dwellings) flattens, however if it does not, they can still take good gains on the trade.
I also believe we forget that the ‘young and aspirational’ are the children of the old and well off. It would be (is?) a strange world where parents find satisfaction in keeping their children out of the housing market so they can fund an extravagant retirement.
In Australia, 36% of households are owners with a mortgage, 35% own without a mortgage, and around 23% are private renters, the remaining 6% rent from State housing authorities. All of these groups will either be in an equal position or benefit from a major housing price decline. The renters will be have better ownership options, the owners without mortgages will be in identical situations, and the owners with mortgages will also be in the identical situation. The fact that the mortgagor’s home is now worth less than what they paid only reduces their opportunity to relocate, as they may have an overhanging debt burden. But, if they were willing to pay the inflated price for the home, and the home is identical, one can argue they are in an equal position.
Which brings me to the key loser from price declines; the investor/speculator. While private housing investment is a key supplier of rental accommodation, rental yields have been ridiculously low for the past half decade. Investors have banked on tax breaks and capital gains for their returns. But as with all investment, there is a trade-off between risk and return, and is appears that the risk factor in the housing markets has been completely forgotten. For those investors looking to take gains in the near future, they will (on paper) lose out significantly – more so depending on their level of gearing. In the long run however, especially if the government tries to inflate our way out of the debt burden, investors who hold on may still do well from residential property (it should be a long term investment anyway).
And what about social benefits more broadly?
But Keen points out that there is a wider benefit to a deflation in house prices – the flow of capital into housing can find a more productive home in business lending.
This is a point I have long made – that borrowing money to inflate land prices (remember that we have a land price bubble not a housing bubble as such) is unproductive. This should be a key message from property bubble discussions.
To wrap up today’s discussion I want to share a bubble checklist I found in a book entitled When Bubbles Burst: Surviving the financial fallout by John P. Calverley. My take on Calverley’s message is to get back to basics. In the long run, there are certain ‘normal’ returns to be expected in various assets. For property he cites a 2-4% capital gain and a 2-6% net rental yield (or a 6-10% gross yield after factoring the high cost of property ownership).
You only have to wait to page 13 to get John’s checklist for identifying asset price bubbles:
1. Rapidly rising prices
2. High expectations of continuing rapid rises
3. Overvaluation compared to historical averages
4. Overvaluation compared to reasonable levels
5. Several years into an economic upswing
6. Some underlying reason/s for higher prices
7. A new element (technology for stocks, immigration for housing)
8. Subjective “paradigm shift”
9. New investors drawn in
10. New entrepreneurs in the area
11. Considerable popular and media interest
12. Major rise in lending
13. Increase in indebtedness
14. New lenders and lending policies
15. Consumer price inflation often subdued (so central bankers relaxed)
16. Relaxed monetary policy
17. Falling household savings rate
18. A strong exchange rate
Let’s check off the Australian housing market.
1. Yes. The period 2002-2004 saw a massive price boom followed by modest rises until the mild decline seen during 2008. Since late 2009 prices have bounced back with force, with record increases seen in some parts of Sydney and Melbourne.
2. Maybe. There are plenty of bears around, but there is no shortage of property spruikers talking up the ‘housing shortage’ (see 7.)
3. Possibly. Gross rental yields in areas I have bought real estate are now about 4-5%, with net rental yields about 2%. Read here for more on low yields and overvaluation.
4. As per 3.
5. Definitely. And we came through the GFC unscathed.
6. Nothing that I believe warrants the bubble (thought others might disagree)
7. Housing shortage anyone? Population growth? Immigration?
8. Some people have noted that Australia is now becoming like other developed countries where housing is expensive.
9. Yep. Every man and his dog (including me some time ago)
10. Who isn’t a property developer/investor these days
11. The Block reality TV series take two
13. Check (Steve Keen would have plenty of good data at hand)
14. Maybe not so much now. Lending is tightening up a bit.
15. Tick. CPI has been notably well behaved.
16. No. RBA tightening up now.
17. Yes. Temporarily no (2008-09) but we’re back on a spending binge.
18. Check. Partly (or mostly) the carry trade, maybe some other factors.
If you disagree (either with the list or my answers) let me know. All signs, including the RBA governor himself, point to a property slowdown.