Monday, April 26, 2010

Housing crash makes us winners and the bubble checklist

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
12. Check
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.


  1. Hi, Thanks for the valuable information, with clearly defined goals you can easily devise a property investment plan.

  2. Agree with 16,17 & 18. 3 out of 18 ain't a bubble.

    How about you turn the whole argument on it's head & imagine that median prices actually were 3 or 4x median income...... what would an economics theorist hypothesise would happen next. Remember that 30% of us have $0 debt... would we upgrade since it was so cheap ?.... would there be a lack of supply of houses for upgraders to aspire to ? would prices immediately rise again. Course they would.

    The bottom line is that there's 4M of us, and we all want to live 15 minutes from the CBD.... there's not enough land there, so only the ones who have worked hard, saved hard, & invested wisely (in a PPoR) get to achieve that goal... the rest of us either work at it or start a blog to whinge about how tough life is.

    It's easy to imagine a scenario that benefits you personally & justify that it 'should' happen, but the reality v. different. Look at 2nd & 3rd round effect - like the one above.

  3. Spambot strikes again...

  4. charlimi,

    It depends what the rents are. If house prices were 3x incomes, but rents we so low that 3x you income meant that your weekly cost of home ownership was twice or three times the rent, you might decide you are better off renting. Relatively, house prices could still seem expensive - it all depends on the comparable rents.

    I would be really keen to see where there is a land shortage, even near the city? We have 5ha vacant at Newstead ebing developed (former gas works) 10ha at West End being developed on the riverfront, the 10ha Landcentre site at the Gabba is for sale. That's just inner city locations I can think of off the top of my head.

  5. So now you want rents to crash along with house prices - you are truly delusional :eek:.

    Can you honestly say that you (& 1M other renters) wouldn't buy a house if they could afford to.... or the other 3M of us owners would NOT upgrade since they were *only* 3-4x median wages ?

    We've always spent money on stuff that makes us happy - new ute, plasma, bigger house, O/S holiday.... 3 of those have dropped significantly in real terms over the last generation... one hasn't. The reason it hasn't is that it is in limited supply & (since the other 3 are cheap) we can afford it. Your gen has the benefit of 3 out of 4 from the start.... the previous gen had 0/4.

    Do the sums - it's physically impossible for 4M of us (Sydneysiders) to cram into the space that's 15 minutes from the CBD.

  6. I believe affordable housing, whether prices or rents, is an important social goal. House prices have been spiralling upwards too fast for too long and no matter what argument you use to justify it, the bursting of the bubble must happen if it continues. Australia has been lucky enough to avoid sharp house price falls thus far, but shouldn't consider itself immune. Rather we should attempt to learn from international experience and look to avoid it or prepare for it with appropriate legislation and policy. Foresight is a difficult quality to measure. Nobody remembers a disaster avoided, yet everyone will lay blame with the benefit of hindsight.

    I hope prices don't crash but agree that somehow affordability must return to market prices. What is the higher social cost? Having such unafforadable prices and personal indebtedness continue, or taking some pain with a small correction now...

  7. No, I don't want rents to crash. I am saying that renting is the substitute for home ownership, and no one in their right mind would pay $1000/week to own a house they can rent for $200/week, even if the price is 'only' 3x their income and they can afford to. They are typically far better off to rent for $200 and spend/save the other $800 as they choose.

    So when you see houses selling for 3-4% gross yields (<2% net) you must conclude that the expected remaining yield (to even get a risk free 6% or a more normal 10% return) to come from capital gains.

    Lastly, there a plenty of cities in the world where 4million people live within 15mins of each other. If population drives up asset prices, does it also drive up BHP share prices because the potential pool of buyers is greater? A greater number of people affect the price only if they bid or buy, and they will only do that if the proposition is attractive compared to the alternative (which is renting in the case of property, and investing elsewhere in the case of shares).

    If a greater population squeezes rents up, then we can see a case for higher prices. If rents are flat and prices rising, it looks all too speculative for me.

  8. Christian said...'I believe affordable housing, whether prices or rents, is an important social goal.'

    Housing until v. recently was more affordable than at any time in the last decade (according to the RBA), due to low IRs, high disposable income & flat house prices for several years.

    Option 2 of course is for FHBs to lower their aspirations - a search of will show 100's of houses < $100K.

  9. CM said 'I am saying that renting is the substitute for home ownership'

    It's a v. 2nd rate substitute. 90% of folks would much rather own, than rent... it's a security & control thing.

    $1000pw to buy or $200pw to rent.... huh... rents must have crashed big time for that example to have legs.

    '3-4% gross yields... remaining yield to come from capital gains.' No... a proportion of the remaining yield is the premium OOs pay for control & security. They don't expect ALL the difference to be CG.

    '...there a plenty of cities in the world where 4million people live within 15mins of each other.' Can you name a few ? Calcutta ? Shanghai
    Would you like to live within 15 mins of 4M others ?

    'A greater number of people affect the price only if they bid or buy'. Sure.. if they don't then their *only* alternative is to create demand for rental accom... with resulting yield increases. Unlike BHP where they *do* have the alternative of standing aside.

    I think you need to do a post on what would happen if prices did a Keenesque -40%.

    And then another post on what house prices will do if population growth continues at +1-2%pa, and lending for new construction remains extremely hard to get. Caravan parks, shipping containers, bus shelters, tents.... or house prices rises ?

  10. Where I live now is a typical example of the exuberance of the property market above a price rents could justify.

    Price $650,000
    Purchase costs $16,250
    Interest rate 8%
    Rates $6,500
    Maintenance $3,000
    Insurance+misc $1,000
    Total annual cost ($72,913)
    Total weekly cost ($1,402)
    Gross yield 3.32%
    Rent $415/week

    By renting I am about $1000 per week better off than if I was an owner occupier of the same house. Sure, I might be more secure, and in thirty years I might own my home outright, but I have paid a $50,000 per year premium for the privilege (although the $50,000 declines over time as rents increase), which could be spent or invested elsewhere.

    Unfortunately if you believe population growth will force prices higher, you must also believe that if population growth stagnates, prices will fall. I wonder what impact our new population minister might have? Also, why would population growth continue so rapidly if it never has before? This post covers my thoughts on the matter.

    You can read Steve Keen's own writing on what he feels will be the impact of his price fall. Indeed he simply cities Japan as an example of what we might expect over the next decade or two.

    For your final question, all those people could reside in the 8million plus empty bedrooms, or the 800,000 plus empty homes. This post shows clearly that occupancy rates have begun to increase after two decades of decline. One key reason for this trend is that downsizer's enable empty bedrooms to be filled by new occupants. The retired couple with a five bedroom house downgrades to a new two bedroom unit and suddenly we for one extra unit constructed and a 5 bedroom home made available for 6 new occupants.

    Time will tell. But I have a house for sale if you are so confident about the market

    And this might also be of interest

  11. Survey's are subjective. From my personal experience I do NOT consider Brisbane house prices and rents "affordable". Having lived in London for the past 5 years, and briefly moving back to Brisbane in between, there is much more affordability in London house prices and rents in my opinion.

  12. Also, i recently spent time in South America, in particular the city of Sao Paulo that >11million people call home. It reminded me of Brisbane more than London with heaving urban roads and traffic congestion. I wonder what housing affordability is like there? By the way, it seemed an expensive place to me, living costs seemed similar to London after converting the currency.

  13. 'Price $650,000' What a distorted example you give... 8% IRs, $3Kpa maintenance ? And you're assuming it's all borrowed $$$. And you give the figures for year 1 only, not for yr 25 when there's no interest to pay).

    Re popln growth:

    If popln growth stagantes, then houses prices will grow at approx wages or CPI, and not above as it currently does with the significant additional demand.

    Keen is a single factor economist (debt) - he's unable to see the bigger picture. Unfortunately he's dug himself a hole & is unable to step back from his (obviously incorrect) view. I guess you agree with him that debt is the only relevant factor and affordability, emotion, security, ever decreasing costs, risk adjusted returns, popln growth, govt land release policy, etc are all secondary - bordering on irrelevant ?

    Re empty bedrooms:

    Huh... how many people do you know that are prepared to let a complete stranger live in their spare bedroom. Sure... economically it's a great idea, but unfortunately reality prevails.

    And 800K empty houses ? Ask yourself why they're empty - holiday homes, city pads, in between sales, between tenants, owners on holiday, awaiting demolition, the list goes on. To suggest that every home should be full 100% of the time isn't sensible. You'll note that the %age of empty homes has remained static for decades.

  14. Hi

    I read this post two times.

    I like it so much, please try to keep posting.

    Let me introduce other material that may be good for our community.

    Source: Account rep job description

    Best regards