Australia – A Housing Bubble That We Can Profit From ?

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Feb 21, 2011
I’m in the process of trying to understand the Australian “housing bubble” and whether or not it is something an investor should try and profit from.



The concerning number is the price to income measure which is really over the long term what has to drive housing prices. And in Australia that number does look very high.



But on the other hand, Australia doesn’t seem to have the same sort of horrible lending machine that the United States created where the people doing the lending did not care about whether the people they were lending to ever repaid their loan.



It is a bit of a work in progress for me, much like Japanese Government Bonds. In the end I may likely decide I’m not smart enough for this sort of investing. But the process should be interesting.



Below is a serious of articles including much commentary on Jeremy Grantham who strongly believes in an Australian property bubble. http://www.theaustralian.com.au/business/housing-market-a-time-bomb-says-investment-legend/story-e6frg8zx-1225880119320



THE Australian and British housing markets are the last two bubbles left in the wake of the financial crisis, and it is only a matter of time before they crash, warns legendary US investor and co-founder of global investment management firm GMO, Jeremy Grantham.



Mr Grantham famously reported a year before the global financial crisis: "In five years, I expect that at least one major bank (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist".



He said yesterday that Australia had an unmistakable housing bubble and that prices would need to come down by 42 per cent to return to the long-term trend.



"You cannot possibly miss it," he said.



"The price of housing typically trades about 3.5 times of family income and in bubble it goes to 6 or . . . 7.5 (times).



"Australia is having one now. You are at near 7.5 times family income . . . which suggests you are twice the size that you should be."



GMO is one of the biggest investment management firms in the world, with about $106 billion in funds under management, and is considered to be an authority on asset bubbles.



Mr Grantham, who is in Australia to meet with GMO clients in Sydney and Melbourne this week, said any bubble could be an exception to the rule.



"Bubbles have quite a few things in common but housing bubbles have a spectacular thing in common, and that is every one of them is considered unique and different," he said.



As an example, he cited the British housing market bubble of 1989. At the time, he said people dismissed the bubble because there was no more rezoning, creating a land shortage and as such, they believed prices would rise forever.



"Seven years later, in 1997, they hit the lowest multiple of family income since the record books started in 1945. It's always the same old argument, they are not making any more land."



In Australia's case, Mr Grantham described the housing market as a "time bomb" just waiting for interest rates to increase and become impossible to support.



Since last October, the Reserve Bank of Australia has raised the official cash rate six times. The rate is now 4.5 per cent.



If the Australian housing market did not return to the normal multiple of family income, he said "it will be the first time in history."



"Sooner or later, the rates will go up and the game is over."



http://www.theaustralian.com.au/news/opinion/something-has-to-give-in-housing-market/story-e6frg6zo-1225939389620



DEMAND is firm but the cost of borrowing will force many to rethink their plans.



AUSTRALIAN housing prices are evidence of a bubble: ridiculously unaffordable and likely to fall sharply. Or prices will taper off, in contrast to the dizzying rises of last year, although they will remain at relatively high levels.



Or prices will rise by 20 per cent during the next three years in Sydney, Perth and Adelaide.



Take your pick of any of these predictions. They are all backed by the latest expert analysis. They can't all be right. No wonder mortgage holders and would-be buyers and sellers are confused.



If they read The Economist, for example, they are informed that Australian property is the most overvalued of any of the 20 countries the magazine tracks in its global surveys of fair value in different housing markets. The Economist believes Australian house prices are close to 60 per cent overvalued and the home price to income ratio is up from 2.7 times in 2000 to more than seven times, which is unsustainable.



US investment guru Jeremy Grantham also has declared that Australia has an "unmistakeable housing bubble" and prices will have to come down.



The International Monetary Fund, despite being relatively glowing about the Australian economy, warned this month that a possible fall in "mildly overvalued" housing prices is its biggest risk outside of another international financial crisis.



It suggested this "potential correction in house prices . . . could hit household wealth and consumer confidence".



The Reserve Bank is more sanguine. It says households remain "sensitive to possible future negative shocks to incomes, interest rates and housing prices". But it describes the recent slowing in housing price appreciation as "a welcome development for the resilience of household finances".



That, of course, is only after house prices jumped by more than 18 per cent in the year to June, according to the Australian Bureau of Statistics. But does that mean a crash?



For all the notoriety of the sub-prime mortgage crisis in the US and the continuing problems there, the Australian mortgage market is very different.



One reason is that, unlike the US, householders are still liable for the full amount of the loan. Australian families can't simply return the keys if the value of their house is worth less than what they owe the bank without having to pay back the full amount.



Nor did Australian banks shovel out money on honeymoon rates to anything like the same percentage of applicants who couldn't afford rates to go up. That puts a large brake on any US-style downward spiral in prices.



It also means the risks on mortgage lending in Australia have remained minimal, with only 0.7 per cent of non-performing housing loans on bank balance sheets at the end of June.



Instead, the real risk for the banks is whether and at what cost they will be able to borrow the vast amount of credit required to keep lending. That is why, for example, Westpac and Commonwealth Bank have cut mortgage lending substantially after expanding so dramatically last year.



"The likely outcome for house prices is that they will idle for a while," an investment manager from one of the world's largest fund managers, Fidelity, told a Sydney forum last week.



"For house prices to fall significantly, you need to see unemployment pick up and I think that is unlikely."



What is near certain, however, is interest rates are going up. After raising rates six times between October and May, the Reserve Bank surprised the market by doing nothing this month.



It is still likely to move the cash rate up 0.25 per cent on Melbourne Cup day.



But even if it doesn't, households can't rely on their interest rates staying the same next month. The big banks are all complaining their cost of funds is steadily increasing and interest rates will therefore have to rise - probably by more than any Reserve Bank increase in the cash rate. That's because the banks get their own funds from domestic deposits where they have to offer customers more than they used to, and from volatile offshore markets that feature Australian banks as among the biggest global borrowers in a world where raising capital is becoming more expensive. Nor does it help that cost when international investors, hearing the Australian housing bubble talk, are also worried about the exposure of Australian banks to any fall in the domestic housing market.



It all means bank margins - the price of lending minus the cost of borrowing - are being squeezed. The banks won't put up with this indefinitely, no matter how angry Wayne Swan sounds about their having no justification to raise rates beyond any moves by the Reserve Bank.



When Westpac's Gail Kelly sat on a panel on leadership with Julia Gillard in Sydney last week, she was polite but firm.



"Money is going to cost more," she declared to a delicate silence from the Prime Minister. "The days we had before the global financial crisis when there was an excess of money are now gone. We all recognise that money is going to cost more. For us, as banks, it is a balancing act."



That balancing act will test the "resilience of household finances", from Parramatta to Moonee Ponds as well as the political resilience in Canberra.



But the scary figures on the ratio of prices to income levels, while reflecting a clear jump from the 1990s, ignore the rise of dual-income households and income from other sources, which bring those ratios back down. The Reserve Bank declared last month that "households' debt-servicing ability is currently strong". And in Australia the term "as safe as houses" still has traction, even more so after investors have seen how the value of shares can evaporate before their horrified eyes. Many self-managed super funds are rushing to invest in property rather than shares even as Chinese money becomes more cautious.



Economic forecaster BIS Shrapnel predicted last week that capital city house prices are still heading up; it's just a question of how much. It expects an increase of only about 9 per cent in Melbourne median housing prices by 2013, for example, about the level of expected inflation. But that compares with a rise of more than 26 per cent in Melbourne last year alone. In Sydney, where growth was a relatively modest 13.2 per cent last year, Perth (8.9 per cent) and Adelaide (9.8 per cent), the research report says prices will increase on average by 20 per cent during the next three years.



That's even though BIS Shrapnel expects variable mortgage interest rates to be just above 9 per cent by then, compared with just above 7 per cent now.



Hmm. It all suggests something's gotta give unless the economy unexpectedly goes into a tailspin. But what? After all, Australia still has a chronic undersupply of homes being built, especially in its largest state, NSW.



Urban Taskforce, a property development industry group, decries the fact NSW built only 26,000 new homes last financial year. This was the lowest on record, way below the long-term average and way below the demands of a growing population.



"The talk of a housing bubble is just nonsense," says chief executive Aaron Gadiel.



"The underlying strength of market demand is there."



But it's unlikely to be met. Owner-occupier finance rose in August by 1 per cent, the second consecutive rise after a series of falls. But it was mainly for renovations (up 1.4 per cent) as opposed to building or buying new dwellings, which was down again.



"The Australian economy will not see a better demand and supply balance of new housing until regulations and taxation around new development is improved," Citi economist Joshua Williamson says.



Don't hold your breath.



The Council of Australian Governments ordered a series of reports on housing supply and affordability reform to be provided to it by mid-year. They are still not available. Surprise, surprise.



http://www.theaustralian.com.au/business/property/treasury-warning-on-home-price-bubble/story-e6frg9gx-1225956866267



SENIOR Treasury official has sounded the alarm over Australia's property market.



He has warned that the prospect of a sudden and dramatic drop in prices is "the elephant in the room" and should not be ignored by the federal government.



While the government and Reserve Bank insist Australia does not have a housing bubble - as some economists and the International Monetary Fund suggest - it remains such a worrying concept that Treasury has privately sought reassurance from its analysts that prices are not artificially high and that Australia does not face the kind of house price collapse that has hit Britain and the US.



Documents obtained by The Weekend Australian under Freedom of Information laws show the Treasury officials preparing the so-called Red Book of briefs for the incoming government were as divided as private sector economists about the strength of the property market.



Phil Garton, the manager of Treasury's Macro Financial Linkages Unit, sent colleagues a draft paper on the rise in household debt, prospects for further growth in the debt-to-income ratio and the potential implications of slower household debt growth.



His email prompted an exchange with Steve Morling, currently the general manager of the Domestic Economy Division, who argued the paper should "make a bit more about the risks".



"The elephant in the room is house prices or more specifically the risk of a precipitous drop in them, perhaps from an external shock or perhaps from their own internal dynamics when affordability constraints or capacity debt levels see prices and expectations of house prices start to move in the opposite direction," Mr Morling wrote on June 15.



"(I) know there are very supportive fundamentals, but prices rose by 50-60 per cent in three to four years in the early part of this decade, with largely unchanged fundamentals, so they can have a life of their own.



"And given what's happened elsewhere I'm far less sanguine about this - and the interplay with debt - than in the past."



Mr Garton agreed that there would be risks if the fundamentals of low interest rates, unemployment, and financial deregulation "reversed significantly". But he maintained the price growth in the early 2000s was based on a "lagged response" to improvements in the fundamentals, and questioned how Australia could have maintained a bubble for more than six years.



Mr Morling said other bubbles had lasted that long, and the fundamentals were often used to justify price rises - including in Britain where a debate over lack of supply drove property prices higher "before the British property bubble burst".



"(I) think price expectations can take over from the fundamental drivers that you have identified for extended periods, including generating house price falls," he wrote.



With house prices static at best - the market is particularly soft in the capital cities - there are renewed doubts over the boom of the past decade and whether prices are sustainable.



Average house prices doubled in the 2000s and, despite the global financial crisis, remain 20 per cent higher than levels three years ago. The latest figures from the Australian Bureau of Statistics showed prices rose just 0.1 per cent overall in the September quarter - and fell in all capital cities except Melbourne, Perth and Darwin - but were still 11.5 per cent higher over the past year. Treasury's Household Demand Unit is re-examining the fundamentals in the property market to determine factors that have driven, or sustained, prices.



A spokesman for Wayne Swan said yesterday the Treasurer retained the view that Australia did not have a property bubble, citing recent reports and statements by Westpac and the RBA. "Of course, we expect our officials to test and debate policy within the department - it is an important and normal process of government," the spokesman said. "However, it is the considered position of the Treasurer and the Treasury that our housing market reflects the fundamentals of supply and demand and not a bubble - specifically that Australia is simply not building enough new houses."



The RBA was concerned by double-digit price growth earlier this year, especially in Melbourne, but now expects interest rate rises to moderate demand and keep prices at a realistic level.



The RBA has gone to great lengths to pull apart claims of a housing bubble by the IMF, Morgan Stanley economist Gerard Minack, legendary US investor Jeremy Grantham and The Economist magazine, even comparing and contrasting their modelling.



On Thursday, RBA deputy governor Ric Battellino sought to reassure the market that the slowing in growth of household debt would lessen the risks to the economy.



"The current picture is one where borrowing for housing is broadly growing in line with income, house prices are stable and there is little appetite for other forms of debt," Mr Battellino said. "From the Reserve Bank's perspective, this seems to be a satisfactory state of affairs."



The RBA believes demand was responsible for the early rise in property prices, and government restraint on housing supply prevented a US-style slump.



The OECD report on the Australian economy released at the weekend did not identify a "bubble" but warned that house prices could not keep rising faster than household incomes.



"Caution is advisable, given the experience of other countries," the report said.



http://www.abc.net.au/news/stories/2010/09/24/3021480.htm



The simmering debate about whether Australia has a housing bubble erupted again this week over a Commonwealth Bank presentation that seeks to assure global investors Australian real estate is a safe bet.



Senior Commonwealth Bank executives have travelled the world in the past couple of weeks with a presentation showing how Australian house prices, and the key price to income ratios, compare favourably with similar countries.



"Housing affordability has actually been going sideways for the last five to six years," said Craig James, the chief economist of the bank's trading arm, CommSec.



"This is something which has now been acknowledged by the Reserve Bank, so one of the great myths has now been debunked - housing is not unaffordable here in Australia."



CBA has waged its war against what it believes are housing doomsayers with graphs, numbers and international comparisons.



In its presentation, the bank rejects arguments that Australia's housing is relatively expensive compared to incomes.



It says Australia's house price to household income ratio of 5.6 in the major cities, and 4.3 nationwide, is comparable to many other developed nations.



It says San Francisco and New York have ratios of 7, Auckland's is 6.7, and Vancouver comes in at 9.3.



However, the Commonwealth's own graph shows Australians are spending more of their income on housing compared with the past.



In the mid-1990s, capital city house prices used to be around three times annual household income - now they are 5.6 times annual income.



Craig James says that is because, as incomes have risen, Australians have been able to spend relatively less on other household necessities and have more free income to invest in property.



"Australians have been getting more prosperous and with that extra income, with that extra wealth, people have decided what they are going to be able to do with that," he said.



"What Australians have decided to do is to put it into property."



'Disingenuous' figures



However, as Australia's largest home lender, the Commonwealth Bank has one of the biggest vested interests in house prices rising.



It effectively owns a massive swathe of Australian housing as security for its home loans as well as many small business loans.



Many analysts say that has led the bank to use misleading figures and comparisons.



If you go to page four of CBA's presentation and read the source information at the bottom of the graph and table, you would notice there is an additional source on the international comparison - Demographia.



However, if the Commonwealth Bank had also used Demographia's analysis of Australia's house price to income ratio, it would have come up with a figure closer to 9 rather than 5.6 or 4.3.



The global strategist at international investment bank Morgan Stanley, Gerard Minack, says many of the figures used by various groups that argue Australian housing is not over-valued are misleading.



"Some of the material has been a little disingenuous. They have used a broader measure of income to calculate house price-income ratios in Australia than they used overseas, which is just an apples and pears comparison," he said.



"If you use the constant yard stick, either a broad-based measure of income, or just a more narrow focus such as wage income, they all pretty much show the same thing, which is we've seen a big step up in house price to income ratios over the last 15 [to] 20 years."



He says, on his figures, Australian housing looks very expensive against comparable countries.



"Adjusting for city size, we look around about 40 per cent more expensive than homes in the UK, Canada, New Zealand and Ireland," he explained.



"If I add the US to the mix, and the US has always had traditionally cheap house prices, we look expensive by about 85 per cent."



Another obvious problem with the Commonwealth Bank's domestic price to income figures is they compare average incomes with median house prices (unlike the Demographia figures that compare median incomes to median prices).



The median is the mid-point, effectively cutting out the highs and lows, and that means the average is generally higher when it comes to incomes and asset prices, because it includes the earnings of Australia's wealthiest people.



To put it another way: the Commonwealth Bank's figures count Ralph Norris' multi-million dollar pay packet on the income side, but not his (no doubt) very expensive house in the property price figures, thus understating the house price to income ratio for middle-income Australians.



The house price to income figures also compare disposable household income to house prices. This measure of income includes superannuation and imputed rent.



In plain English, imputed rent is the money home owners would have earned in rent if they leased out the home they live in, rather than money they actually receive.



Craig James was not a part of the team that drew up the Commonwealth Bank presentation - CBA told the ABC they were all still out of the country - but he says the figures do present an accurate picture of changes in prices relative to income over time.



"In terms of Australia as a whole, housing hasn't become more affordable or less affordable over the last five to six years," he said.



"We do know things like food, clothing, transport, normal household items are taking up a much smaller proportion of people's budgets over time, which means that they are better prepared to be able to put more money into housing."



But he seemed somewhat stuck when asked whether you could look at that trend another way - that increasing house prices have pushed down the amount of money people have left over to spend on consumption and transport.



"Yeah, I suppose there are different ways of looking at it," he replied.



"The simple fact here in Australia is that we have had real wage gains over a long period of time. You say the concept real wage gains to anyone across the world and they will look at you blankly. They just haven't experienced those sorts of things."



Another problem of comparing household income, instead of average weekly earnings, to house prices is that it masks the trend towards more dual-income households.



For instance, where one person on an average full-time wage could pay-off a typical house in Sydney a couple of decades ago, it now takes two.



That means Australians are working a lot more hours to pay off their home loans.



Stagnation 'a dream outcome'



The Reserve Bank has used the same methodology as the Commonwealth Bank in a report released this week to show that house prices have been relatively stable compared to incomes over the past five years.



However, unlike the Commonwealth Bank, the Reserve was willing to go back beyond the five-year period and hint there was a housing bubble in the late 1990s and early 2000s, that it leaned against at the time with policy statements and a series of interest rate rises.



An RBA graph of real dwelling prices highlights the rapid increase in property values, at a time when capital gains tax changes and the introduction of the First Home Owner Grant fuelled demand.



Prices roughly doubled between the mid-1990s and early 2000s.



The point the Reserve Bank does not publicly acknowledge is that prices have not come down relative to incomes since then.



While the Reserve Bank consistently denies the current existence of an Australian housing bubble, Gerard Minack argues the bubble that formed nearly a decade ago still needs to deflate.



He says the RBA is probably hoping house prices will stagnate for an extended period to allow incomes to catch up.



"My sense is that is what policy makers would be hoping for - a sense of stagnation to allow things like income to catch up to make home prices more fairly valued," he said.



"I can't speak for the RBA, but my sense would be this would be a dream outcome if they could stabilise house prices for let's say five or even 10 years and let income catch up.



"That would be a best case - far better to have that than to have outright house price declines."



One thing the Reserve Bank, CommSec and Gerard Minack all agree on is that Australian house prices are unlikely to collapse US-style in the short-term, provided unemployment stays low.



Citi Group's chief economist Paul Brennan also agrees, and says the reason is that Australians are unlikely to sell up at discount prices unless they absolutely have to.



"The real test is the ability of households to service their loans and, if we look at that, the Australian situation is that the level of housing arrears is extremely low," he explained.



But an outlook of stable prices is not so good for investors.



Gerard Minack warns prospective property punters that buying an over-valued asset never offers a good return.



His research includes tax office figures that show the percentage of landlords making a net loss on their properties has risen from 50 to 70 per cent over the past decade.



The vast majority of those loss-making investors are middle- and low-income earners.



That means they are relying on negative gearing in the tax system to offset some of those losses in anticipation of future capital gains.



But if those expected capital gains do not eventuate, there will only be losses for investors joining what Gerard Minack describes as Australia's biggest Ponzi scheme.