Sorry folks, this ain’t no property bubble

I have been predicting the collapse of the Australian property bubble, so feel obliged to also present the opposite view. Nothing like confirmation bias to screw up a good investment strategy.

Here Jessica Irvine argues that the property bubble will not burst:

Believe me, no one is keener than me to see a property bubble burst.

But sadly – for would-be buyers, at least – I just don’t see it happening.

Sure, there are risks.

If it turns out that banks have been lending to people who really can’t afford it, then we have a problem when interest rates start to rise.

Experts have been calling the end of the property market for years. But banks insist they stress test customers for a 2-percentage-point rise in interest rates and require “interest-only” borrowers to prove they could afford to repay principal too, if required.

More worrying is the mortgage broking channel, where a recent ASIC investigation found most of the high loan-to-value loans are written. If there is a weakness in the housing market, it’ll be in this area of lending standards and so called “macroprudential” policies when interest rates start to rise. The recent clamping down on investor loans is welcome.

But ultimately, the defining thing about bubbles is that they inevitably must pop.

But where is the trigger for a widespread home price collapse?

In a world of low inflation and growth, the Reserve Bank is likely to raise interest rates very gently, cushioning households.

Widespread job losses would be a trigger, but there is no talk of that. With record low wages growth, labour is hardly expensive at the moment.

Bubble proponents point to very high household debt levels relative to incomes. But the structural lowering of interest rates in the late 1990s and again after the global financial crisis has increased the amount of debt households can afford to service from a given income.

Lower rates have also helped many households build significant “buffers” against future rate increases, in offset accounts and other forms of saving.

Bubbles form when asset prices disconnect completely with market fundamentals.

But there are very good reasons to expect housing to be so expensive.

Forget the Cayman Islands, housing – owner occupied and investment housing – offers the best tax shelter around, from negative gearing and the capital gains tax discount on investment housing to the complete exemption of the family home from capital gains tax AND from the pension asset test.

Meanwhile, rapid population growth has been met by sluggish increases in housing supply. Incompetent state governments have created a premium for inner-city housing, where buyers can avoid paying the indirect costs of long commutes.

In the aftermath of World War II, home ownership rates skyrocketed as governments focused on supply.

But since then, governments have instead implemented policies that boost only the demand side of the equation, with tax concessions and cash bonuses for buyers that only increase prices.

Absent any trigger for widespread forced property sales, home owners will always respond to sluggish market conditions by sitting on their properties for longer. Lower volumes provide a cushion against falling prices.

In such a market, the best a first-time buyer can hope for is that future price gains might come back into line with income growth.

Indeed, that’s exactly what happened after the early 2000s property boom when Sydney prices stagnated for almost a decade.

It’s less exciting, but more likely.

Jessica makes a good point about offset accounts which may cause real household debt to be overstated. This warrants further investigation.

But she seems too complacent about market fundamentals:

  • an oversupply of apartments;
  • negative gearing and capital gains tax advantages that could be removed by the stroke of a pen (or a tick on a ballot paper); and
  • prospective sharp cuts to immigration (again dictated by the ballot box)

Interest rate rises seem unlikely in the near future as inflationary pressures are fading. But I doubt that new homebuyers could afford a 2 percent rise in interest rates, that would amount to an almost 40% increase in monthly repayments for some. Even if they survive, repayments will take a big bite taken out of other household consumption and hurt the entire economy.

Also, the RBA may plan to increase rates gradually, to cushion the effect on homeowners, but Mr Market could have other ideas. And if you think central banks act autonomously from markets, think again.

Source: Sorry folks, this ain’t no property bubble

8 thoughts on “Sorry folks, this ain’t no property bubble

  1. […] economy is still exposed to a property bubble and APRA is likely to keep the pressure on banks to increase their capital reserves, which would […]

  2. ColinTwiggs says:

    When discussing market fundamentals, I failed to mention the elephant in the room: China. Summarized succinctly here by David Llewellyn Smith at Macrobusiness:
    “…. if China suddenly hit a debt and building brick wall, then it’s on like Donkey Kong as the terms of trade collapse triggers a housing bust and global repricing of Australian risk.”

  3. ColinTwiggs says:

    In other words, low wage rate growth is a sign that the economy is under stress and job losses may be coming around the bend.

  4. ColinTwiggs says:

    To answer your question. Rates aren’t normally rising in times of low wage growth, they are usually falling.But that is a sign the economy is under stress, not a sign of strength.

  5. ColinTwiggs says:

    Thanks Craig. He’s one of my favorites too 😉

  6. Craig Watson says:

    The author argues: “Widespread job losses would be a trigger, but there is no talk of that. With record low wages growth, labour is hardly expensive at the moment.”

    To play devil’s advocate, isn’t record low wage growth the argument for increased stress in a rising rate environment? Aren’t “record low wages” a limitation on rising prices for homes?

    OR, to quote one of my favorite technicians……
    “The quick rule-of-thumb forecast — Private sector employee payroll x Average Hours Worked x Average Hourly Rate — has proved remarkably accurate and has become one of my favorite indicators.”

  7. frankaquin0 says:

    Hope she’s right (I think).
    But when I read “…mortgage broking channel,…” I read Freddie Mac and Fannie Mae.

    • ColinTwiggs says:

      The RBA brought out a paper in 2015 that discussed the impact of mortgage offset accounts and the extent that real household credit may be overstated. The graph below shows household credit before and after adjustment for mortgage offset accounts.

      Housing Credit & Net of Offset Accounts

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