Are We In The Mother of All Dwelling Booms?

The jury’s out on whether Australia is entering the ‘mother of all dwelling booms’ as Robert Gottliebsen warned in Business Spectator last week.

While the construction sector continues to fall short of expectation, the established housing market has moved, most notably in Sydney.

Source: Phillip Capper via Flickr

Auction Report

War stories are emerging from buying and selling agents, who have attended auctions where prices have exceeded the reserve by 10-20 per cent. In turn, vendors are reassessing their value expectations based on neighbouring results. Amidst talk of future cash rate drops, purchasers are shopping lenders to see how far their budget will stretch.

Are We In a Bubble?

When prices start to rise – in some areas quite dramatically so – there is always heated debate over whether it’s a bubble.  The term itself is somewhat overused, perhaps because of the image it evokes.

A bubble gives the impression that the market is a flimsy airless balloon that will quite suddenly, irreversibly and dramatically pop. For some commentators, the very fact that this hasn’t yet occurred in Australia is enough to demonstrate that the theory is incorrect. In other words, you can only define a true bubble whilst viewing the devastating aftermath.

Source: Cordey via Flickr

However, a bubble or the recognition thereof does not have to fall into this definition. They are not always easily deflated, and there are plenty of different particularities between the policies and lending requirements that have played into house price corrections in other countries post-GFC, and those we have in Australia. 

Furthermore, in economies highly exposed to the residential sector, where central banks and governments have the ability to manipulate policy and the amount of cheap credit that flows into mortgage lending, it’s possible to prop and temporarily prevent falling house prices that would otherwise occur in line with a challenging macro outlook.

In Australia, this would include rising unemployment, lower prospects for wage growth, an aging number of retirees lowering the participation rate, and the gradual winding down of the mining sector, to name but a few.  While this will be relevant when moderating the level of price appreciation long-term, there are plenty of ingredients in the pot to ignite the current environment, which is causing a range of voices to warn of bubble-like conditions in fragmented areas of our established capital city terrains.

The Buying Market

The main force behind the buying market is a mix of investors and up-graders who, in turn, are boosting the premium housing sector using funds from the sale of lower priced properties to leverage up. When coupled with lower rates this reduces the size of their loan, distorting the forward analysis of lending data in relation to price growth.

In contrast, demand from first home buyers has weakened significantly. It waxes and wanes only on the back of various grants and incentives.

Each are buying for different reasons. As we know, in this sense, the environment has been nicely manipulated by supply side constraints, which keep Australia in a donut-like geographical outlook.

However, as Robert Gottliebsen points out in his column, and as I mentioned last week, a very low interest rate environment encourages investors to pull back on saving in favour of a spend/borrow mentality.  And in our property-obsessed culture, following years of woeful planning for population growth, most of this pent-up demand is being fed into the second-hand housing sector.

Price Rises

Price rises are more often than not fuelled by speculation that the next generation will pay double for the second-hand house in – how does it go – eight or so years’ time? And while population growth can push demand, as I’ve commented previously, actual house price appreciation directly stems from a higher proportion of mortgage holders, not necessarily home buyers, shopping within an area of limited supply.

In this respect, the money governments have donated through tax breaks to encourage investment into the established residential real estate sector, with policies such as negative gearing which has disproportionately inflated existing property values and created a growing gap between rental yield – rises of which cannot keep pace – is another area of significance which has propped up the prices. It’s also one of many policy measures that should be addressed if affordability were really an issue of concern for our competing political parties.

Speculation as a Market Driver

While there may be heated debate over the recognition of a bubble, in every instance speculation is a significant driver behind any of the said increases – which rings nicely with US economist Robert Shiller’s analysis. In his book “Irrational Exuberance” he defined a bubble as;

“a situation in which news of price increases spurs investor enthusiasm – spreading by psychological contagion from person to person, in the process amplifying stories that might justify the price increase attracting a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”

Entering the ‘Recovery Phase’

This mentality is evident when we enter what is so often termed the ‘recovery phase’ of our market cycle – usually after a period in which home values have declined in real terms.

It’s an interesting turn of phrase, because it gives the impression that prices have dropped so low they needed to be healed like a sick patient. However, seeing prices overshoot the mark as greed, along with expectation of another boom, inevitably takes a force on investor mentality is a common feature of this part of the cyclic psychology.

The Auction Mentality

The effects are often amplified in areas where auction sales predominate.  When buyers see properties openly selling above their pre-conceived perception of market value (something that generally doesn’t happen when the sale is conducted via private negotiation) it provides a very visible reality that the market’s appreciating and the effects on the mindset act like a kind of contagion.

Interestingly enough, the reverse is the case when a larger proportion of properties pass in at auction. This leaves buyers with the worrying impression that the market’s tanking.

During a competitive auction, buyers spend far less time thinking about exceeding budget constraints than they do when – in a rational ‘pre-auction’ moment, they take time to discuss (usually with their partner) where to draw a sensible limit for the property in question.

In truth, when the market is buoyant, and competition evident, buyers don’t bid for the property – they simply bid to win – something I witness weekly.

And of course, whenever rising prices openly occur, stock inevitably reduces. After-all, who wants to sell an asset that’s increasing in value, when the observation prevails that a vendor can get more if they hold and wait for further gains to come?  Especially as additional rate cuts are still widely predicted.

Foreign Acquisition

The other issue Robert Gottliebsen touches upon is foreign acquisition. The falling Aussie dollar has given Asian property investors an opening to look favourably upon dwelling investment in our capital city markets.

As reported in the Australian Financial Review last week: “A Sydney Property developer sold 90 off-the-plan apartments at the opening of a new tower in Bondi Junction in 5 hours.” While a large proportion of funds will be fed into off-the-plan construction, assisting developers in the approval process somewhat, it’s arguable as to how many of these new apartments will actually make it onto the rental market.  With limited options for investment, real estate acts like a magnate for Chinese buyers – who are not averse to purchasing speculatively whilst leaving apartments sitting empty. 

The Boom Cycle

There will be plenty of argument yet to come as to the level of the current boom and its longevity. But what cannot be argued are the conditions that took values to their 2010 peak following our golden decades of growth. These will not be replicated as we enter a very different and challenging macro environment than previously experienced – hence why I hold the opinion that we’ll see shorter durations to the traditional boom and bust market cycle.

Furthermore, while rising established house prices may be perceived as positive, particularly for those who want to downsize or tap into the equity, it is worth remembering that it’s doing little for the productive areas of our economy such as manufacturing, small business or job creation.

The oft quoted perception that the feel-good factor from rising house prices stimulates consumption has been disputed in several studies – the most recent of which can be found here.

Although those who purchased early in the 2000s have seen their assets boom, the consequences have forced a social divide as purchasers priced out are forced into areas where schools, transport and local amenities have not been funded to keep up with the flood of lower and middle income households in search of affordable options.

Rising Yields

Rising yields ensure renters find it particularly hard to locate close to work hubs (not to mention the pressure it puts on students battling for a university qualification), and unless we face up to the ‘non-voter friendly’ challenges that prevent sustainable solutions and reduce unwarranted inflation in the established sector at the expense of construction, nothing will change.

New Zealand, which is experiencing its own property boom (principally in Auckland), has released plans to moderate mortgage demand through speed limits on high loan to value lending. However, it’s widely acknowledged that without effective polices to enable home building over a wider footprint of land, first home buyers will suffer inevitable pain, and debate circulates as to whether it will lower prices in the long-term or just produce a blip on the radar.

Even if it were possible to effectively implement and audit similar restrictions – thereby tapering the flow of money into mortgage debt – it won’t necessarily stimulate lending for productive purposes.

Furthermore, although in real terms, values remain below peak, the property market chills at the thought of prices adjusting downward materially, yet not at the bank controlled credit creation process that inflated the huge increase in the first place (in so much as banks create money every time they make a loan, and then decide where the bulk of lending is directed – building up the price of their preferred assets at their own discretion). 

In this respect, it’s not the health of the housing market that needs to be tacked, it’s the disease. 

The Impact of Interest Rates

Lastly on interest rates, since November 2011 we’ve been on a downward rate cycle, some of which was only passed on in part by the banks. Yet it took until mid-2012 for any marginal improvement in median values to emerge (boosted by consumer confidence,) and only fairly recently have we seen a significant uptick. 

Despite it all the building industry is not picking up enough pace to compensate for the tapering of construction in the mining cycle, and we’re a long way from a point where the RBA can start raising rates to offset any unwelcome boom in established asset prices.

For the time being, existing owners and investors will continue to fuel demand, and despite loan service affordability costs improving, those looking to enter the housing market will continue to compete in a challenging and heated environment.