Photo by: bitzcelt
This is the second post in my World-Changing Wednesday series. Tune is each Wednesday to read my thoughts on an issue which I think will have a huge impact on how we live our lives in the years to come.
Originally I had planned to talk about the U.S. Housing Bubble and how it collapsed in spectacular fashion over the last couple of years. However, having just spent three weeks in Australia I thought I’d focus on what I think could be another looming housing bubble…. this time in the land Down Under.
While I was in Newcastle, I spent some time talking to a couple of people about the property market. One friend who is sole provider for his wife and four children, has been unable to get a loan to build a house on some land he already has mortgaged. He was telling me that property was set to boom and that he wanted to get into the market now at all costs because he didn’t want to miss the boat. Despite being rejected for loans from all the major banks, he had managed to find himself a broker who was willing to be little bit creative to get him a loan. Is any of this sounding familiar? Like what was happening in the U.S. before the housing bubble popped? To say I’m worried for my friend is an understatement.
So far Australia has managed to escape recession and is one of the few countries not dragged completely into the global financial crisis. While I was visiting I really got a sense that nothing much had changed for most Australians and they were simply spectators to the global recession. There are a couple of reasons Australia avoided most of the pain. The most obvious one is China.
“Australia’s pre-crisis China boom meant both federal government and business balance sheets were in good shape when the shock hit. And, while export prices slumped, Australia has actually increased the volume of exports during the crisis thanks to China’s ramped-up demand for our iron ore and coal.” ~ The Australian
The second reason I think Australia has powered on through the global recession is that a large part of our economy is boosted by the housing sector which from all appearances is still going strong. As I travelled around the country I was consistently amazed at the prices being asked for properties. I thought I would spend a little time today looking into the housing market situation in an attempt to understand where property prices might go.
Australian Housing is Unaffordable
Australia currently has amongst the most expensive and unaffordable housing in the developed world. The following chart from Scott Reeve’s Economics and Share market blog shows how Australian house prices have grown far beyond household incomes, construction costs and rental yields. One has to wonder how this situation could possibly be sustained.
According to a new Housing Affordability Survey by Performance Urban Planning, Australia has the most unaffordable housing of all the nations surveyed. Not only that, but according to the report, Australia doesn’t even have a single urban area in which housing is merely “moderately unaffordable.” In order to determine what is affordable, the survey uses a ratio of Median House Price to Median Household income. A house is “Affordable” if the ratio is 3.0 or less and it’s “Severely Unaffordable” if the ratio is 5.1 or more.
Australia has a ratio of 6.3 which is “Severely Unaffordable” compared to the U.S. nationwide ratio of just 3.2. If you’re in the market for something just “Seriously Unaffordable” you should try Bendigo (4.8), Wagga Wagga (4.9). or the goldfields in Ballarat (5.0). The other 24 major urban areas surveyed are prohibitively expensive.
“Unlike the other national markets in the Survey,” the survey surmises, “Australia has thus far been able to avoid material house price declines. It seems likely that, sooner or later, the inherent instability and unsustainability that characterizes bubbles will lead to house price declines in Australia. However, were it possible for Australia to retain its highly over-valued house prices, there would still be a significant cost. Future generations would pay far more for housing than in the past, and Australia’s relative standard of living would decline.”
Here’s another chart from Who Crashed the Economy which visually shows the house price index in Australia compared to the U.S. This chart finishes at 2005, just prior to the collapse of the US market, but it really does show how inflated the Australian market was in comparison to the US pre-crash prices.
Australians are in too much debt
Australia has enjoyed prosperous times for a number of decades and as a consequence, individuals, companies and banks have taken on more and more debt. It goes without saying that the U.S. subprime crisis caused massive problems for the global economy. The Australian economy is also reliant on a buoyant housing market and with the huge amount of money the average Australian owes on their mortgage, things could get very messy if/when housing prices come down.
The following chart from Who Crashed the Economy compares Australia’s household debt ratio with that of the United States. While the U.S. may have had lower quality loans and lower lending standards which contributed to their housing crisis, Aussies have accumulated far more household debt and it’s growing fast.
Australian’s have over leveraged in order to buy into the great Australian dream of owning a home. The situation is precarious and anything which could negatively affect employment rates could bring this house of cards crashing down around us.
The Australian Government has been encouraging first home buyers
Since 2000, the Australian Federal and State Governments have been encouraging more purchasers into the market through handouts and stimulus packages such as the First Home Owner Grant (FHOG). In October 2008, the Premier of Victoria announced that Victorians who entered into a contract for a newly constructed home would get cash grants of up to $29,000 for regional areas. That’s a whole lot of money and you can’t tell me that these huge injections of cash from the government aren’t inflating property prices artificially. What happens later this year when the cash boost tapers off?
“COMMONWEALTH Bank of Australia has cautioned that the Federal Government’s sweetener on the first home buyers grant should not become an open-ended offer because it could encourage some into the housing market who may not be able to afford home ownership.” ~ The Age
Interest rates are set to rise
On 6 October 2009, the Reserve bank of Australia (RBA) increased the official cash rate by 25 basis points to 3.25%, making Australia the first developed nation to increase rates since the start of the global financial crisis.
“The International Monetary Fund is advising central banks to take pre-emptive action to control asset price bubbles by raising interest rates.” ~ ABC News
I enjoyed the interest rate holiday while it lasted but we had to know it was never going to be long term. I remember only 18 months ago that people were beginning to struggle with their mortgages when interest rates exceeded 9%. How many people jumped in and purchased a house when interest rates dropped and will struggle with repayments return to those higher levels?
What about demand?
The one thing I can’t quite determine is where the demand for property in Australia is heading. When it comes to property prices, most Australians think they only go in one direction. We have been lulled into a false sense of security by prices which have consistently grown by 5-10% for the last couple of generations. Apart from the Australian dream of owning their own home, many Australians see property as a sure fire way to get rich. This has certainly been true for the Baby Boomers but I wonder how the younger generations will fare when they are finding it difficult to even get into the market in the first place.
This chart from Wikipedia demonstrates what’s been going on in terms of population growth in Australia. This exponential growth has continued to put pressure on housing availability which has driven up prices to obscene levels. Most reputable sources predict further population growth over the next 40 years. In fact while I was in Australia, the news was announcing record growth this year with a new baby boom (no doubt stimulated by the Government’s Baby Bonus) and record immigration.
However, lets look at the ABS Population Pyramid for Australia in 2008. What’s interesting about this graph is that you can notice a definite ‘bulge’ in the population aged 35-60. This is the Baby Boomer generation moving towards retirement. This generation has amassed massive wealth over the last few decades of their working lives and much of it is in the form of property. As these boomers retire, often they will sell their expensive city properties and make a sea-change or tree-change move to more regional areas. This has the added effect of driving up prices in rural areas and small towns making it extremely difficult for younger people to afford houses.
I have to wonder what is going to happen as more and more retiring boomers try to sell their properties upon retirement. Will the generations coming through behind them be able to afford the prices they are expecting? Somehow I think not. There are simply not enough people in the younger generations to support a large retired population and to turn the boomers property wealth into cash. I think this will be a very interesting aspect to watch over the coming years.
- Australian housing is unaffordable compared to similar developed nations.
- Australian households hold records amount of debt.
- The Australian Government has been artificially inflating housing prices with grants.
- Interest rates won’t stay low forever.
- For the property market to continue to rise, buyers must be secure in their employment, banks must continue to lend at current rates and boomers must find property purchasers who are willing to fund their retirement.
Before making any decision to buy property, I would encourage everyone to consider these facts, but also do your own research. I have quickly put together some thoughts based on a three week visit back to Australia, but I’m sure there are plenty of experts out there who have undertaken more analysis on this issue. Just be careful not to believe Government, real estate or media spin. They have their own agenda which is growth at all costs.
Check out my previous article on the Creation of Money to understand why Governments and Banks must continue to grow debt.
Disclaimer: I do own property in Australia, however I am currently liquidating some assets. I don’t know what the market is going to do, but I do not see sufficient likelihood of further massive growth for me to consider holding out for more capital gains. For reasons I’ll probably discuss in another blog post, I am getting out of debt as fast as I possibly can.
Read more from me: