How far will property values fall?
Up to 50% if you believe the latest doomsayer to hit our shores.
US researcher Jonathan Tepper has been wandering around the country telling anyone who’ll listen to him (including 60 Minutes) that Australia’s real estate market is in a bubble that will burst and wipe out up to half the value of property.
Tepper expects property prices to plummet at similar rates seen in the US, Ireland and Spain as a result of high debt to income ratios and overvalued property prices.
Is he right? Are we in for a property market collapse?
I’ll try and answer this with a Q&A.
What’s all the fuss about?
Firstly, everyone is asking – who is Jonathan Tepper? We’ve never heard of him.
He’s an English economist and author, who appeared on 60 Minutes and together with a local hedge fund manager posed as a gay couple (I don’t really understand why) to engage mortgage brokers in Sydney’s west, who apparently said the banks are easy to fool with loan applications and people are borrowing more than they can afford because of limited checks and relaxed lending criteria.
Citing the mining town of Moranbah as the canary in the coalmine, Tepper told stories of people who are badly exposed because they hold mortgages they can’t afford and are facing bankruptcy.
Tepper believes the Australian banks are in a potential debt death trap, highlighting concerns such as record household debt-to-income and price-to-income ratios, a dilution in lending standards, an influx of foreign buyers, record interest-only loan shares, unprecedented investor participation and valuations that are seemingly stretched well beyond.
Not surprisingly he’s advised his clients to “short” the banks – sell their shares in the hope of buying back cheaper later.
Over the past week a number of my clients and many media outlets have asked my opinion on these claims and only last night my sister, who knows little about property, asked:
“Is the value of my house really going to drop by half? I heard somebody on the ABC say that’s going to happen.”
Has this happened before?
Yes, it’s not uncommon for overseas “experts” to come here and predict economic Armageddon.
Only 12 months ago demographer Harry Dent came to Australia and incorrectly (for the third or fourth time – I can’t remember which) predicted our stock market would crash in the first quarter of last year subsequent to China’s stock market problems and this would be followed by a crash in our housing markets. He said:
“The real estate bubble is like a popcorn popper with different markets frothing over and peaking at different times, but all will burst ultimately.”
In 2010 Jeremy Grantham, founder of the $100 billion fund manager GMO, warned Aussie housing was a “time bomb” that was overvalued by 42%.
And back in 2008 during the Global Financial Crisis, Sydney Professor Dr. Steve Keen told us we were in a property bubble and house prices would fall by 40%. Instead they corrected by 6% and Dr. Keen was forced by Westpac’s Rory Robertson to hike 224-kilometre from Canberra to Mt Kosciuszko for his forecasting sins.
What is a property bubble?
Investopedia defines a property bubble as:
“A run-up in housing prices fueled by demand, speculation and the belief that recent history is an infallible forecast of the future. Housing bubbles usually start with an increase in demand in the face of limited supply which takes a relatively long period of time to replenish and increase.
Speculators enter the market, believing that profits can be made through short-term buying and selling. This further drives demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices – and the bubble bursts.”
For mine, bubbles are also accompanied by easing of lending criteria so loans are easily obtained leading to rapid rises in housing credit, with many people who can’t really afford to take on loans speculating and overcommitting themselves.
So are we in a bubble?
The simple answer is no and property values are not about to collapse.
Sure house prices are high compared to many parts of the world but rising prices per se don’t cause a bubble.
What is needed is for the rises to be fuelled by increased borrowings or leverage, which makes the banking system fragile and unstable.
Interestingly many of Tepper’s concerns have already been addressed by the Australian Prudential Regulation Authority, which has aggressively cracked down on our banks’ lending policies over the last 18 months and significantly strengthened Australia’s banking system.
Will property prices collapse?
No, not in general and yes, they will (they already have) in some selected markets with little owner-occupier depth such as in mining towns.
Why won’t property values collapse?
Remember for a property market to crash – and that’s different to price growth slowing as part of the normal cyclically correction – you need desperate sellers willing to give away their properties at fire-sale prices and no one willing to buy them.
To make our property markets crash we need one or more of the following four things.
- A major depression (not just a recession.) Nobody is suggesting this will occur.
- Massive unemployment with people not able to keep paying their mortgages. This is unlikely.
- Exceedingly high interest rates so homeowners are not able to keep up their mortgage payments. Again this isn’t on the horizon.
- An excessive oversupply of properties with no one wanting to buy them. Other than in a few spots this is not occurring in Australia.
Again, when I suggest property values won’t collapse I’m talking about well-located properties in our big capital cities, not mining towns where values are driven up by speculators, and without large numbers of home owners and multiple pillars of the economy underpinning property values. There is more hurt to come in these markets.
Aren’t property prices overvalued?
House prices are expensive but in the Australian Financial Review respected economist Chris Joye cites Bank of America Merrill Lynch’s Dr. Alex Joiner, who has demonstrated if you take the median house price in 1985 and adjust it only by disposable household income growth between 1985 and 2015 and the change in borrowing capacity over this period – via lower mortgage rates – you find that the 1985-adjusted value is 1% above current median prices.
So the change in incomes and interest rates since 1985 implies Australian housing is fairly valued or actually slightly undervalued.
This analysis is crucially predicated on interest rates staying at or below their present marks and if interest rates rise, then housing could be considered expensive. However, the bond market currently implies that over the next 10 years the cash rate will only climb by about half a percentage point.
What is likely to happen to property values this year?
After a number of years of exceptional house price appreciation, it looks like we’re in for a period of lower house price growth across the country, underpinned by expectations of lower economic growth, lower inflation, lower interest rates and slower income growth.
But there’s no likelihood of property values collapsing unless something unforeseen happens.
The reasons for this are:
- Despite the complaints of some first homebuyers, home prices are not overpriced and unaffordable as explained above;
- Our economy is strong and the envy of many countries in the developed world;
- Over 300,000 jobs were created last year, the second highest total for a calendar year since the turn of the millennium;
- The world’s large economies are sorting themselves out. While the world’s problems haven’t gone away, many of the global economic fears that plagued us over the last few years are now subsiding;
- Our banking system is sound, mortgage arrears rates are low and household budgets are in good shape;
- Inflation is contained and interest rates are low and likely to remain so for a while. Low interest rates encourage homebuyers and investors into the property market while at the same time allowing current homeowners to pay off their mortgages quicker;
- Our strong population growth underpins our economy and housing markets. Interestingly most of these new Australians want to live in our four big capital cities and in many cases in many of the same suburbs; and
- Other than in a few specific markets – especially high rise apartments and new housing estates in Melbourne and Brisbane) we do not have an oversupply of property.
Of course there is not one property market and as always some markets will perform better than others. But on the whole, a mixture of low interest rates, strong population growth, job stability, affordability and increasing confidence will have more people getting involved in property this year.
As long as I’ve been investing in property, and that’s over 40 years now, there have been doomsayers and “chicken little’s” warning the sky is falling. And the media lapped up their stories.
During those times of uncertainty, while smart investors and homebuyers were out buying the right type of property, others who were more cautious were sitting on the sidelines waiting to see how things pan out. While this may have seemed safe to them, they missed out on some great opportunities.
It is easy to do nothing … as Donald Trump says: “Nothing is easy… but who wants nothing”.
By the way…I’ll be explaining what I think will be happening to our property markets at my National Property & Economic Market Update one-day training sessions in five capital cities in March and April.
Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.