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Housing bubble

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There are some words that you are not supposed to mention for fear of causing panic. When it comes to the housing market, one such word is “bubble”. Yet this emotive label is being bandied around by all and sundry - and it’s getting attention and grabbing headlines.

History shows that market bubbles are never crystal clear at the time. If that were the case, runaway price increases would stop. It’s only when asset prices reach dizzy heights that a critical mass of people - economists included - agree that they are overpriced and due for a major correction.

As noted by economic researcher, Timo Henckel, from the Australian National University:

Economists disagree on how to define a bubble, or even whether bubbles exist. Intuitively, a bubble (and this applies to any asset, not just real estate) exists when the price of an asset is over-inflated relative to some benchmark. And here’s the rub: no one can agree on what that benchmark should be.

Consequently, no one can conclusively claim that Australia currently faces a housing bubble. Nonetheless, debate rages whether the Sydney and Melbourne property markets are in a bubble which is on the brink of popping. If you believe the naysayers, the imminent price correction will be devastating.

In the cold light of day, dire warnings of a housing market bloodbath do not reflect history. Australia’s housing markets are characterised by orderly growth-and-correction phases. There has never been a collapse of Australian capital property values in modern times.

Regardless, the media is replete with predictions of a hard landing for residential property. While the scaremongers continue to attract most of the air time by talking up the possibility of a crash, other commentators with more measured assessments should also be heard.

To this end, S&P believes that the east coast residential property boom will “unwind in an orderly manner, as has generally been the case over past property cycles”. The ratings agency added that a “sharp fall in property prices remains unlikely in the next two years”.

Similarly, a recently released home values report by CoreLogic-Moodys, forecasts that Sydney and Melbourne house prices will fall marginally between 2018 and 2020. During this period, Sydney home prices will decline by 1.4 per cent in 2018 and by another 0.9 per cent in 2019.

Sydney prices will rise again after 2020 but nowhere near the double-digit growth of the past four years. “Although we do not expect a steep decline in prices, Sydney’s property market will likely stagnate through to 2020 as interest rates begin to normalise,” the CoreLogic-Moodys report says.

Louis Christopher, MD of SQM Research and arguably one of the country’s most accurate forecasters of house price growth, recently stated that “the last downturn in Sydney was in 2004, where the market did correct a little bit that year and then stayed flat for an extended period of time”.

According to Mr Christopher, ongoing strong population growth in Sydney and Melbourne will continue to drive underlying demand for housing and should act as a buffer against any major correction. But not everyone is as sanguine about the future value of housing.

Dr John Hewson recently declared Australia has a property bubble. ASIC boss, Greg Medcraft, supports this view. Two years ago, Commonwealth Treasury secretary, John Fraser, also declared a bubble in parts of the Sydney and Melbourne markets. 

But at a banking conference in March, APRA boss, Wayne Byres, refused to utter the “bubble” word, instead opting for the “B-word” reference. “I don't use the B-word. I refuse to use the B-word,” said Byres. “It implies a binary, that’s too simplistic”.

Likewise, the RBA refrained from using the B-word in the minutes of its last board meeting, preferring to say there is a “build-up of risks”. That accords with the language of the big banks and is a narrative that I believe more accurately reflects the state of the housing market.

From a risk perspective, there are two macro-triggers that could give rise to a home price collapse. Widespread job losses would be one, but there is no talk of that. A rapid rise in rates would be another, but with low inflation and low growth, the RBA will want to raise rates gently to cushion households.

Monetary policy is a blunt tool with interest rate rises affecting both housing and business lending. So, the RBA is unlikely to push rates higher just to quell housing market exuberance. Doing so could push the Australian dollar higher plus reduce much needed stimulus to many sectors of the economy.

This is why the RBA has been working in concert with other regulators to assess and contain housing market risks. APRA and ASIC have been able to target segments of the market - such as investor and interest only loans - thereby negating the need for RBA intervention via interest rates hikes. 

In 2015, the RBA stress tested the financial resilience of Australian households to “macroeconomic shock”. The RBA concluded that even if house prices plunged by a quarter, likely losses for banks would only be “limited” because most of the debt is held by higher income earners.

When all is said and done, predicting the demise of the Australian housing market has become a sport. For fifty years, the pundits have been calling a crash. However, my considered opinion is that - in the absence of either a recession or much higher interest rates - a property crash is highly unlikely.

 

Regards
Paul J. Thomas, CEO

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CEO Paul Thomas