Beware Australian Housing - the debt bubble will burst

(*Note: this post is a rough draft and will be edited/added to in the coming weeks. More new posts will come around mid March)

Australian Housing Bubble?

Almost no other economic topic right now, is as hot and contentious as the direction of Australian housing.

I have come to the conclusion that Australian housing prices must fall, indeed all property prices (commercial, industrial, rural). Demographics, low interest rates, "a housing shortage", historically low interest rates, first home owner grants - cannot stop the direction of the market forces. Both debt and lending are now imploding.

Housing prices, just like the sharemarket go through cycles between boom and bust. However, in Australia I believe we have become very complacent. We think property is a sure fire way to wealth. We believe its normal for prices to increase 5 percent or 10 percent per annum (just like we believe we are recession proof because we haven't had one since 1991). Throughout history house prices have always busted after times of major credit (debt) expansion. A crash will come to Australia soon - its just a matter of timing. Timing is everything.

As Warren Buffett once said,

"You only find out who is swimming naked when the tide goes out."

The tide is well on its way out. Full employment is the key for most individuals on whether they can weather the storm. For others the size of total debts will prove the Achilles heal.


Unaffordable Housing

Australia right now has amongst the most expensive and unaffordable housing in the developed world. The reason it's so unaffordable is that four letter word, D-E-B-T. As we have had economic good times since the early 1990s, individuals and banks have felt more and more comfortable to take on my risk and more debt. With such a long period of job security (for most), we foresee our future to be bigger and better than the past.

As an example I once used, during the mining boom, Perth had a stella rise in housing prices. Miners were flying in and out of Perth and getting paid over $100,000 p.a. to drive a truck. With more and more people on higher incomes, inevitably the housing prices in Perth rose strongly against all the other major cities. To secure their dream home close to the city, buyers out bid each other and took on larger mortgages. Now that the mining boom has come crashing down, where is a mine truck driver going to find a $100K job to meet their mortgage repayments?

Right across Australia, how can the retrenched workers keep their mortgages?
Banks whom are tightening who they lend to... would they now give a mortgage to a low-wage metals factory worker in Western Sydney?
All of a sudden in the last 6 months, Australian individuals and banks have changed their outlook from that of increasing wealth to a complete reversal. Alarm bells are ringing. Some are asking questions about the future. Too many think things won't get bad here. Just like the patriotism we see on US news networks, many Australians think "everything will be different for this time, the Australian economy is strong and resilient!"...

As chart 1 shows below. Real house prices have vastly outrun real wages for the last 25 years. Even more startling is rental yields have just been so low. Negative gearing is one of the big reasons why rents have remained much lower than where they should be (but I will save rent discussion for another time).

Chart 1: Australian Real house prices, wages, construction costs and rents.

Australian housing vs the world

Australia has the most unaffordable housing – study confirms

A group called Demographia released a 'Performance Urban Planning' report ranking property affordability across various countries. The report concluded that Australia has the most unaffordable housing of all the nations surveyed. The report simply used a ratio of Median House Price to Median Household income. A house is "Affordable" if the ratio is 3.0 or less. It's "Moderately unaffordable" if the ratio is 3.1 to 4.0. It's "Seriously Unaffordable" if the ratio is 4.1 to 5.0. And it's "Severely Unaffordable" if the ratio is 5.1 or more.

Results: Australia sports a ratio of 6.3, which is both "Severely Unaffordable" and "Seriously Daloob." New Zealand comes in next t 5.7, followed by Ireland at 5.4 and the U.K. at 5.3. Owing to its large number of metropolitan areas in which there is a wide variety of median prices and incomes, the U.S. nationwide ratio is just 3.2.

On a city basis: The Sunshine Coast in Queensland is the least affordable. The Gold Coast came third, behind Honolulu, and Sydney was fifth, behind Vancouver. Melbourne and Adelaide were equal 12th and were still less affordable than New York (14th), London (16th) and Dublin (32nd).

(More on this survey, including a table of least affordable cities can be seen at Daily Reckoning)


Graphs of concern:

To put more of a perspective on Australia's housing bubble the following graphs compare Australia to some of the other developed countries, which have seen large declines in recent years.

Chart 2: Compared to the United States, Australian households are much more weighed down by household debt.

Chart 3: House Index - Aus, US, UK

Chart 4: Like Japan?


And the big daddy of all graphs (also seen on Chris Martenson's economic crash coarse series)

Chart 5: The history of US housing (in inlfatoin-adjusted terms) since 1890.
The picture speaks for itself. The recent housing boom and crash in the US has been like no other before it. Notice the 1970s and 1980s bubbles came back to pre-bubble levels when it burst. The US is in completely uncharted waters. A graph of Australian housing would look worse than this chart.
Chart 6: This is what WhoCrashedtheEconomy worked out
Australian household debt

If we think subprime was a mess in the US, things could potentially get much worse in Australia when housing prices come down. Indeed, a recession (an ultimately a depression) in Australia is tied to Australian housing (more than anything else). We just have too much debt tied to housing (inflated mortgages)!

Household debt as a percentage of disposable income

Household debt in Australia is alarmingly bad as Alan Kohler pointed out late last year.

In Australia the total debt to GDP ratio is at 160 percent, compared to 100 percent in 2000 and 50 percent in 1980. Household debt to disposable income is over 150 percent, compare to 50 percent in 1990.

Chart 7: Australian vs US household debt
The US reached a height of around 130. Australia has gone over 160. It doesn't matter if we don't have a high level of sub-prime loans in Australia - we are up to our ears in debt.

Once Australia's unemployment rate reverses from around 4% (if you believe that number) and heads towards 6 or 10 percent, housing prices will come down. Australian's are over leveraged to their houses, by taking out huge mortgages to pursue the Australian dream. Few people have taken into consideration that they may loose their job along the way. With no sound income, many Australian's will have no choice but to foreclose on their mortgage. Banks won’t want to hold empty houses, so an avalanche effect can take place when the banks flood the market with discounted homes.

Housing market tends to crash after the sharemarket.........

Sell the holiday house first?

Last year just before Xmas, I was holidaying on the southern coast of New South Wales. The town was, Tuross Heads, a small beach house/fishing town near Bateman's Bay with a population of about 2,000 people. I have never seen so many houses for sale in one spot. In some streets it was nearly every second or third home with a "For Sale" sign on the front lawn. If people expect house prices to come down, is it plausible that people will sell their beach house/investment property first? Is this a sign of the top of the bubble? With one in every 2 or 3 houses for sale in the street, the first couple of sales would impact the selling price for all the other houses in that street. Perhaps this is one reason why property prices (like shares) can fall so quickly if sellers are massing at the front gate. It's better to get out early, then to get out after everyone else.

Since this trip, 'For Sale' signs have become common place around many towns and suburbs. When I went home for Xmas, I noticed nearly 1 in 3 homes/BnB's/holiday houses along a river stretch was for sale. This is a visual sign that things are shifting...

But Australia has record demand for housing!

Some argue that Australian household prices will continue to hold its ground or gain in value in the coming years because we have record immigration levels and demand for housing.

Chart 8: Alan Kohler ABC News 28 November 2008

For a while I felt this argument had some traction. I've come to realise that this will probably not be. If anything, strong housing demand will mean much higher rent prices in Australia. Strong demand does not mean higher prices. For instance, world silver prices are falling right now, but there is now a 10 to 16 week wait to take delivery of silver from a bullion dealer. Silver demand has never been stronger. Prices can disguise real value. There are always market manipulators at play trying to influence under-educated investors, and one of the worst in the housing market is the Australian Government.

2007: The falls have started

Despite record high immigration levels and strong support from first home buyers, Australian housing prices fell in all states except South Australia and the NT.

Chart 9: House Prices 2008
Chart 10: Doesn't matter how you measured it - Australian housing prices will continue to fall.

Australian Government encouraging first home buyers

The Australian Government continues to encourage (through handouts and stimulus packages) Australians to jump into the property market. Buying a property is big investment decision, and unfortunately many buyers do very little due diligence.

I believe the first home buyers grant is extremely irresponsible. (Will add more on this soon)


Housing Deflation - The key ingredient is bank lending (more to come on this section)

There must be liquidity of buyers in the market who can absorb selling pressures. If buyers dry up and widen their spread, price deflation will take hold. Once buyers expect prices to come down $100,000 or so, they will sit back and not participate. In effect you get price deflation (prices fall quickly because you only need a few sellers in the market
without liquidity - home financing + willing buyers (who can absorb selling pressures) - the market falls

In a housing bull market, buyers compromise to the seller. For example is a home is advertised as $500,000, but the nearest buyer is at $490,000 (the spread is $10,000), the buyer is more likely going to raise their offer to $500,000 to get in before someone else.

However in a housing bear market, sellers start to outnumber buyers. Price spreads widen because buyers are no longer willing to take on increased amounts of debt because of uncertainty in the job market and wider economic conditions (ie. what we have today). But the key is expectations. If buyers and sellers start to expect prices to go down (such as selling lots of for sale signs and data which shows this), sellers start compromising and sell to the nearest buyer. eg. if the seller wanted to sell for $500,000, but the nearest buyer is $450,000 ($50,000 spread), they they are likely to do so, particularly if they are forced to because they have no job and the bank repossesses the house. In effect we end up with price deflation (asset destruction) - buyer liquidity dries up and prices fall rapidly (like in the US housing market today).

Price deflation has already hit the Australian sharemarket, with many small stocks registering very few trades now, because buyers feel safer to stay on the sideline. Those holding stock also want to exit the market and will sell at almost any cost to get out and switch to an alternate investment. In the housing market, more pressure will come onto the rental market. Rents will continue to inflate, while the underlying asset value of the house will fall. In effect rental yields will become more attractive over time (as they have been historically low).

Chart 11: Interbank Lending



The value of Australian housing prices in Gold and Silver

A few blog posts back I measured the All Ordinaries in terms of Gold and silver which showed that the Australian sharemarket actually peaked in 1999. It has only been going up in fiat currency terms (until the last year). The same applies to Australian housing. Australian housing has peaked and made plateau (stage 3 consolidation) between 2001 and 2005.

Chart 12: Just like the sharemarket, gold gave early warning signs a few years ago.


The data I have (till 2006) shows that Australian housing has fallen by 38 percent in terms of gold.

In 1986 you needed 208 ounces of gold to buy an average Australian home. At the peak of
the cycle, in 2004 you needed 923 ounces of gold to buy an average Australian home.

(silver chart to come shortly)


Conclusions:

- Debt, debt, debt. Australian's have way to much and its tied to our home prices. The world will continue to witness destruction (deflation) of debt ridden assets. We have seen it in the sharemarket. I will ultimately come to property.
- The ability of banks to lend (debt) is paramount.
- On the buyers side – liquidity (amount) of buyers must be outnumber sellers for prices to hold (and continue to go up). If buyers expect prices to fall, they will widen their spreads and price deflation will set in.
- On the sell side – Unemployment levels are the key, however the type of employment in the economy is critical. If people go from full-time to part-time or casual, or no employment whatsoever, they will be most vulnerable to defaulting on their mortgage. These sellers will sell to the nearest buyer regardless of price offered.
- Holiday houses and the most expensive houses in the cities will be most vulnerable.
- Many regional communities that rely heavily on commodities could face dramatic price declines if the commodity prices and shipping movements do not rebound very soon.
- Perth is the capital city most at risk. Canberra is probably the least at risk. In the long run, all areas in Australia are not immune.
- Above all, do not rely totally on what the Government says, the media, or myself. Everyone must do their own due diligence and come to their on conclusions and act accordingly. The free market is emotionless and does not care if you make money or loose money. Take responsibility into your own hands.

Cheers
Scott


[The 4 Corners program had a look at how the financial crisis has hit Australia so far on Monday night. Worth a look]