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Finance - Will the property bubble be the next to pop? |
The fallout from the booming 1990s is still being felt.
Two and a half years ago the hi-tech bubble in the US popped and the NASDAQ index is now down more than 75 per cent from its peak. The broader share market in the US is down 40 per cent and at the time of writing is still falling.
Share markets in Europe, the UK, Canada and Japan are down by similar amounts.
The Australian market, which did not rise as far, has had a more moderate fall.
The only reason we have not had a recession of any magnitude is that consumers remain confident and willing, apparently, to go into higher and higher levels of debt. With interest rate set to rise this remains an area of concern, both here and in the US.
In the meantime investors, like they did after the 1987 share market crash, have switched from equities to property, particularly residential property, in a big way. In Australia for example investors have tripled their presence in the residential real estate market over the past ten years.
Prices have been soaring right across the country with the biggest rises in Sydney and Brisbane. Prime coastal areas, perhaps experiencing the first wave of baby boomer migration, are also doing well.
But the Reserve Bank is getting nervous and has issued warnings that the boom is unsustainable. APRA, the Australian Prudential and Regulation Authority that looks after the financial stability of banks, insurance companies and superannuation funds (with a mixed success) has voiced concerns that lending institutions are being too aggressive and lending too much to borrowers. Some are apparently lending up to 100 per cent of the purchase price.
So can the boom be sustained? If not, will prices fall or just remain static?
Predicting asset price movements is always fraught with difficulty because so much depends on sentiment. Fundamentals, while they tend to triumph in the longer term, are often thrown out as the frenzied herd instinct takes over.
As any real estate agent will tell you, the property market behaves differently to the share market. With high government taxes and high agent fees, transaction costs are high. This tends to reduce turnover. In addition a house for an owner-occupier is a place to live. In a slump they are unlikely to sell if they don’t have to. They will often sit on their property for years waiting for the “right” buyer to come along and pay the price they think it is worth.
So instead of prices slumping dramatically they often remain static. In part this price resilience is illusion. If the owner seriously wanted to sell then prices would fall – often by as much as the share market.
Its apparent resilience can mean however that the market will remain depressed for years as the overhang of supply grows larger and larger. But even so this does not prevent property prices from falling in some instances.
At the end of the boom of the late 1980s, property prices at the top end of the market fell as the country went into recession and the bonuses paid to the high-fliers dried up. So what fundamentals do we need to consider in this boom? The first is the return to investors.
Ultimately the price of an asset should reflect the income return available to the investor.
In this case it means the net rental return.
Capital gains play a part but a rise in the value of the house should reflect what rental prospects are likely to be in the future and what returns are available from other investments.
If rental returns are likely to rise substantially in the future then the property should rise in price. If the returns from other investments do not look too good then this too can add to property prices.
In many areas of the market the prospect for higher rental returns does not look too good. Vacancy rates in Sydney, Brisbane and other areas are high and in some cases rents have actually been falling as landlords compete to find tenants. The net rental returns to landlords have been falling dramatically over the last two to three years.
If interest rates rise as they are expected to do, then other investments such as bonds and fixed interest will become relatively more attractive. This is not good for property.
But of course not all housing is an investment. People want to live somewhere and most want to own their own home. Rental returns are not really relevant. However the cost of housing is. Over the last 20 years the cost of housing has soared relative to average incomes. In fact it has doubled and is still rising. This is a huge change and is probably unsustainable.
In Sydney many people are now commuting to work from the Blue Mountains and the Central Coast simply because they are unable to afford Sydney’s house prices. The median house price in Sydney is now $388,000, up 22 per cent on a year ago. In inner Sydney the median price is around $700,000. Even in outer Sydney the median price is $320,000.
Rising vacancy rates, falling rental yields and growing unaffordability for potential owners is not a mix that suggests the boom will continue.
When the music stops, which will probably be when interest rates start to rise, the pain will start. We will feel it everywhere.
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