Christopher Joye | 28 Mar 2014 | http://www.afr.com/p/personal_finance/smart_money/property_prices_headed_for_record_gSdGyBWsYfyuDcVBwatptN
The $4 trillion Australian housing market is now overvalued by at least 10 per cent. Every day, valuations get more stretched. Indeed, Australia is just months away from having the most expensive residential property market in history. Anyone with exposure to the banks, which account for one-third of the sharemarket’s value, or to housing, should be focused on two questions.
When will a bona fide bubble emerge and how steep are the price falls likely to be when borrowing costs are normalised? After calling a housing recovery at the start of 2013, we warned that the Reserve Bank of Australia’s decision to slash its cash rate to a record 2.5 per cent low in August – opening the door to never-before-seen 4.8 per cent mortgage rates – would fuel double-digit house price inflation that risked blowing a destabilising bubble.
At the time, we argued the housing market was already “priced for perfection” – home values could not afford to outstrip incomes for any sustained period. Our worry was that if national prices expanded at, say, a 10 per cent annualised pace for six to 12 months, or more than triple wages growth, Aussie homes could become dearer than fundamentals warranted. So it has proved. Australian dwelling prices have jumped more than 10 per cent over the year to March 2014. In Sydney and Melbourne, which make up 55 per cent of the metropolitan population, home values leapt by 15 per cent and 11 per cent, respectively. Yet disposable incomes per capita only rose by 1.7 per cent over 2013.
According to a valuation benchmark regularly cited by the RBA – Australian house prices divided by family incomes – the asset class is three months from piercing the valuation peaks touched in June 2006 and June 2010. After both episodes, home values fell: by 6.1 per cent in 2008 and 6.6 per cent in 20011-12 according to RP Data.
The high watermarks set in 2006 and 2010 for the ratio of average dwelling prices divided by average disposable incomes per family is 4.5 times. When this newspaper started sounding alarm bells last year the ratio was 4.1 times. Taking the latest price data and assuming recent income growth rates, we get a price-income ratio of 4.4 times as at end March 2014. That is, 1.7 per cent off the peaks. Valuations are already 10 per cent above the average since 2000 and 20 per cent beyond than the benchmark since 1993.
Speculative activity on the rise
And there’s no evidence the boom is abating. In 2014, national auction clearance rates have consistently punched above 70 per cent – echoing the 2009 ebullience induced by low rates and the government’s first time buyers’ bonus. Speculative investment activity, boosted by self-managed super funds, is also on the rise. The RBA observed this week: “the share of households favouring real estate [as their wisest place for savings] has risen to a level approaching the early 2000s property boom”.
Notwithstanding ultra-low borrowing costs, the proportion of people nominating “paying down debt” as the best thing to do with their savings is back at pre-global financial crisis levels. In contrast to the first-time buyer craze in 2009, the current boom looks more like 2002-03. Investors make up the largest share of new loan approvals in Sydney since that time. The proportion of owner-occupiers using “interest-only” loans has crept up to over one-quarter, and buyers with deposits less than 10 per cent of their property’s value make up a remarkably high 15 per cent of all loan approvals (after slumping to almost 10 per cent in the GFC).
While sticking to its line that there’s nothing to worry about, the RBA conceded this week that “there are indications some lenders are using less conservative serviceability assessments . . . and signs of an increase in high-LVR lending among some institutions”.
Acknowledging a burgeoning bubble is awkward for the RBA given the conflicts between its monetary policy objective, which requires super-low rates, and its “financial stability” mandate, which is tasked with preventing imbalances, like destructive bubbles, being induced by abnormally cheap money. The governor has also questioned the merits of “macro-prudential” policy, which are tools that limit lending, suggesting rate hikes might be the best tonic. To get the discounted variable mortgage rate back to normal, which is around 6.6 per cent, the RBA would have to lift borrower repayments by 30 per cent. If inflation becomes an issue like it was in 2007, home owners could face variable rates over 8 per cent. Either of these outcomes would likely induce significant price corrections as buyers cut expectations of capital gains, which are being biased upwards by current experience. When prices do start sliding, it is not inconceivable that we could see unprecedented 10 to 20 per cent losses across the board.
This has ramifications for home owners and investors in the banks, which are, on average, leveraged 25 times and only need a circa 5 per cent fall in the value of the assets held on their balance sheets – 60 per cent of which are home loans – to have their equity capital wiped out. My message is: buyers beware.