Will Australian house prices crash?
14 November 2008
Property ownership used to be an infallible investment strategy in the minds of most Australians.
With one third of Australians owning their own home outright and millions more paying them off, we have always held a longstanding belief that owning is better than renting.
Now, young investors are following their parent's love affair with property and buying investment property.
But with the avalanche of bad economic news in the US and now Europe, and falling house prices in the UK and the US, concern has been raised that Australian property prices are overvalued and could also crash.
Residential house prices peaked in 2003 and many commentators said the property sector was forming a bubble, which was about to burst.
It didn't. Interest rates increased and house prices were largely unaffected.
The reality is house prices increased dramatically in all developed countries. Australia simply followed the global trend.
Reserve Bank Governor Glenn Stevens told a business audience recently that housing is taking an increasing share of people's income.
He said house prices had softened and speculated whether the long period of household gearing may be at an end.
So why haven't house prices crashed in Australia like the US and UK?
Factors such as mortgage rates, population growth, economic growth and bank lending practices need to be considered.
Is Australia insulated?
Now there is evidence of a tightening of credit, which will stop householders getting loans without a larger deposit.
But despite all the economic doom and gloom, Australian house prices over the long term are still trending upwards.
According to the ABS, the weighted average increase of eight capital cities from June 2007 to June 2008 - an 8.2 per cent increase.
But house prices across the eight capital cities did drop 0.8 per cent in the March-June quarter of this year with Perth and Hobart leading the charge down. And they also fell in the September quarter.
The dream of owning your own home and paying off the mortgage has flow-on effects to the whole economy. With one third of Australians owning their own home, the average housing cost is brought down.
But there are isolated pockets of mortgage stress such as Western Sydney.
Surprisingly, the rate of default on loans is very small, compared with the United States.
RBA Assistant Governor Philip Lowe told a Retail financial Services Forum in Sydney last month that currently the banks' residential mortgage arrears of 90 days or over, is just 0.4 per cent.
In the UK it's around 1.3 per cent and in the United States, non-performing loans are around 4.5 per cent.
The IMF estimates only 7.5 per cent of households were spending more than 30 per cent of their income on housing, and had a gearing ratio of over 80 per cent.
Since the last crash in the late 1980s, low quality (low-doc) loans have made up a very small part of Australian banks' portfolios.
But we are not immune, with some of the major Australian banks recently reporting exposure to sub-prime securities and writing off hundreds of millions of dollars.
Local banks have also made a point of diversifying across a number of asset classes, which has ensured that their losses are minimal in comparison to that of their US and European counterparts - which is in the billions.
The difference between many mortgages in Australia and the US low-doc loans is Australian mortgages are variable and move in tandem with the cash rate set by the Reserve Bank of Australia.
But many of the US sub-prime loans were fixed with a low honeymoon rate for two years to attract borrowers.
So when the values fell, borrowers walked away from the houses reneging on their debt, and leaving banks holding empty houses that were worth less in value.
In Australia, low-doc loans only make up 1 per cent of all home loans and the IMF estimates that it would take a 15 per cent drop in house prices to increase mortgage defaults to 2 per cent.
House price bubbles?
But the reality of house price increases is quite different from the concept of a boom-bust cycle.
What appeared to be a bubble in 2003 in Australia was in fact, house prices catching up after a flat period.
Since the mid-1990s, the RBA reports the Australian median house price has risen 180 per cent from 1970 to April this year, compared with an increase of a little over 30 per cent in the CPI.
Experts claim that the demand for housing will not fall, keeping prices steady.
BIS Shrapnel's Chief Economist Frank Gelber, writing in the Australian argues property markets are not oversupplied.
"This is nothing like the late 1980s bust where property rents and prices fell sharply. Leasing markets are tight, rents strong and property values, while affected in the short-term by softening yields in investment markets, will hold up reasonably well."
That's probably good news for investors and householders and the next generation that have seen property prices on the upward trend since the early 1970s.
The IMF started calling the Australian property market overvalued at the beginning of this decade. However the recent report on Australia released by the IMF stated that house prices are now only moderately overvalued. And the IMF predicts that by mid-2009 house prices will be fairly-valued.
Australia is experiencing a high level of immigration and population growth and this has led to a high level of demand for housing. But a weak housing construction sector has seen supply of new houses fall throughout Australia, particularly in NSW, which is under-building.
Colonial First State's Hans Kunnen argues residential house prices tend to rise in steps and plateau out - but increases in house prices are due to a mix of tax and interest rates, and demand in Australia.
He adds we have a housing shortage in Australia with 200,000 migrants coming to Australia each year.
And now the RBA has also conceded that within the Sydney market, house prices can also be quite varied with Western Sydney experiencing double-digit falls in values, while other suburbs in the East and North have experienced smaller falls.
Deputy Governor Ric Battellino told the Housing Affordability inquiry this year that the increase in household debt has "been overwhelmingly driven by those households that had the greatest capacity to service it - middle aged and high income."
But it's not just the rich that are driving house prices, younger investors are following their parents, and there is also the demand from immigration.
The First Homeowners Grants (FHOG) - introduced by the Howard Government in 2000 - has allowed this generation of younger investors to gain a foothold in an ever expensive market, which has seen house prices in capital cities rise to over seven times average earnings.
In the Senate Select Committee on Housing Affordability held this year, the committee noted that the FHOG's has had an inflationary effect, which has benefited existing homeowners rather than those seeking to enter the market.
Now with each new generation gaining a foothold in the property market, it's hard to see prices crashing through the floor.
To Australians, their house is their castle, and they will do whatever it takes to make sure the walls don't come tumbling down.
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