Australian Property’s Reaction to the Financial Crisis.

The last 6 months have been a real roller coaster ride for pretty much everyone financially, even more so for the people like myself who have tried to buck the trend and continue investing during these times. Whilst the majority of the hyperbole has died down over the past couple months there’s still a strong feeling of doom and gloom from a lot of people. This is despite signs that the property market, which was everyone’s favourite punching bag, is on the mend and the unemployment rates whilst increasing are not as bad as was predicted. This then begs the question: is there still potential for Australia to suffer a major hit to it’s property markets?

Ever since this crisis was thrust upon us by the collapse of the sub-prime market in America the outlook has been that Australia would soon follow suit with our property prices plummeting anywhere from a reasonable amount of 5% all the way up to 50%. The gap in speculation should show that no one really has a definitive idea of where the Australian property market will be going and depending on what data you use you will get a different story. The first problem that most of these predictions make is translating the problems that the American sub-prime market had and translating them to Australia. It’s really not that simple.

Let’s step back from the current crisis for a moment to study what lead to the economic crisis over in America. The straw that broke the camel’s back was the fallout from the sub-prime mortgage market. In essence this refers to the practice of lending to individuals who do not meet prime lending criteria and as such have a much high chance of defaulting on their loans. With the helping of insurance companies like AIG banks were able to repackage these liabilities as mortgage backed securities which then allowed them to put these high risk loans back on their books as assets. Banks are typically allowed to lend out more money than they have, and the repackaging of these loans means that they could then re-lend that money out to someone else. You can now see that when one of these loans went belly up it would have a much bigger effect than it would previously. Due to the way the loans were written at the time most of the home owners were on honeymoon rates for the first 2~5 years. After that they reverted to a much higher rate, of which most of them could not afford. What you then had was a lot of loans all defaulting at the same time, which brought the banks and insurance giants to their knees.

I can not stress enough how different this is to Australia. What the American banks were suffering from was a lack of capitalization, I.E. they didn’t have enough real assets under them to back up the money they were lending out. Banks in Australia do not suffer from this and can not perform the kind of magic accounting that the American banks did due to the much more strict regulation they have to comply with. Lending criteria in Australia is also much more strict than what America had prior to its collapse and was tightened significantly after the crisis hit (I got loans before and after the crisis hit, and the second time around was far more stressful than the first).

The next couple facts I generally see is that house prices are unaffordable and the current increases are merely due to a boost in the first home owner’s grant. Whilst I’m not going to argue that Australian property is cheap it’s definitely not as bad as some and with interest rates so low now renters are usually better off buying a house if they have the savings for it. The next 12 months will show us how the market is going as I will admit the figures are somewhat distorted by the FHOG extension.

At the heart of the doom and gloomers is a desire for more affordable housing for everyone and their idea of reducing house prices is for the market to crash so that everyone can jump in. With 70% of the houses in Australia being owned by the people that occupy them (with 50% of those having no mortgage) there’s not really a lot of pressure on the market to sell. The only sector of the market that stands to make a great loss, and as such would have motive to sell quickly and below market, are the investors. With only 30% of the market at real financial risk it stands to reason that the property market won’t be suffering too much price wise, but there are some other factors to consider.

When people can’t sell a property for what they want/need there’s few options left for them: refinance or rent it out. With the tight lending market currently you’re not going to see many banks offering favourable deals so many will choose to rent it out. What you will then see is a glut of rental properties which will put a downward pressure on rents, which we have already seen. This will continue for a few years until America and the worst hit countries find their feet again which, in my view, will lead to a short to medium term stagnation in property prices. In real terms this means a decrease in property prices in line with inflation over the same period, or about 3% annually. There will be no crash but housing will become more affordable.

The government on the other hand could easily make housing more affordable by releasing more land and pumping more cash into base infrastructure to get the new land releases fully serviced. One of my good friends just recently finished building a house in a new suburb in Canberra for which he purchased the land almost 3 years ago. This kind of delay in new housing puts an upward pressure on established buildings and is one of the many causes of the affordability problem. Right now would be the perfect time to speed up development of new areas as the market is primed for a influx of affordable properties.

So overall I don’t believe that the markets will suffer as much as the doom and gloomers believe. Whilst the potential is there for properties to come down in value there’s several key factors that are missing and without them a decrease in real value is all that aspiring home owners can hope for. As I’ve said previously though property is a long term investment and any hit that it might take now will be recovered in the years to come.

Times are tough, but not as tough as some would have you believe.

10 Comments

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  1. From the article you linked to “Canberra was the only city to post growth in rent for houses in the quarter, up 1.2 per cent, while the weekly rents for houses on the Sunshine Coast fell of 1.3 per cent.” Lol, sucks to live here…

    It would be interesting to see overall house price to income ratios for Australia wide. We don’t have quite low population density (even given we all live on the coast) and yet expensive housing. The x factor seems to me systematic efforts by our government to keep house prices high (and rising). Its benefited most people, esp the baby boomers handsomely but we’re only just beginning to see the effects: More young ones moving overseas, delaying having families, and a generation likely to be saddled in debt for the term of their natural lives, reducing their ability to give their kids a strong start. A classic example of short term political expediency winning over the longer national interest

    Unfortunately you have to be a ‘family man’ if you want to be elected (or ‘working mum’) and parents are the first to play the victim card (At the apex of our longest sustained economic boom in history Rudd still won voters over by telling them they were poor ‘working families’) In Tony Abbott’s new book he even has a sub-heading ‘how families have been forgotten’! Sure, its not easy raising a family, but people seem to have come to see government as the third breadwinner these days.

    Good post dave.

  2. The prime housing on the coast was the first to suffer in the GFC, as the first thing people cut back on are luxury expenses. It’s a lot more stable than it was before though, and a loss of 1.3% is heaven compared to what they’ve already lost.

    A quick and dirty Google of Australia’s median house price ($468,819) and median wage ($53,404) gives us a figure of 8.77 years worth of wages to pay off your average home. Rounding up and using the rule of thumb that you should only dedicated 30% of your income to your mortgage shows a loan term of approximately 27 years. Most people will tell you that the real affordable range is something in the order of 3~4 and seems quite appropriate using figures from 2000 ($143,900 and $30,470 giving 4.72). You would have to factor in higher interest rates though, which is why using this metric is flawed.

    Am I reading that last paragraph as a stab on middle class welfare? Surely not πŸ˜‰ But I agree with you in principal, all the families in Australia are spoilt a bit when it comes to subsidies from the government, but it is such an easy card to play. As someone who has decided not to start a family young (with an agreeable missus on the matter) it does irk me a bit when those who choose to start families complain about how hard it is financially. I’m not having kids until I can support them even if even I can’t work ever again. But that’s what you get from looking at kids as a financial investment rather than an loving bond with your partner.

    I think I might be a robot in disguise… πŸ˜‰

  3. It gets harder when you are in a similar position to me. I am at the point where I would like to own and live in an investment property (rent the second room out), because it would be cheaper; but that comes with a lot of responsibility.

    In reality I would prefer to rent somewhere in the city, but the cost is becoming more and more prohibitive. Rent is going up here in Canberra at a faster rate then inflation (in the city area not so much in surrounding suburbs).

    It’s just a nasty situation, baby boomers are realising they need to charge more on their tenants to make a profit / pay off the house, and the young renters are getting stuck with the burden. All the house prices here are also artificially inflated by all the public servants. It’s a ridiculous place to live. Nice for investors when you can get the capital, but not for the non investors πŸ™

  4. more land, more houses, more everything.. the idea that we must have growth constantly just seems flawed, how long can it possibly last?

  5. It’s interesting to note that a lot of the affordability crisis stems from the conflicting desires of wanting to own your own home whilst being in a decent location. For many the sacrifice is too great, especially when you can get a property that’s 5 minutes from you work. Believe me I’ve considered giving up both properties and renting closer, just because my quality of life would be that much higher.

    Unfortunately Canberra isn’t artificially inflated, it’s just damned expensive. There are many houses that are available in the mortgage belt areas that are cheap (many 3 bedrooms for $360,000) and when compared to places like Sydney, are extremely close to the CBD. Canberra has some of the highest earnings per capita due to it being the hub of government for Australia. Whilst this would seem to be “artificially” increasing the price of housing it actually means that your typical Canberran has more money than the rest of Australia. It does make the situation a lot worse for people trying to get their foot in the door however.

    I will admit the baby boomers aren’t helping the situation, but with many of them with little super their house is the last asset they have to ride into retirement. It sucks for us, but just think that in the near future there’ll be a glut of deceased estate properties for you to snap up πŸ˜‰

    As for the constant growth, we’re a warm blooded species just like any other and pro-creation is hard wired into us. As long as people keep having children we’re going to keep on needing more and more housing. There will be a point where the world can’t sustain anymore people and then those who are unable to feed themselves (or pay others to) then they will begin to die off.

    Technically speaking the world is quite capable of supporting a much larger population, we’re just not using the land as efficiently as we could. In reality the best thing for the world would be to live in large epicentres with high density housing, saving arable land for food production and reducing needless transportation. However that’s a radical shift from what we currently expect as a standard of life today and I don’t see change happening until it needs to.

  6. “There will be a point where the world can’t sustain anymore people and then those who are unable to feed themselves (or pay others to) then they will begin to die off.”

    yep, it’s happening right now, esspecially in the third world.

    The world population is projected to reach 9 million by 2050, and most of those increases will happen in areas where they are already strugging to support the population.

    Locally, we need to seriously consider how many people we can sustain in this country. There are projections out there, like in 1994 the Australian Academy of Science said that the limit of Australia’s population should be 23 Million (others like Tim Flannery have suggested 8 – 12 Million). Currently we are sitting on 21.3 Million with a growth rate of 1.7% p/a (higher than any other developed nation).. at this rate, we will have 100 Million people by 2100, 42 Million by 2050.

    And what is the government doing? we currently have no policy on population at all, in fact we have a pro-growth policy by default because theres a perception that more people = economic growth, which is simple not true (out of the top 10 richest countries in the world, 8 have populations lower than 10 Million)

    anyway, slightly off topic for this post, maybe population could be the topic of another blog post sometime, i’d be happy to talk more about it.

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