An Example of Over Inflated Property Values

Kris is putting the final touches to the November issue of Australian Small Cap Investigator, so I’m filling in today.

But so you don’t get too many withdrawal symptons, I’ve got a subject you’ll be familiar with…

Property!

You and me, we’re constantly bombarded by the media about the housing shortage. If that message isn’t in your morning paper, chances are you have a flyer in your letter box from a real estate agent, telling you, that there is a shortage of homes in your area. Followed by the question, “Would you like our company to come and value your home?”

Of course you would. To quote Darryl Kerrigan “It’d be nice to know what we’re sittin’ on, darl.”

Imagine how rich you would feel, with a bit of paper and six numbers telling you how much your address is worth.

People love to hear what their house is ‘worth’. But, the problem is, it’s not actually ‘worth’ that.

Whenever this subject comes up, and it pretty much always does, I use my little street I live in as an example of over inflated property values.

Nine years ago, the average price paid for a block of land was $80,000. Most of the houses built were fairly normal sized family homes. The average cost to build back then was about $160,000.

On those numbers you can assume that the average cost was $240,000. But these figures are pretty rough, as I’m not allowing for any deposits or other costs.

In December 2005, my neighbour put their house on the market. My friends in my area were blown away when we found out the new couple paid $495,000.

Mr. Smith and I smirked to ourselves, “Hmmm, doubling the original cost of building in five years? That’s odd.”

A few more years have gone by, and for whatever reasons, five houses have gone on the market this year.

Now, in a street of only 12 houses that is a lot. What was even more interesting is that the lowest price paid for one of those houses was $730,000. And the highest? $863,000.

Supposedly the first price of $730k was when the market took a breather and property prices were dropping back to ‘normal’ levels.

Even at the lower end of the scale, $730,000 is three times the initial cost to build. Three times the value in nine years?

That can’t be right, can it? The figures above means that in five years, the property had doubled in value. It had gained just over 106%.

Or how about if we look at it this way. The most recent price, when there was a supposed ‘dip’ in housing prices, means that in nine years the house was now worth 204% more.

204% more! No wonder everyone tells you that property is where to ‘stick your money’. With figures like that you would be mad not to invest in property.

But you see, that is the problem.

Thanks to the tax laws being changed in favour of investments properties, and add in easy lending and that has been responsible for driving prices up as well. And, you know how much the banks love lending against property.

A tale of mine that I bash around at BBQ’s is my own application for a mortgage.

When I applied, I was $10,000 short of what I needed for my house. But my ‘broker’ came to the rescue. He told me that all I had to do, was tell the bank it was an ‘investment property’ and the bank would lend me another $20k.

Guess what? I told the bank it was an investment property, and didn’t use the last bit of the draw down, leaving me ‘in credit’ before I had even made my first payment.

Stupid banks.

But, how did we get to this point? Why is housing so over inflated?

The price of houses simply can’t continue this rocket-like rise. You’d think the Australian government holds a Buzz Lightyear attitude to house prices – “To infinity and beyond” – because they keep bragging about how well our economy is holding up as a result of our strong housing market.

Newsflash Messrs Rudd and Swan. It’s not holding up. You’re keeping it there.

Don’t you remember why the first homeowner’s grant was introduced? At the beginning, it was to offset the cost of the newly introduced GST. However, that $7,000 did little to encourage buyers. So PM Howard decided to boost it up to $14,000.

At the time, some suggested the first home owners grant would add to inflation.

Have a look at the chart below. In the year 2000, you can see the start of year property prices started to sky rocket.

Before I move on from the chart, have a look at the period from 1990 – 1996. Property prices remain pretty stable through this period.

But then, just before the end of last century, our credit restrictions started to change. Do you remember hearing stories of dogs receiving ‘pre approved’ credit cards? Well, that was the beginning the loose lending.

At no other point in history have properties been so overvalued. Add to that over lending – like we have now – and you have yourself one over inflated property market.

This is a major part of the problem. There is too much easy money around to buy a home. Australia has been flooded with money from the banks and the government to buy a house.

That’s a funny thing about supply and demand though. The more there is of something, the less its worth. And the less there is of a product, well, then it’s worth more.

The amount of houses up for sale didn’t change. But the number of buyers did.

Buyers were able to flood the market. They had ‘pre approved’ bank loans and for some, the first home buyers grant.

And not much longer after the grant, came the 105% finance. This type of finance meant you didn’t need a deposit, or even the cash to pay stamp duty and legal fees. You could finance the ‘value’ of the house and the other fees that go along with buying a house.

After all, why wouldn’t you? Your house is only going to go ‘up’ in value.

I continue to read articles that Australia has resisted the recession, and our strong banking system will save us. That our economy has been spared, and our property prices will continue to soar at unprecedented rates.

(Cough cough) Excuse me, I’m choking…

We can’t hold these property prices up forever.

But, the government wants you to think that they can.

In fact, as of August this year, the mortgage market was worth about $763 BILLION dollars to only the four major banks. Just so we’re clear, that’s $763,000,000,000.

Can you imagine the chaos should our mortgage market fall over? The major banks would collapse and our economy would look as strong as a box of wet tissues.

The prices have been pushed so high, not by a property shortage, but from the fearless leaders in Canberra.

All the government has achieved by pumping money into the housing market – which has been done via home owner grants and easy tax laws for investment properties – has encouraged people to borrow more than they can afford.

Oh, I forgot, the bank said they can afford those repayments.

That means it must be ok.

But at least once a week I see an article in the mainstream press talking about the property bubble. Not only that, but the Money Morning mailbag is constantly full of reader feedback wanting to know when the property bubble will end.

Of course, I don’t know when the property bubble is going to burst. No one does.

But most importantly, if you take a serious look at what has driven the property market in the last ten years, you will understand that what goes up, must sometimes come crashing down.

Regards,

Shae Smith
Assistant Editor, Money Morning

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 dropped 2.90% on Friday, closing at 4,572.10. You can expect a quiet market today as traders and investors sit back and wait for the RBA decision’s on raising interest rates tomorrow. However, it’s expected that the RBA will raise rates 25 basis to 3.75%.

The Dow Jones Industrial Average closed at 10,309.92, down 154 points. Trader’s alarm of America’s exposure to the Dubai Debt saw a panic sell-off, but some money managers feel that this was an overreaction.

Despite the doom and gloom on markets around the world, in the UK, the FTSE100 finished up 51 points, to 5,245.73. The banking sector in the UK rebounded on Friday as traders showed little concern for the Dubai Debt crisis.

The Nikkei was driven deeply into the red on Friday, closing down 3.22% to 9,081.51.

The price of spot gold in Australian dollars is trading at $1,298.80, while in US Dollars it is trading at $1,177.67. The price of silver in Aussie dollars is $20.18 and in US Dollars it is $18.30.

The Aussie dollar versus the US dollar is trading at USD$0.9132, and against the Japanese Yen JPY79.14

Crude oil closed at USD$76.05

For the biggest movers on the market yesterday click here…

Tagged as: Australian government, australian small cap investigator, housing shortage, inflation, investment property, mortgage, property bubble, property prices, real estate agent, rudd, Swan