No Evidence of a “Chronic” Undersupply of Housing

If you’re one of the many Money Morning readers suffering from property and housing withdrawal symptoms then don’t worry, because this morning we’re back on the bandwagon.

And if you’re one of the many Money Morning readers who’s glad we’ve stopped banging the housing drum then all I’ve got to say is, “Sorry, we’ll have a non property article for you tomorrow.”

Since we last stuck the boot into property a couple of weeks ago there have been more ridiculous headlines from the property spruikers than we could eat.

We had intended on keeping a record of them, but we figured it was a waste of time as it’s basically the same story being recycled every day:

“Sydney property prices set to double” – News.com.au

“Up to half of Sydney homeowners are set to become property millionaires, with house prices predicted to double in the next decade” the article claims.

Ah, we remember the good old days when striving to be a millionaire meant something. And when being a millionaire was based on net wealth rather than phony wealth.

You still see stories from time to time, the amazement when some old hermit pops their clogs and newspapers announce the deceased had been sitting on $5 million in cash which has been left to the local dog’s home. And the annoyed family wishing they’d paid more attention to stinky old grandpa.

But the future will be different. In the future there will be the same stunned amazement, except when the apparently wealthy old codger kicks the bucket eager relatives will find out the “millionaire” uncle hasn’t been lording it on a pile of cash.

Instead, they’ll find out he’s being chewing away at a $5 million equity finance redraw reverse mortgage facility. There goes the inheritance. His only legacy is for the family to scramble over who has first dibs on his underwear drawer!

“It’s equity mate!”

Anyway, we left you yesterday with this comment:

“[W]e quite often hear from readers who tell us that the best position to be in right now is to have oodles and oodles of debt. That the last thing you want to be is a net saver. At face value, there’s something to be said for that argument. However, as we’ll point out tomorrow, it’s not quite that simple.”

The argument goes that you take out as big a loan as possible, and over the course of ten, twenty or thirty years, hyper inflation, or even just normal inflation will help you pay off the debt.

As we said, there’s something to be said for the argument. We’ve heard a number of contrarian US commentators offer much the same advice to US home owners – more on that in a moment.

The problem is that it isn’t quite that simple. In the US, you’d be mad not to follow the advice. Especially when buyers can lock in a 30-year fixed rate for 4.875% for properties in Florida.

And if the loan is non-recourse then it’s even better.

With a rate as good as that, and with property prices already having slumped, buying property in the US should be a doddle. And thanks to inflation nipping at your heals, soon enough buyers will be left paying peanuts.

That all sounds pretty good right? Not quite, but again, more on that later.

In Australia, the case for leveraging up as much as you can isn’t as sound. For a start, prices are still sky high. Even the spruikers acknowledge there hasn’t been an Australian housing price crash so there’s no need to dwell any further on that point today.

Second, your fixed rate choices aren’t quite as good. Commonwealth Bank has a 15-year fixed rate mortgage charging 8.44% interest. With variable rates two percentage points lower, few home buyers would be prepared to pay the extra.

Not when the mainstream commentators have convinced the masses about there being a new “normal” rate of interest. Trouble is, it’s not “normal” at all. It’s completely abnormal. Almost grotesque in fact.

But anyway, the real problem with befriending inflation or even hyper inflation is three fold. First, you’ve got to have a fixed rate loan, ideally for the term of the loan.

But then there’s the second problem. In order for you to really “benefit”, the period of hyper inflation needs to kick in while your loan is still outstanding, the earlier the better. Plain old normal inflation just won’t cut it.

Even if you accept that housing is a hedge against inflation – which we don’t – then over the course of your home loan you’re still paying twice the cost of the property when you factor in the interest.

In other words, you need the value of the property to double just to break even.

The third problem with embracing hyper inflation is that all your other costs of living go up. Even if you managed to score a gain by locking in a fixed rate mortgage.

Can you imagine your weekly groceries bill going up from $200 to $5,000? Or your monthly electricity bill climbing from $90 to $850? Or even taking the train to work costing you $3,000 for the weekly fare rather than $80?

I know that may sound like crazy talk, but those are the sort of numbers you’ll be looking at if hyper inflation did take hold. Hopefully it won’t come to that. But can you see what I mean about the madness of wishing for inflation or hyper inflation?

But let’s set aside the pie-in-the-sky stuff. The stuff that hopefully won’t happen.

You see, there is another possible outcome. And that is the possibility the house you’re leveraging yourself up to the eyeballs in, the asset that you’re paying twice as much as the market price for, may not give you the kind of returns you’ve been promised.

Let me just repeat that one point first. When you buy a house with a mortgage, you’re paying twice the market value. That point, never mentioned by property spruikers shouldn’t be forgotten.

So, what if Sydney house prices don’t double by 2020? What if Melbourne house prices don’t rise by 10% per annum? What if the population of Australia doesn’t reach 50 gazillion by 2050?

And what if there isn’t an undersupply of housing?

We’re just asking. I mean those are all the arguments put forward by the spruikers to claim that house prices will always rise.

But as we look at those scenarios we’re trying to pinpoint which one of those inputs is iron-clad guaranteed to happen.

Let’s take the old favourite about there being an undersupply of housing. We’ve chosen that one simply because we could easily find the numbers to counteract the argument.

The numbers bandied around recently have been extraordinarily, erm, unscientific. Not that we’re making any claims to being the Sir Isaac Newton of property forecasting of course.

But anyhoo, we decided to run a few numbers…

According to the Australian Bureau of Statistics (ABS), the population of Victoria increased by 113,900 for the year until the end of June 2009.

Then if we look at the number of ‘dwelling units commenced‘ during the same period we’ll see that 41,900 dwellings began construction during that time. Even if we slide the commencements back a few months to take into account a nine month lag between commencements and completions, we can see the number is broadly the same – 42,451.

If we take an average of those two numbers, that works out as around 2.7 people per dwelling constructed. Which isn’t far off the ABS estimated household size of 2.6 people per household.

And then, during the same time, according to the numbers from the Victorian Valuer General, there were 96,426 sales of houses, units, apartments and vacant house blocks.

Now, not all of those house, unit and apartment sales would have just been churning between existing Victorian residents. There would be people leaving the state, entering the state, selling investment properties, buying investment properties, building one of those 40,000 new homes, and even – R.I.P – some deceased estates.

What we’re saying is, we’re still yet to see any evidence of a “chronic” undersupply of housing. What we can see is a rabid and irrational belief that house prices always go up.

To our way of thinking it’s not a chronic housing shortage that’s pushing prices up, it’s the availability of easy credit and no comprehension of risk by buyers of taking out a recourse loan – although perhaps the golden years of easy credit could be coming to an end, we’ll see.

So, as I say, imagine that all the things the property spruikers claim to be true aren’t true. What will happen then? Well, is it possible we’ll experience what the Yanks are going through with their housing bubble and crash?

This morning we jumped on to www.realtor.com to take a look at what a few thousand dollars will buy you in Michigan.

A three storey, four bedroom, two bathroom home in Detroit selling for… USD$89,900.

Don’t get us wrong, we know nothing about the area. But looking at the pictures of the property we can well imagine it coming straight from a scene in a 1980s daytime movie – dad, mom, two bratty kids with freckles, and a station wagon with wood down the side.

But the point to note on this property is that it’s a “short sale.” What does that mean? As we found out today, a short sale means that the house is on the market for a price below the outstanding mortgage against the property.

It also means that the sellers aren’t in foreclosure, so the bank isn’t forcing them to sell. But clearly the seller has a good reason to sell the home. And they aren’t the only ones either. Take a look at any number of the properties on the website and there’s a whole bunch of foreclosures or ‘short sales.’

And don’t forget, the owner obviously has a non-recourse mortgage. So the bank will want to make sure the property is sold for as much as possible, because there’s no recourse to the seller if the sale price is less than the outstanding mortgage.

But by the same token, the bank isn’t going to push too hard. Because if the owners just want to get out they can just stop paying the mortgage, go into foreclosure and walk away, then the bank could be left selling the property for peanuts.

Such as has happened with this four bedroom, two bathroom, two storey home going for… USD$499.

And no, it’s not a misprint, it’s a “HUD Home” sale. That’s means it’s a Housing Urban Development Home. In other words, it’s a property that’s been foreclosed on by a bank and where the US government is trying to encourage buyers to pay rock bottom prices – before the neighbourhood is ghettoised.

If you think that’s a one-off, what about this four bedroom, one bathroom home going under the hammer for… USD$1,200.

Look, we’ve picked an extreme example using the rust belt city of Detroit. But guess what, property buyers in Detroit would have been told house prices always go up too. We’re only guessing, but we doubt if that property that’s going for USD$89,900 was originally bought for just USD$100,000.

Our bet is the current owners probably paid at least double that amount. The bank is on the verge of losing half of its “investment.”

So, we’ll ask again, could this happen here? To the same extent we’d have to say possibly not. Or rather, it won’t happen under the same circumstances due to the different liabilities for borrowers.

Simply for the fact that the non-recourse nature of mortgages in the US makes it more attractive for home owners to just walk away. Why pay thousands of dollars on a mortgage when you can walk away and rent for a few years, or even save up for a few months and buy a house for cash? Maybe buying from someone else who’s been foreclosed on!

But while the US housing market and non-recourse lending has been looked down upon by mainstream Australia, the fact is, wouldn’t you like to have a non-recourse loan?

Wouldn’t you like to have a loan where there was no risk of you losing all of your worldly possessions apart from your overpriced house?

The fact is, non-recourse loans are great for buyers. If you fall behind with your repayments or you just can’t be bothered to pay then you let the bank foreclose. They can’t grab a single extra penny from you.

Contrast that to borrowing here where loans are recourse to the borrower. Imagine the carnage if property prices fell by even just 20%, let alone the 95% some of these Detroit homes have fallen by.

Borrowers going into foreclosure would not only be thrown out on the street by the bank but they’d get a notice telling them to hand over the rest of their belongings to make up the shortfall.

From a savers perspective, when you compare the two, Aussie savers get a better deal. I mean, from the savers’ viewpoint, assuming there was no middleman (the bank), would you lend money to someone with the terms that they didn’t have to repay the loan if they didn’t want to?

That’s effectively what non-recourse lending is. A saver would be mad to lend money in those circumstances. But for the borrower it’s great.

The downside in Australia is that lending is recourse. If you can’t pay, tough luck, the banks will do all they can to grab the money back.

If household debt levels were low and property prices weren’t obscenely high then you’d rightly say recourse lending had done its job by making people more aware of the risks of borrowing.

But that’s the trouble isn’t it. Recourse lending should make borrowers more wary about what could happen if things go wrong. But who cares about that when you’re told house prices always go up, that there’s a chronic housing shortage and that the Australian population will be 60 bogzillion in 2050.

There is no doubt at all, that the concept of risk in the Australian property market is completely and utterly absent. Market signals that should indicate to borrowers the level of risk have been manipulated to such an extent that what is high risk now has the appearance of low risk.

And that’s the core of the problem. Strip away all the opinions, statistics and indices and you’re left with the simple and unarguable fact that the perceived risk of housing has been eliminated from the market…

Just at the time when it’s at its highest risk – it’s all upside and no downside apparently.

Cheers,
Kris.

Tagged as: Australian Bureau of Statistics, fixed rate mortgage, housing, hyperinflation, inflation, Melbourne house prices, property, Sydney property prices