Housing Shortage Set to Hit 35 Million in 2050

We’ll explain our ridiculous headline shortly. But first…

Yesterday we crossed the t’s on the March issue of Australian Small-Cap Investigator, today we just need to dot the i’s so we can send the March issue out while it’s still March.

If you’re a subscriber – if all goes according to plan – you should see the issue drop into your inbox after 4.30pm this afternoon. If you’re not a subscriber click here to sign up without delay.

So, while our compliance boffin is making sure our latest issue of Australian Small-Cap Investigator is publishable, here’s what we’ve been thinking about this morning…

ARMageddon.

I know, more gloom. That’s just the way it is I’m afraid. We tell it like it is. Of course if you prefer sugar-coated stuff telling you everything is rosy then you’ll be sorely disappointed if you keep reading here.

But don’t go away, if nothing else it can’t be that bad to get an alternative view compared to the pap you get in the mainstream press.

But just to clarify, our reference to ARMageddon isn’t a prediction about the end of the world, but rather a reference to another article in the Weekend Australian Financial Review titled: “ARMageddon hangs over home owners.”

The ARM in ARMageddon refers to the ingenious mortgage product in the US called an adjustable rate mortgage. Broadly speaking it’s similar to our variable rate mortgages here, with one exception.

Many buyers signed up to an ARM’s with what they called a ‘teaser rate’. Again, similar to the introductory rates you’ll get with Australian mortgage products. But again, not entirely the same.

The main difference is that the ‘teaser rate’ set the repayment level lower than the interest charged on the loan, with the balance being added to the mortgage debt. So for instance, if monthly mortgage repayments were supposed to be $1,000 the teaser rate would see the repayment drop to say, $500 with the remaining $500 added to the mortgage.

As you can imagine, that’s gonna work out fine when property prices are heading to the moon. But as soon as prices stabilize and then drop, mortgage owners are in trouble. As the AFR article points out, “There is concern in the US for home buyers who hold reset loans that may leave them negatively geared.”

The reset part is important, because as I mentioned these ARMs came with a teaser rate which resets to the normal higher rate after a given period, say 3 or 5 years.

So not only do you have mortgage payments being added each month to the outstanding mortgage debt, but you’ve also got a mortgage repayment that could double or triple in one move as soon as the teaser rate period ends.

You can see the potential impact in the chart below:

The light yellow bars I’ve circled above gives you an idea of just how big the problem is. Although, take a look at the Alt-A mortgages as well. Alt-A are those mortgages deemed to be lower quality than Prime mortgages but higher quality than Subprime mortgages.

If this next leg of the US housing crisis is even half as bad as the last one, then world markets are in for another bumpy ride.

I mean, at the time buyers were taking out these loans everything seemed fine. What could possibly go wrong? So what if the monthly repayment increases, the price of houses always goes up. If the repayments are too high, home owners can just sell at a profit and move on.

And yep, they had the same mantra in the US as we’ve got here – house prices always
go up. Which brings us on to this point. Money Morning reader James sent us this article from The Acorn Online, “Northern LA and Ventura County’s Best Community and Weekly
Newspapers”.

The Acorn Online had this to say in February 2006, just before the US housing market started to implode:

“The Californian Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California. Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.”

Sound familiar? The article continues:

“Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit.”

Need we say any more? Of course. We’re not going to pass up an opportunity like this. Now read this press release from the Housing Industry Association (HIA):

“The report finds that if current building trends persist, then Australia’s cumulated housing shortage would reach 466,000 dwellings by 2020… Housing to 2020, which focuses on future housing demand and the number of dwellings required in meeting this demand, highlights a current housing shortage that already numbers over 109,000 dwellings.”

The impact of the so-called shortage? The press release states:

“If we don’t get a comprehensive supply response to the accumulating housing shortage then the lack of affordable and appropriately located rental properties will only worsen…”

It’s funny isn’t it. All those economists that failed to predict the financial meltdown are the same economists who now say, “Ah, but of course the US had a massive overbuild of housing leading up the financial crisis, that’s why their property market slumped.”

Maybe they did, but no one seemed keen to point it out at the time. They were too busy claiming there was a housing shortage. In fact, the CBIA claims there was a housing shortage as recent as 2006.

It was only after prices slumped that the so-called massive overbuild became apparent.

Make no mistake, the much claimed Australian housing shortage will also be seen as a myth after our housing market crashes. The Australian market is making the same mistakes as the US.

But take a look at those numbers from the HIA again. If today’s housing shortage is 109,000, and the figure in 2020 will be 466,000, that works out as an annual growth rate of about 15.6%.

That got us thinking. As luck would have it, Money Morning reader Pete sent us this video of Dr. Albert A. Bartlett, a physics lecturer at the University of Colorado. It’s well worth watching if you’ve got a spare hour or so.

What’s the relevance of the video? It’s the theme of his presentation, “The Greatest Shortcoming of the Human Race is our Inability to Understand the Exponential Function.”

Sounds riveting eh! Actually it is. And the reason it’s riveting is that it gave your editor the inspiration for the chart below we ‘cleverly’ created in Microsoft Excel.

I won’t try and repeat exactly what the prof explains, but the idea is fairly simple. If you take a seemingly small growth rate over a short period and apply it over many years the exponential growth becomes unsustainable.

For example, he makes the point:

“Every time the growing quantity doubles it takes more than you used in all the preceding growth.”

If we apply that to housing, every time the spruikers tell you property prices double every ten years it means that the price growth during that time has exceeded the price growth of every other period in history… ever!

We’re not a mathematician, so we’ll take the prof’s word for it. Take this example he gives on population growth:

“If this modest 1.3% per year [of population growth] could continue, the world population would reach a density of one person per square metre on the dry-land surface of the earth in 780 years. And the mass of people would equal the mass of the earth in 2,400 years. Zero population growth is going to happen. We can debate whether we like zero population growth or don’t like it, it’s gonna happen whether we debate it or not, whether we like it or not.”

That’s the thing isn’t it. You read all the time about growth rates of population and house prices and everything else. You hear – as we have from the HIA – that “if this rate of growth continues” then the housing shortage will be X amount, or the population will be Y, and house prices will be Z.

But the reality is, at some point the growth rate has to stop. It’s impossible for it to continue forever at the same rate of growth.

And that’s exactly what we’ve argued time and again about house prices. But it wasn’t until we saw Dr. Bartlett’s video that the penny dropped. And when we saw those house shortage numbers from the HIA everything clicked into place.

You see, if we take the HIA’s 15.6% annual growth rate – remember, we’re using their numbers – and extrapolate the number further, then by 2025 there will be a housing shortage of 958,946.

But why stop there. If we go out to 2030, the housing shortage rises to 1,979,626. And best of all, if we follow their growth rate all the way out to 2050 we find out the housing shortage will reach 35,953,391…

Coincidentally, according to the most recent Intergenerational Report, the government number bods predict the Australian population to be 35.9 million by 2050.

In other words, the housing shortage will equal the population!

Here’s the chart we’ve reproduced using the HIA housing shortage numbers and extrapolating that growth out to 2050:

The even funnier thing is, if we take the HIA growth rate out to 2055, the housing shortage will reach 74,221,381, or double the predicted Australian population.

Now do you see how dumb these housing shortage and house price growth numbers are? Sure, maybe we’re taking it to the ridiculous extreme. But it’s no more ridiculous than the arguments about the housing shortage and house prices.

The point we’re making is that at some point the exponential growth will breakdown. The unknown is at what point it will occur. We know for a fact there isn’t going to be a shortage of 35 million homes in 2050 (unless every house in Australia is demolished) when the population is only 35 million. The breakdown will have to happen at some point before that.

The fact is, just as a so-called California housing shortage turned out to be a housing glut, the same fate is destined to happen to the Australian market. House price growth can’t continue indefinitely either. If we use the same method and the doubling every ten years approach, then a $100,000 house today will be worth $1.5 million in 2050:

Again, it’s not sustainable and the growth will breakdown at some point.

The danger is that right now spruikers are using a twenty year period of extraordinary growth in house prices and extrapolating those numbers forward. And even worse is the same spruikers are taking an unproven housing shortage and making up their own future growth rate to arrive at a similarly impossible number.

Oh, and just one more thing to put this in perspective, the February 2006 article from The Acorn Online stated:

“Next year, the average home price in California is predicted to hit $573,000.”

Last week Housing Predictor website claimed:

“A lack of more affordable homes, particularly in California, where prices are still more than 50% below the markets peak on average sent the median price 9.8% lower for the one year period at $207,900.”

Good luck if you’re out house hunting over the weekend. Because this time next year you could need all the luck you can get!

On the other hand there could be a 35 million housing shortage in 2050, and you’ll be laughing all the way to the bank. I’ll let you work out whether that’s likely.

Cheers,
Kris.

Tagged as: Acorn Online, ARMageddon, Australian housing shortage, australian small cap investigator, CBIA, HIA, house prices, housing shortage, mortgage owners, property prices, subprime mortgages, US housing crisis, US housing market