Australia’s housing bubble is one of the largest in the world.
The bad news – for Australians – is that it looks as though it’s on the verge of popping.
That could spell disaster for the Australian economy. One pundit reckons that prices could fall by as much as 60%.
Of course, this wealth effect is in many ways illusory. For a start, upgrading to another, larger home also becomes pricier. And because rising house prices are just another form of inflation, it means that incomes, and cash savings, are worth less than before.
But you don’t notice the downside until the housing bubble bursts. And your average politician doesn’t think that far ahead. So it’s no surprise that Australia’s house price bubble was initially inflated by the government, starting in the late 1980s.
The 1987 stock market crash had hurt confidence in the economy and also the Australian property market. So in 1988, to perk up home prices, the Hawke government brought back a scheme that gave grants to first-time buyers if they loaded up on home loan debt.
Australians began piling into property. Over the next 12 years, mortgage rates halved from 14% to 7%. But Aussie households took on so much debt during that time that their interest payments doubled as a proportion of their disposable incomes (if their debt levels had stayed static, the proportion should have halved, which shows you how crazy things became).
After the dotcom bubble bust at the turn of the millennium, Australian politicians were worried about another recession. So what did they do? In 2001, the first-time buyer grant was doubled to give the domestic property market another boost. But it didn’t need it.
Lending secured on property as a percentage of GDP was already soaring: it had trebled to more than 40% since 1988. The government handing more money to property buyers made matters worse. Add in overly-low loan costs in the noughties, which spurred even higher borrowing, and Australia was soon inflating a huge housing bubble.
In nominal, ie actual price, terms, Australian house prices have soared about six-fold in the last 25 years. That’s extravagant even compared with the UK, where values rose just over four-fold between 1986 and 2007. Or the US, where the increase between 1986 and 2006 was about 3.5 times.
Australian mortgage debt has soared to more than 85% of GDP. The debt now equates to 130% of household income: five times the 1988 level.
That level of growth in both mortgage debt and house prices simply couldn’t continue. And home values have now topped out. Yet in the first 11 months of 2011 they only dropped 3.7%, says market watcher RP Data.
Whenever prices hold up in one market but fall elsewhere, there’s always talk that “this time it’s different”. Australia is no exception.
Several experts reckon the country’s property is still a good bet, as lower inflation and interest costs mean buyers can afford to pay higher prices than before.
Mmm… I’m not so sure about that. Here’s why Aussie property prices could be about to plunge.
This would be bad news for Australia. It’s one of the main providers of raw materials. It has the world’s largest known supplies of bauxite, iron ore, lead, zinc, silver, uranium, industrial diamonds and mineral sands. When the global economy is booming, Australia cashes in.
But the reverse is also true.
“The average Aussie may think the massive demand for Australia’s raw materials will bail the country out of any economic hole into which it risks sinking”, says Ron Fraser in The Trumpet. “That may appear so, as long as… strength in demand continues.” But the country’s problem is that all “its economic eggs [are] placed in one mineral resources basket, being marketed to one major customer – China”.
We also fear the Chinese economy will slow down fast.
But in short, if China’s demand for raw materials drops off, it could crush large parts of Australia’s economy. That will mean lower incomes, more job losses – and much lower demand for houses. Meanwhile, many over-indebted Australian households could become forced sellers.
Leading US real estate analyst Jordan Wirsz predicts that a flood of properties will begin to hit the market in Australia from next year as investors scramble to bail out. In fact, he reckons this could lead to the biggest property crash the country has ever seen.
“Right now is not a time to be buying real estate in Australia,” he says. “Residential prices are likely to fall up to 60%, possibly even more, within five years.”
What does this mean for you? A country’s – or region’s – currency is a useful barometer of investor confidence: just look at the eurozone.
Right now, the Aussie dollar (AUD) is high against the US dollar as AUD buyers hope the looming China slowdown won’t be too bad. But as markets begin to ‘price in’ what less Chinese growth really means, this AUD strength is likely to reverse. A housing market crash would drive it down much more.
Associate Editor, Money Morning (UK)
Publisher’s Note: This is an edited version of an article that originally appeared in Money Morning (UK)
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