Despite the spectre of higher interest rates, residential property continues to strengthen as Australians pile additional debt on top of their already leveraged balance sheets.
Last week, Today Tonight ran a leading story on Australian residential property ‘hot suburbs’, the modern day equivalent of someone ringing a bell to signify a booming market. Fairfax-owned Australian Property Monitors noted that prices have risen by more than seven percent in 2009 — Melbourne prices leapt by 6.1% in the September quarter alone — that is equivalent to an annualised rate of 25%.
Australia’s remarkable economic resilience has contributed to the housing boom, with unemployment remaining under 6%. Continued immigration and lack of supply have also been factors, but it is difficult to envisage any asset remaining divorced from its intrinsic value forever.
As Crikey has noted, income and median house prices suggest that Australians tend to like property far more than our close friends in the United States and Britain. When compared to household income, the cost of Australian property is virtually double the US and UK. This has been assisted by the continued willingness of the big four banks to lend on loan-to-valuation ratios of above 90%.
Of course, Australian banks have good reason to keep the debt-fuelled boom going – the assets on their balance sheets (which for most banks consist of around half in Australian residential loans) are secured by the very property which they are lending against. Stop lending and prices fall, which reduces the value of that very collateral.
But it isn’t only optimistic local buyers who are throwing logs on the residential property bonfire.
The Financial Review reported yesterday that the influence of overseas (largely Chinese) investors is a major factor in Melbourne’s recent home price inflation, particularly in the leafy ‘blue chip’ suburbs of Kew, Camberwell and Hawthorn.
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Jellis Craig agent, Peter Vigano told the AFR that prices “have been influenced by overseas investment, the Chinese particularly.” So much so that the Chinese have “single-handedly been responsible for increasing the market” in recent months.
Apparently, the Chinese, not always known for their investing expertise (they are world beating savers, not necessarily world beating investors), “…believe that the Australian property market is under-priced by 30%.”
Exactly how Peter Vigano, or the Chinese themselves, came up with that figure remains to be seen, but given yields on most residential property on a net basis are barely two percent and economic growth is relatively stagnant, it seems a somewhat optimistic claim (real estate agents tend to quote ‘gross’ yields, which to shrewd investors are completely useless, much like a company reporting to shareholders only its ‘gross profit’).
It also appears doubtful that the Chinese have considered the recent strength of the Australian dollar in their purchasing decisions.
The value of property, like any asset, is equal to the present value of future cash flows (even if you plan to live in the property yourself, that principle still applies). That value should therefore be based on the present value of rental payments and the increased value of the land (which should roughly correspond to economic growth).
However, in recent years property prices have vastly outstripped growth rates, largely because buyers have been willing to pay for ‘blue sky’ — that is the hope that in a few years someone will pay even more for the property than they did, vindicating the awful yield they receive in the interim. Which sounds an awful lot like a Ponzi scheme.
But logic is the last thing on most buyers’ minds during a bubble. Instead, expect to hear more comments like “property never falls”, or “if you don’t buy now, you’ll miss out”.
You would have heard the same thing a few years ago in Florida or Las Vegas…before prices fell by 50%.