Assets prices inflated by excessive leverage are not sustainable, leading to a gross misallocation of scarce resources. It is a lesson that Australian property buyers appear slow to learn.
The inflation of Australia’s housing bubble was confirmed recently as data released revealed that for the first 11 months of 2009, property prices in Melbourne sky-rocketed by 17%, closely followed by Darwin (15%), Hobart (14%) and Sydney (12%). During that period, inflation (which over the past century has been the primary determinate of house price growth) was 1.3%.
The real estate industry was as usual on hand to encourage the boom. Real Estate Industry of Victoria boss Enzo Raimondo told The Age
that "if your budget is around the median and you want to live close to the city, the best option is a smaller place, unit or apartment as they allow you to build your equity and put yourself in a better position to buy the home of your dreams in a few years".
RP Data reported that over the past 19 years, Melbourne house values have grown by 6.9% -- in real terms, the median house prices have risen from $144,039 to $509,987 today. Had house prices tracked inflation (as they have historically in Australia and the United States), Melbourne’s median house price would have grown from $144,039 in 1990 to about $230,000 today. The past decade is even starker -- while Melbourne house prices have risen at 9.4% annually, inflation has increased at approximately 4%.
Had property prices tracked GDP since 1990 (which isn’t necessarily the best indicator as GDP is affected by property and finance growth itself), Melbourne median house prices would be about $420,000, approximately 20% less than their current levels. Had property prices tracked employee earnings since 1990, the median would be about $320,000.
Of course, housing bulls will continue to claim that property prices outstripping inflation is perfectly legitimate due to population growth and alleged shortages. Very few "experts" suggest anything other than mid-to-high single-digit increases in prices during 2010. If for no other reason than mid-high single digits has been the norm over the past decade.
Macquarie Capital Advisers real estate strategist Rod Cornish told Robert Harley, at the Financial Review
, that "the risk is on the upside", with prices expected to rise by 5-7% in 2010. Harley noted "for Cornish, affordability is a key metric, incorporating prices, interest rates and household income". Essentially, property bulls are betting that interest rates remain historically low (even after the three recent interest rate rises, rates are well below long-term levels), unemployment stays low and the flow of foreign money continues unabated. The chances of all three factors continuing, especially in the light of continued United States quantitative easing, is wishful.
The continued dependence on historically low unemployment and interest rates, coupled with ever increasing debt (of which, about half is sources from overseas) is also ignored, in favour of the "shortage" theory. Craig James told The Age
With population growing at the fastest rate in 40 years boosting demand for homes, state and federal governments need to be focused on ways to get more homes built … barriers to housing investment need to be removed, and scrutiny needs to be applied to lifting land production and revising zoning laws.
While economists point to shortages, as this column has pointed out previously
-- not only do those shortages appear to be largely made up, but the housing shortage caused by immigration would have the more immediate effect of higher rental costs (rather than higher purchase costs). This, however, has not occurred, with rental costs increasing in recent years at a far lower rate according to bullish property house BIS Shrapnel.
The real reason for the dramatic boom in property prices? Simple. Australians are borrowing more to buy their homes and investment properties. According to the ABS
, in 1990, the level of household debt was $190 billion, in 2008, even after adjusting to remove the effects of inflation, debt increased almost six-fold to $1.1 trillion. Property prices have increased due to any real shortage, but rather, because people are borrowing more to bid up prices. Banks then use the higher prices to vindicate ever-increasing valuations and continue to lend at an ever-increasing rate.
Why hasn’t this been a problem? Largely because interest rates have plummeted and unemployment has remained at historical lows. This has meant that housing affordability has ostensible remained at reasonable levels notwithstanding the price growth.
The global financial crisis and US (and Japanese) housing busts should have taught us a valuable lesson -- that assets prices inflated by excessive leverage are not sustainable, leading to a gross misallocation of scarce resources. It is a lesson that Australian property buyers, experts and bankers appear slow to learn.