Sometimes it’s hard taking a contrarian view. When the price of an asset that, by all logical means, appears over-priced but continues to rise, even those who steadfastly hold a view can waver. It can even happen to wealthy, confident investors such as hedge fund bosses John Paulsen and Steve Eisman, who had moments of self-doubt when they famously “shorted” the US property bubble in the mid-2000s

However, taking a contrarian view is made somewhat easier when one reads the straw-man arguments being proffered to provide a rationale for the decade-long Australian housing bubble.

In the weekend Financial Review, property writer Ben Hurley profiled several young home buyers. The first was banker Lee Pamler, who recently paid $641,000 for a 47-square metre, one bedroom apartment in Sydney’s fashionable Darlinghurst. Palmer claimed buying the property was “better than paying rent”. Palmer noted that “over the years I looked at Sydney property [and] it never really dropped so [I thought] I might as well get in some time”.

Palmer’s comments are hardly unusual. Instead of determining the price of an asset based on its future cash flows, most home buyers are irrational, basing their decision on emotions like fear of missing out on jumping on the “property ladder”, or envy of friends and family who already own their own “their own” property. For Palmer, buying his home doesn’t actually appear to be a smart financial decision. A quick look on realestate.com.au indicates that a similar one-bedroom apartment could be rented for about $450 a week — so the cost of renting is $23,400 annually, compared with the interest alone (assuming a 100%, interest only loan for ease of comparison) on the property being $47,000 — that’s before council rates, insurance, maintenance and depreciation. It’s probably costing Palmer $30,000 annually for the privilege of owning his home.

Then there’s Justin Doobov, who is the managing director of mortgage broker Intelligent Finance. Doobov told the Weekend AFR that “five years ago they said it can’t go up any more, crazy prices, it’s too expensive, but then it went up further … people would prefer to pay their mortgage before they put food on the table, Australia has such a low arrears rate. There is going to be huge migration and a lot of them are coming with money and they’re buying property. That’s just going to fuel more demand and push the prices up.”

Doobov appears to be relying on the technical “property never goes down” argument. The fact that Australia’s low arrears rate has been assisted by near record, low unemployment, sustained low-interest rates and a China-led boom appears irrelevant. As for huge migration, that appears contrasted by statistics that indicate that student visa applications fell by 32% last year compared with 2009, while the federal government has been gradually reducing skilled migration in recent years.

But it’s not only uneducated investors and self-interested mortgage brokers who make illogical excuses for the property bubble. In Business Spectator last week, current HSBC (and former RBA) economist Paul Bloxham produced some fairly dubious arguments to underlie his claim that the housing bubble is a “furphy”.

Bloxham alleged that “standard measures” such as the house-to-rent ratio are “naïve”. Bloxham suggested that valuing an asset-based on the income it generates (i.e. rental yields), “ignores a large structural adjustment that occurred in the Australian housing market between 1997 and 2003. This transition involved lower interest rates, better-anchored inflation expectations, and increased availability of housing credit”.

It appears that Bloxham is no fan of the discounted cash flow model (regularly used by investors and bankers to value assets) or a return-on-equity growth model is “naïve”. Perhaps Bloxham should send Warren Buffett a letter letting him know that the method he uses to value assets is naïve. Of course, there are few better indicia of a bubble than “experts” claiming a structural adjustment — almost identical excuses were trotted out during the dot.com bubble to vindicate sky-high valuations on companies that would never make a profit.

Bloxham appears to believes that it is wiser to base ones views on “forecasters”, who apparently believe that “Australia has an undersupply of housing”. Bloxham also suggests that Australian prices are fair because Australian dwellings are large (even though they aren’t double triple the size of American houses), or because of poor public transport to outer suburbs (even though outer suburbs prices have increased in price as well) or low levels of mortgage arrears.

Like any speculator who is blind to the existence of a bubble, Bloxham ignores the fact that Australian unemployment is at near record low levels and that interest rates are well below long-term averages. The cost of money, which was low during the great moderation, continues to increase. US inflation shows extremely worrying signs of rising (food prices soared by 3.9% in the US last month). Coupled with crippling deficits and the spectre of Japanese fund repatriation, the so-called “structural change” of low interest rates doesn’t appear quite so solid. Meanwhile, with virtually full employment, that means that mortgage arrears are bound to increase (as they did last month, when they rose by more than 7%).

The only worry — virtually every comment to Bloxham’s article was highly critical of him.

Peter Fray

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Peter Fray
Editor-in-chief of Crikey

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