As clearance rates slump in capital cities across Australia, vendors appear to be quickly realising that what they thought (or have been told) their properties are worth is not quite accurate.
While Australian property has enjoyed almost two decades of uninterrupted price growth, as Japan, the US and much of Europe have discovered, price and value are often two very strange bedfellows. As Ben Graham famously opined, in the short term, the market is a voting machine, in the long term, it’s a weighing machine.
The Australian property bubble has followed the script almost perfectly.
A decade of price growth, largely fuelled by a massive increase in lending. Most pertinently, Australia’s debt to GDP ratio has increased from about 20% in the late 1990s to be almost 90% now. This tells us that much of the recent house price appreciation has not come from improved “fundamentals”, but from banks’ willingness to take greater risks to chase higher short-term returns.
As prices have increased, so too has property buyers’ willingness to pay more for property. While some studies place Australia’s “house price to income ratio” at more than eight times, even Chris Joye, who recently wrote that a housing bubble was a long shot, has produced statistic indicating that the price/income ratio has increased by 60% since 2000.
But all “good” things must come to an end. And an end we are at.
The first indicator of a downturn in the housing market is the auction clearance rate. While not a precise measure, a high clearance rate will indicate rampant demand for property. In 2009 and 2010, clearance rates in Melbourne were often above 80%, meaning that almost every property that went to auction was sold for a price that the vendor was willing to accept.
Anyone selling an asset will be naturally inclined to set a target price, and if that price is not met, they tend to wait and hope that any downturn in the market is temporary. What tends to happen is that buyers start reviewing what they are willing to pay for a property, but sellers are usually unwilling to immediately drop the price they are happy to accept. This leads to a lower clearance rate. It is in effect, a housing “stand-off” — buyers happy to wait for prices to fall, but sellers not willing to lower their expectations. Ultimately, the market forces will prevail, with properties remaining on the market for longer until vendors lower their asking price.
This is exactly what has happened.
In Melbourne, clearance rates have fallen below 60% (even by the Real Estate Institutes’ somewhat dubious calculations). In Brisbane (which doesn’t hold a large number of auctions), clearance rates have dropped in some weeks to comical levels at barely 20%. Meanwhile, Sydney has struggled for a clearance rate of 60% for much of this year.
As clearance rates drop, vendors slowly come to the realisation that if they would like to sell their property, they will need to adjust their asking price downwards. This causes a substantial shift in thinking — instead of property buyers fearing that they had better purchase a property for fear of being “priced out” as prices increase, they are instead motivated to wait. This is because the longer they hold off on their purchase, the less they will need to pay. This has occurred in the US and Ireland since 2008, as buyers wait for vendors to discount property prices.
This is very much playing out in Australia.
The Financial Review reported this week that “in February, vendor discounting nationally was 6.5% for housing and 6.6% for units.” RP Data’s Cameron Kusher told the Financial Review that “vendors need to question whether or not selling up is the best option based on today’s market conditions while for buyers the news is much more positive because they hold the power and can really being to negotiate and pick up a property at a reduced price”. Kusher appears to have had a dramatic change in his views — only last November, he was proudly announcing that “there is nothing to suggest we are in a housing bubble. In fact, the price growth we are achieving now will be sustainable long term”.
The price bubble also leads to another problem — those who bought during the tail end of the decade-long price rise, especially those who used large amounts of debt, are especially vulnerable to deteriorating economic conditions. So when property prices start to come off bubble-era highs, and the economy accordingly weakens, over-leveraged home owners find themselves in financially stressed situation. Coupled with the threat of further interest rate rises, a “perfect storm” of market forces can lead to a very rapid down trend in prices. As property prices fall, the economy slows (construction is a key component of economic activity), this causes increased unemployment and higher foreclosures, causing a further drop in prices.
Even Shane Oliver, who has been sceptical of the notion of a bubble, told Ben Hurley of the Financial Review that “further interest rate hikes, particularly before the economy has recovered from the current soft patch, risk knocking households over the edge, and with them house prices”.
Despite the Australian economy appearing to be running a full pace, with near record low unemployment, all four large banks recently reported substantially higher delinquent loans. Westpac stated that loans more than 90 days overdue have increased by almost 75% since September 2009.
But readers should not fear a property correction. Aside from the inevitability of it, there is far more danger from assets being priced above their intrinsic values, than an asset returning to its intrinsic value.