Despite the best attempts by housing bulls, banks and politicians to resuscitate the flailing residential property sector, the Australian market (Sydney excluded) continues to struggle. RP Data stated this week that capital prices fell again in the December quarter, dropping by 0.5%, led by a dramatic drop in Perth (down 2.1% in December alone) while Sydney continued to buck the trend with a small 0.7% rise over the quarter.

It’s interesting to read the comments of Bill Bonner, talking of the US property bubble and subsequent burst. Bonner noted on Tuesday:

“People who buy houses don’t really worry too much about the price. What concerns them is the monthly payment. They buy as much house as their monthly income will allow.

“That was the real driver of the housing bubble of ’05-’07. Interest rates had been going down for 30 years, lowering monthly mortgage payments. That made it easier to pay a mortgage. Housing prices were going up steadily, giving the impression that houses were a good investment. And the mortgage industry would lend to anyone, solvent or insolvent, jobless or working, dead or alive. That put a lot of air into the housing market.

“Now, interest rates are still going down, as near as we can tell. But with incomes going down and lenders much more cautious, the air has whooshed out of the market. It’s no longer pressure-packed. Now it’s vacuum-sealed.”

While bulls will be at pains to deny the differences between the US and Australia (for example, pointing to the factually incorrect notion that the US has across the board non-recourse loans), the run up in prices in the US bears a great deal of similarity to the Australian bubble. Specifically, the US bubble was caused by a dramatic increase in leverage used to purchase houses. Ominously, Australian home owners are even more indebted than their US counterparts were before their bubble starting initially deflating (2006) before bursting (2007).

As the column has observed, property prices tend to move at a glacial pace for several reasons. First, unlike the share or bond markets, information on property prices is difficult to obtain (for most buyers) and the market is far less liquid. The sophistication and emotions of many participants in the property market also cause it to react far slower than more efficient capital markets. That means it takes longer for property prices to return to their intrinsic value from bubble level highs. In the US, property prices stopped accelerating in mid-2005 before flat-lining in 2006 (this is when hedge fund stars such as Michael Burry, Steve Eisman and John Paulson starting make very large bets again the US property market).

Interestingly, while the US property market was crashing in 2007-2009, mortgage rates were also being drastically cut form 5% to only 2.4% (inflation adjusted).

Meanwhile, as Australian prices fall, the fundamentals of the housing market also continue to deteriorate. Fairfax reported last week that Melbourne’s vacancy rate had surged to 4.4%, with Louis Christopher of SQM noting that “of particular concern is Melbourne’s seemingly ever increasing vacancy rate, a figure that most definitely reflects an oversupply issue”. (The outlook for Sydney and Perth looked slightly more positive though).

The over-supply issue in Melbourne as reports circulate that Melbourne vendors are agreeing to “subject to sale” transactions, in which the sale of a property is made contingent upon the purchaser being able to sell their own property for a certain price. A subject to sale agreement is hugely advantageous for buyers, who effectively have a call option on purchasing a property, but leaves vendors locked into a sale, which may not even proceed. High-profile agent Barry Plant noted that ”the vendor is taking all the risk and the purchaser is taking no risk, other than the investment of some funds to advertise their property … I think it may start to come back because of the conditions we’re seeing.” Vendors wouldn’t be agreeing to such onerous terms unless they were having trouble selling their property.

Australian property buyers are realising, like buyers did in the US, that value and price are two very different concepts. Purchasers no longer expect property prices to stay stronger forever — instead, they are gradually adjusting expectations, from little growth, to “no growth” to capital loss. As this continues, property prices will gain their downwards momentum until they reach an intrinsic value that is based on their return, not how much banks have been willing to lend.

Peter Fray

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