Playing with Bubbles

June 20, 2017
Editor(s): Michael Williams
Writer(s): Vivienne Bear, Lang Qin, Kevin Fan

There is something undoubtedly fun about blowing and bursting bubbles. But try telling that to the Australian housing market.

What is a housing bubble?

The recent issue of rising Australian housing prices, often referred to as the housing bubble, has been a major point of focus for many economists and policy makers. Latest figures from the Hedonic Home Value Index show that housing prices in Melbourne rose by an average of 1.9% last month, with the national weighted average increase sitting at 1.4%.

In order to explore the issue in greater detail, it is necessary to first understand what a housing bubble really is. A housing bubble, or asset bubble more generally, is simply the over-inflation of the price of an asset to a level that is unsustainable. This often occurs during a period of very low interest rates, when bonds offer a lower yield than usual and investors look to alternative forms of investments to generate more returns. The increase in price is largely demand driven, caused by investors flocking to buy a particular asset class, but it can be further exacerbated by shortages in supply.

The danger of an asset price bubble lies in the unsustainable nature of the price increase. At some stage, the bubble will burst, leading to a dramatic decrease in price and massive losses for investors holding the asset. An ignominious example of this occurring is the ‘Dotcom Crash’ of the early 2000s.

Looking closely at the bubble

In the present Australian context, gravity defying prices, particularly concentrated around Melbourne and Sydney, have become (pun intended) a household fact. But regulatory concern has intensified sharply in the last year. So what is it about the current situation that has commentators and regulators worried?

Objectively, there is scope for alarm. Whilst house prices in Sydney and Melbourne soared in the last year (19% Sydney, 14% Melbourne), last December quarter recorded the biggest hike in property prices nationally (4.1%) since June 2015. Since the Global Financial Crisis, Melbourne prices have grown by 88.8%, whilst median Sydney prices have grown by 106%. This March, overall Australian house prices rose by another 1.4%.

Of course, these figures don’t exist in a vacuum.  What is truly worrying about this property price trend is that simultaneously, household wage growth in the past 3 years has noticeably stagnated at unusual lows. In September 2016, quarterly growth in the wage price index was a mere 0.4%. Indeed, the surge in house prices coincides with rising levels of debt. The ratio of household debt to disposable income is now, in Reserve Bank of Australia (RBA) Governor Chris Lowe’s words, at a “high and rising level” of around 188%.

The meat of the problem is therefore that rising property prices, high unemployment and weak wage growth equals rising levels of debt. The RBA, still holding the cash rate at a low of 1.5%, is basically impotent in this scenario. The RBA cannot raise rates to discourage the boom given subdued growth in the rest of the economy.

Where and how bubble floats

Despite the recent astounding growth in prices of Australian properties, the issue of overpricing remains hard to tackle. This is due to the unfortunate reality that prices throughout Australia do not share a positive correlation with one another. In the eastern capital cities, prices have risen by large percentages. Whilst on the flipside, cities such as Darwin and Perth have experienced negative growth in prices by significant figures of -5.3% and -4.5% respectively. Given this, any positive changes in policy made to diminish the negative effects of property prices in a particular city will result in the opposite for cities that do not correlate. Large discretionary, sledgehammer type changes will devastate markets on the other end.

However, Australian regulators have not abandoned the ship of turbulent property prices. Regulators have taken the ‘safe’ procedure of making minuscular changes to combat this issue.  The Australian Prudential Regulatory Authority (APRA) recently persuaded banks to limit new interest-only loans to 30% of total new mortgage lending from a previous rate of 40%. Interest-only loans typically attract property investors as they result in lower payments in a short period of time, as only the interest is repaid whilst the capital is untouched. Ultimately, investors ‘bet’ that eventually the property price will overcome its original price, prompting them to invest and drive up demand. This new measure from APRA is aimed at dissuading property investors as fewer interest-only loans are issued.

Consequently in January, Australia’s largest source of foreign property investing, China, experienced an abrupt change in its policy on cash outflows. In a new measure to curb Yuan transfers overseas, banks and other financial institutions are required to report any cash transactions overseas that are larger than 50,000 Yuan, compared with 200,000 Yuan previously. In relation to the Australian property market, this will evidently cause demand to fall as Chinese investors are less able to purchase assets, leading property prices to be less overpriced.

Can the bubble just go away?

This is easier said than done. Relaxed building permits across the country in recent years have allowed landowners to turn one dwelling into many, and given the commercial profitability of constructing high-rise, high-price apartments, these types of building projects have continued to dominate the housing construction landscape in the major cities. Whilst this has allowed seasoned investors an abundance of choice when it comes to diversifying their portfolios, young investors looking for a home to settle into have been hit hard.

There are simply not enough affordable homes, in enough good locations, for enough people, and with young investors unable to get their foot into the market, this doesn’t seem to be changing anytime soon. In Sydney and Melbourne for example, many families are faced with the tough decision of whether to raise their children in the confines of a small apartment, albeit in a convenient location, or to relocate to the outskirts of the city, an hour’s drive or more from the CBD.

With this housing bubble no closer to bursting than it was a year ago, and with federal and state governments all around the country struggling to confidently come up with adequate solutions, it has been refreshing to see the Victorian government taking initiative and proposing a series of concessions for first home buyers. Stamp duty exemptions, First Home Owner Grants (FHOG) and Vacant Residential Property Tax (VRPT) are all geared towards giving young and new home buyers an edge. The overall idea, however, is not to help them buy their dream home in the heart of popular inner city suburbs, but rather to encourage them to settle down into new regional residences.

Whilst this prospect may not be attractive to all, the fact that the Victorian government is at least beginning to commit to longer term expansion measures gives reason for optimism. Whereas an increase in supply of homely residences in metropolitan areas cannot be magically conjured, maybe the answers to this pressing question of supply lie, logically, yet somewhat ironically, in the areas where supply is aplenty. In Victoria for example, Melbourne’s population is set to increase by over 30% by 2050, and regional Victoria may soon not be as regional as people perceive it to be today.

Ultimately though, governments, or anyone else for that matter, will struggle to stop this housing bubble from bursting. It seems more a matter of when, not if. Given the seemingly irrepressible upward trend that has been fuelled by greater and greater amounts of debt has failed to buckle under constant pessimistic speculation, the potential for substantial economic damage is concerning. And whilst many will have seen it coming, countless many will, perhaps inevitably, be caught unprepared.

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.