What is a housing bubble?
A housing market bubble, in simple terms, means that property prices will rise significantly nationwide before a crash of prices takes place in a rapid pace within the market. This is distinctly different from when the housing market is undergoing a boom period, as a boom period signifies rising prices that take place within the ordinary cycle of the market. The bubble is caused by an increase in prices due to persistently rising demand when investors uphold expectations of future capital gains. Due to the inherently limited supply of housing, it may take time to satisfy this demand. Its aftermath would be a situation in which demand stagnates at the same time as supply has already increased, which will cause property prices to fall (Yardney 2016).
In the past two decades, the Australian real estate market has experienced sequential growth with its upsurge in house prices of 121%, signifying the largest development in the market since 1880 (Chung 2016). Currently, with over 9 million properties worth an estimated 5.9 trillion after the third quarter of 2015, there is no doubt that the housing industry strongly influences the economy as it employs more than 330,000 workers and is threefold of Australia’s GDP (McCool 2016). This has led to much debate amongst experts on whether Australia is in a housing bubble now, and consequently whether the bubble will soon burst and spawn an economic recession.
What has been happening recently?
During 2016, the composite house price average across the five capital cities increased by 7.7% on an annualised basis. Most notable are the developments in Melbourne and Sydney, two of Australia’s most expensive real estate markets that encompass nearly half of Australia’s population. Melbourne grew 10.8%, whilst Sydney rose by 10.3%, both of which are substantial increases compared to the national level (ABS 2017). The median dwelling price for both is also significantly above the national median of $656,800 (ABS 2017). Melbourne and Sydney, on the other hand, are at $780,000 and $1,100,000 respectively (SBS 2017).
This has led to concerns over the affordability of housing for those seeking to purchase their own home. Research conducted by the United Nations indicates that there is a pervasive global trend in the financialization of housing. This means that investors are treating houses as a financial repository for capital as a means of accumulating wealth, which is a shift away from the traditional view that housing should be shelter inhabited by owner-occupiers (United Nations 2017). Globally, Melbourne and Sydney were found to be severely unaffordable (defined as a 5x multiplier of the local median income) at the respective multiples 9.5 of 12.2, second only to Hong Kong at 18.1 (ABC 2017). Conventional economic theory suggests that such prices are unfounded based metrics such as rental yields, which are at historic lows – especially in Melbourne at 2.7% and Sydney at 2.8%. In such a situation, the number of investors planning to hold onto their investment properties for more than a year has fallen from 95% to 90%, indicating that there is great investor optimism in continually rising housing prices – hoping to make a capital gain from the sale of the property rather than dividends in the form of rent (Somasundaram 2017).
Investment in housing has been made more favourable over other investment classes, such as equities or bonds. Investors in property can also negatively gear a property, a tax mechanism where investors can deduce the losses of the property against their taxable income. In effect, an individual can reduce their tax liability, which can then be used to subsidize a loss-incurring investment property. Furthermore, capital gains taxes are exempt on a person’s primary residence and there is a 50% reduction on other investment properties if held for more than a year. According to the Grattan Institute, the Government forgoes $11.7 billion a year from negative gearing and capital gains tax exemptions (Grattan Insititute 2016). This is more than what they spend on childcare or higher education (The Conversation 2017).
Is this just a boom?
Despite claims of an existing housing bubble in Australia, Westpac’s managing director and chief executive officer, Brian Hartzer, strongly disagrees. Hartzer argues that the sharp rise in property valuations (particularly in Sydney and Melbourne) are due to supply constraints placed onto the housing sector. According to Hartzer, the so-called ‘housing bubble’ occurring now is actually a credit-fuelled speculative bubble. This bubble takes place “when people believe prices only go up, start borrowing to buy a house and sell it within a year, only to buy a bigger property” (“Australian House Prices Not in a Bubble: Westpac Boss”, 2017).
Hartzer’s view on the growing rise of properties in Sydney and Melbourne is that this situation has arose due to the consequence of severe supply constraints running into a significant step up in demand from foreign buyers particularly those from China. Hartzer believes that the primary buyers in the Australian housing market are the overseas investors. Generally speaking, this should not be an issue especially since money comes flowing into the Australian economy from foreign investment. The problem arises, however, when foreign investors do not desire the same nature of property that local buyers do. This creates a significant segregation in the prices for the different types of properties in Australia’s housing market.
Critic Alan Kohler concurs with Hartzer – the housing market is not in a bubble, it is instead experiencing a boom period in its cycle. Kohler argues that demand for Sydney and Melbourne properties are real and not speculative. Instead, what drives the demand for properties in these two major cities are the super-low interest rates, the global trend to urbanisation, China’s capital outflow, and the well-heeled baby-boomers downsizing to make up for inadequate superannuation (Chancellor, 2017). All of these factors combined lead to inflation, which financial educator Jamie McIntyre argues is a key driver to increasing property prices.
A rise in interest rates leads to an increasing difficulty to obtain housing loans and, consequently, eventually results in a decline in demand for property. Nevertheless, a drop in the demand of Australian property does not equate to a crash of property prices nationwide, and instead it could signify an ordinary bust in the typical cycle of the Australian property market. McIntyre, in fact, forecasts the exact opposite outcome to take place. He anticipates Australian property prices will continue growing as the market undergoes its boom period despite the allegations of the Australian housing market being in a bubble that is close to bursting (“No Housing Bubble in Australia, says Leading Financial Educator Jamie McIntyre – Australian National Review”, 2017).
Director of One Agency, Peter Harper defends the claim of Australia’s property market experiencing a boom period. He points out that places such as Tasmania do not share the same outcome as bigger cities like Sydney and Melbourne, as they “experience a stable market without the high and lows of the bigger cities” (“Australian Property Market – Bubble or Boom?”, 2017). In fact, Evaluator Lucas Roger points out that the median house price in Australia has never crashed in the past and that “even through the GFC (Global Financial Crisis), the median only lost a few percent” (Rogers, 2017). Thus, the current situation of Australia’s property market could be similar to that of 2008, where Australia successfully avoided being a victim of the GFC for its housing market compared to the other countries in the world who did experience a crash.
Or is there a bubble?
While the growth in Australian real estate might give the impression of economic prosperity, there are several predictions about the state of the market contradicting this notion. Economist and former Liberal leader Dr. John Hewson recently asserted that “[the] housing market is in a bubble caused by the ‘neglect and drift’ of… federal governments.” Maintaining Dr. Hewson’s outlook that Australian real estate is headed towards a crisis, ASIC’s Greg Medcraft and Commonwealth Treasury secretary John Fraser have speculated further about the housing bubble (Jandy, 2017). Industry experts remain wary of the housing bubble because the Australian market is exhibiting signs previously observed in other world markets where bubbles burst and exacerbated economic troubles. One key indicator analysts have identified is the rising level of household debt in the country. The line graph shows the household credit percentage of GDP has more than tripled since 1990.
Hewson argues that prices in the industry are mostly escalated by debt-fuelled speculation instead of actual demand and supply components such as increases in the incomes generated by ownership of property assets (Jandy, 2017). The latest Reserve Bank of Australia (RBA) board minutes also revealed that in capital cities, prices are growing precipitously and auction clearances are high. As an increasing number of housing loans are being approved and credit has risen in Melbourne and Sydney, the central bank acknowledges “there is a build-up of risks in the housing market” (Holden, 2017). In particular, the RBA identifies the large supply of new housing developments, the rising differential between average household debt and income, and the recovering investor environment as major signals of risk in the housing market. It is also significant to recall that one element contributing to this is changing demographics. The influx of immigrants and international students is asserted to be a major cause of real estate growth in highly urbanized areas such as Sydney (Birrell 2008, p. 31). Unsurprisingly, this leaves the RBA on a tightrope.
With the unsustainable price movements in Australian housing, Assistant Treasurer Michael Sukkar posits a case permitting first homebuyers to use their superannuation. Optimistic that the government’s housing affordability package would effectively curb overvaluation, Sukkar puts strict emphasis on increasing the house supply to prevent greater liquidity in the market. Alternatively, Daley and Coates (2017) claim that the government must focus on the policies that would make the biggest difference in balancing supply and demand factors. On the demand side, this requires eradicating government subsidies and cutting the capital gains tax to 25% to discourage negative gearing and lower house prices by at least 2%. This scheme must also be accompanied by measures that boost the house supply in growing metropolitan areas.
But why should investors be worried? Sustained low domestic wage pressures and household income growth would have consequences on consumption and heighten the risks of the increasing level of household debt. If the economy continues to strengthen and investments increase, the cash rate could go up. This poses a threat to the economy because the weak labour market will struggle with large amounts of loans, therefore “detonating the property market” (Holden, 2017). What’s more, the housing market could suffer severe blows if lending is reduced significantly. This possible chain of events has fuelled the recent emphasis on household affordability proposals and speculation on the housing bubble in Australia.
So where does this leave us?
It appears the recent rise in property prices has resulted from ever-increasing investor optimism that had originally stemmed from desperation, given the instability of governments at that time and poor returns in other investment classes following the advent of the global financial crisis. According to economic theory, it is clear that there is a speculative bubble mainly fuelled by both domestic and international investors. Housing prices continue to rise despite being considered a conventionally unattractive investment because of low rental yields and high nominal prices placing barriers of entry to new would-be buyers, elevating risk in the sector.
The full extent of future property price increases is unknown. With the current high levels of private debt and a trend of rising interest rates in global central banks, the cost of credit will likely rise. When the cost of credit rises, current investors are faced with less disposable income and there will be fewer investors in the overall market. Thus, without this continuous expansion of credit, house prices cannot rise indefinitely. It appears that Australia’s property market is in a speculative bubble that is likely to end in the short to medium term, yet the magnitude of this bubble and its potential impacts on the overall economy are currently little more than speculation. It is evident, however, that there is a build-up of risks that must be examined to prevent an economic recession.
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.
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