Are property prices headed over a cliff?

The OECD jumps on the Australian property bubble bandwagon

It might not surprise you, but some well-known commentators have been calling a bubble in Australia’s housing market for more than a decade.

Wrong guess

Associate professor of economics and finance at the University of Western Sydney, Steve Keen famously lost a bet with Macquarie Group Ltd (ASX: MQG) interest rate strategist Rory Robertson, after betting house prices would fall by 40%. That was in November 2009.
For losing the bet, Dr Keen wore a shirt that said “I was hopelessly wrong on house prices! Ask me how“, on a 200km walk from Canberra to the top of Mount Kosciuszko. Despite losing the bet, he was still predicting doom for Australia’s real estate market.

In June 2010, Jeremy Grantham, the chief investment strategist of GMO, claimed that Australia had an unmistakable housing bubble and that prices would need to come down by 42% to return to long-term trend. “The price of housing typically trades around 3.5 times household income, but in bubbles it goes to 6 or 7.5.” At the time he suggested Australia was nearing 7.5 times and called the market a time-bomb, just waiting for interest rates to increase. According to Global Property Guide, Australia now sits at 11.2 times, with New Zealand at 9.8x.

Interest rates were 4.5% when Grantham made his call, with the RBA raising rates 6 times since October 2009. Grantham may well have expected the RBA to continue raising rates – unfortunately for him, it didn’t happen.

IMF and OECD join the bandwagon

The International Monetary Fund (IMF) has called the property market bubble twice, in 2008 and again in 2010.

Now the Organisation for Economic Cooperation and Development (OECD) has also chimed in, suggesting property prices are at risk of ‘a sharp correction’. But they certainly aren’t alone, with Treasury secretary John Fraser warning Sydney was ‘unequivocally’ in a house price bubble, as well as parts of Melbourne.

Are they all wrong?

Unfortunately, there’s no right or wrong answer to that, but there does seem to be some evidence that the property market is on a hot streak.

In Australia’s cities, particularly in Sydney and Melbourne the market might’ve run ahead of itself, given recent jumps in median house prices in those two cities.

According to CoreLogic RP Data, Sydney’s median house price has gained 16.4% to $949,800 while Melbourne’s median is up 9.8% to $737,870 over the past year to the end of May 2015. By comparison, Brisbane, Adelaide and Perth have seen rises of 3.4%, 3.5% and 1% respectively. The following chart shows median dwelling (includes both houses and units) prices have surged particularly in Sydney and Melbourne compared to other cities.
ABS Median Dwelling prices
Source: ABS

Then we have data suggesting that investors now represent 40% of all housing loans, up from 29% since the end of the GFC in March 2009. That is evident from the chart below.
ABS Cumulative change in loans
Source: ABS

As you can see, investors’ loans have grown significantly since early 2011, coinciding with the official cash rate falling and rapidly overtaking owner-occupied loan growth.

The other issue the property market faces is household debt levels compared to annual income. As at December 2013, that was approaching 180%, after growing rapidly up to 2007, according to the ABS. In other words, Australian households have nearly twice as much debt as annual income.

ABS Household debt to income
Source: ABS

Household debt also stands at close to $80,000 for each person, according to the ABS.
By comparison with other countries, the only one that comes close is Canada – and it is also reported to be in a housing bubble. The United Kingdom saw its household debt peak at around 180% in 2007 and has been declining ever since. The US peaked around 140%, also in 2007 and is steadily declining.

ABS Household debt to income by country
Source: ABS

The reason household debt is an issue is our ability to repay those housing loans. If unemployment spikes, we could see many property investors unable to repay their loans and default on their debt. Should that occur, lenders (including our big four banks) may take possession of the investment properties and sell them for whatever they can get for them, which could be significantly lower than market prices.

You might be able to imagine what would happen to house prices if there were suddenly many properties on the market at fire sale prices.

Foolish takeaway

From the data alone, it appears that risks have increased of property prices falling. But calls for a crash appear to be more speculation. As you can see from the chart below, the rate of annual property prices appears to have peaked and is now falling.
ABS Annual change in median prices
Source: ABS

That could suggest we are heading for slower growth, or perhaps even a moderate fall in property prices. The big problem the real estate market faces is an unexpected external shock, which could come from anywhere at any time, and drive prices lower, faster.

Given the issues and trends above, I’d be more cautious today rather than crowing about a property bubble,  with prices likely to deflate slowly – as they did in 2009 and 2011.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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