Reprinted from academic e-zine The Conversation

In a previous article, I analysed four of the common arguments used by those who deny there is a bubble in Australia’s residential property market. The bubble deniers have employed other explanations for the largest run-up in prices in Australia’s 131 years of land sales records.

Restrictive government regulations

One argument is that restrictive government regulations (RGR) limit the supply of land and timely dwelling construction through zoning controls, development, planning and building laws, driving up housing prices. This idea gained popularity in the US during the property boom, with some economists asserting that it is a substantial factor in creating a bubble.

The major difficulty is that RGR can only affect rent prices and thus the market-efficient price for land. The logic is straightforward: if RGR limits supply with demand holding constant or rising, and property prices increase, then it follows that rents too must rise proportionally as well. If rent and land prices diverge, however, this argument falls flat – as is the present case. Housing prices have experienced a far greater run-up than rents since 1996. Further, markets would have already priced the supply-side distortions into the cost of housing long before the bubble began. There is no change in RGR that could explain the increase in housing prices from 1996, skyrocketing in 2001.

The other case against this argument is that the boom-bust housing cycle has existed for centuries in many countries, far before bureaucrats perfected the art of red tape during the 20th century.

The theoretical and empirical literature provides little help with this topic. Some studies show RGR comprises a large factor, some claim a smaller impact, and others argue it results in no tangible effect, and that correlation is often confused with causation. Even the idea’s leading proponents acknowledge the benefits of RGR could well outweigh the costs.

Arguing that a greater supply of housing could limit skyrocketing prices is similar to saying that the 17th century Dutch bubble driven by tulip mania could have been mitigated if farmers had grew more tulip bulbs. The problem is not on the supply side; rather, debt is used to fuel a pyramid scheme, resulting in a tremendous demand surge that significantly raises prices.

This is not to say that RGR shouldn’t be changed; many aspects need improvement. The case for RGR causing bubble-level pricing, however, is slim to non-existent.

Low inflation and interest rates

Another explanation cited is the structural downturn in inflation and interest rates that began in the late 1990s and continues today. Interest rates peaked in 1990 when the RBA radically increased interest rates to combat inflation, culminating in the recession “we had to have”.

That year, the standard mortgage rate stood at approximately 17% and real interest rates at 11% (nominal rates were higher). Eventually, the rate of inflation fell, and interest rates followed. With cheaper borrowing costs, households could take on greater levels of mortgage and personal debt.

But the decrease in inflation and interest rates can only explain part of the increase in household debt. In 1990, the household debt to disposable income ratio was 46 per cent, rising to almost 160 per cent today. The household debt to GDP ratio jumped from 19 per cent to 86 per cent.

Even as far back as 2004, the RBA noted that the decrease in inflation and interest rates could only explain a doubling of household debt relative to incomes, and probably less. Household debt has more than quadrupled over this period.

If this argument were credible, the 1960s should have prompted an even greater household debt ratio as rates were the lowest on record throughout this decade. This did not occur.

Returns to property

That residential property provides substantial and ongoing returns to investors and owner-occupiers, based on fundamentals, is another argument.

Two types of return tempt house buyers: owning a property valued by the market at a higher price than it was purchased for (capital gain), and increases in the rental income (yield). Property owners hope that they will make a substantial capital gain when they sell, and that rental income can overtake costs over the long run.

Data from the ATO tells an interesting story. On aggregate, net real rental income has resulted in continuing losses starting at $966 million in 2000, and peaking at $8.8 billion in 2008. Rental income has not exceeded interest costs since 2000, let alone met the costs of maintenance, rates, agent fees, and property tax.

No rational investor knowingly purchases an asset that yields a negative return. Investors are sacrificing cash flow to build assets and realise eventual capital gains.

The problem with this state of affairs was explained long ago by the late economist Hyman Minsky, who showed state capitalist economies cyclically generated crises due to the interaction of financial markets with the productive economy. Minsky’s analysis revolved around describing three stages of financing.

Hedge finance: income flows from an asset is sufficient to pay down both principal and interest on the debt financing asset purchases. Prices are based upon fundamentals.

Speculative finance: income flows cover only interest, not principal, requiring debt to be continually rolled over. Asset owners may experience financial stress, but it is not widespread, and fundamentals are in kept largely in check.

The final stage is Ponzi finance: income flows cover neither principal nor interest charges. Owners are completely reliant on escalating sale prices (capital gains) to make a profit and meet the cost of the debt. Prices are completely delinked from fundamentals at this stage, resulting in the dreaded bubble.

The tipping point comes when the household sector is so overloaded with debt there exist no more ‘greater fools’ willing to commit to a lifetime of debt serfdom to purchase property. With few buyers and many sellers, prices stagnate then rapidly fall as assets are unloaded en masse onto the market. With demand falling in the housing sector, coupled to an inevitable increase in unemployment, a vicious deflationary spiral occurs. Economy activity grinds to a halt.

That Australia’s residential property market has resembled the Ponzi stage of financing for the last 11 years is nothing short of astonishing. The market would have collapsed during the GFC in 2008 were it not for another First Home Owner’s boost re-inflating asset prices to a new, higher peak.

Trusting the “experts”

Rational discussion about the state of the property market is fraught. Many outspoken bubble deniers are conflicted by their interests in industry and government. Many – not all – are employed by, consult for, manage, and/or own organisations with a direct interest in maintaining the status quo of an overvalued property (land) market. These institutions are primarily commercial lenders, investment banks, real estate intelligence firms, insurance, real estate agents, Treasury, the RBA, vote-seeking politicians, and the mass media.

Skilled and intelligent specialists, trained in neoclassical economics in leading US institutions, did not see their enormous housing bubble until it burst in front of them with horrendous consequences. What makes Australia’s “experts” any more competent?

As investor Jeremy Grantham has noted: “Bubbles have quite a few things in common but housing bubbles have a spectacular thing in common, and that is every one of them is considered unique and different.”

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ABS Inflation data out today shows a big fat zero: we have nil inflation, at least for this quarter.

The consequences for interest rates are profound. Mortgage rates may seem reasonable at 6 to 7 per cent.  In practice they are agony. A real interest rate of 6 per cent is a significant transfer of wealth to lenders and spills borrower blood.

The World Bank’s Real Interest Rate table (which measures the lending interest rate adjusted for inflation as measured by the GDP deflator) shows real rates in Australia were 1 per cent in 2009, vastly different to today. The 2010 figures for our peers are: Canada -0.3, UK -2.4, USA 2.4.  No wonder they want to buy Aussie bonds.

Price stability may seem worthy and honourable, but the RBA has an inflation target of 2-3 per cent for good reason: it reduces the friction in economic activity with a drop of lubricant.  Australian activity is now on dry axles and the wheel bearings are running red hot.

One quarter’s figures are not a country’s destiny, but inflation has been trending down for some time.  This prompted the RBA’s two 0.25 per cent cuts in November and December.

The politico-housing complex will be out claiming big interest rate cuts are imminent and will reignite house prices FOR SURE!  Nothing could be further from the truth.

The banks are already decoupling their interest charges from the RBA’s guidance.  Their very big overseas funding requirement is getting more expensive, not cheaper. If the RBA cuts hard, the banks will not follow.

We have severely unaffordable land prices, gross housing oversupply and poor employment prospects in manufacturing, retail, finance and construction.  High real interest rates will be the final blow that prompts the heavily geared to tap the mat.

The good work by consumers to pay off debt is no longer assisted by inflation.  They will increase their efforts and put a further crimp on aggregate demand.

These are not the conditions for house price rises.  Don’t Buy Now!

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12 January 2012

Prosper calls for timely, rigorous and transparent statistics on property sales to be collected by the ABS.

“Property is the single largest asset market in Australia – worth around $5 Trillion,” Prosper Australia Campaign Manager David Collyer said today.

“It is of profound importance to individual and national prosperity. The lack of peerless sales and volume data is gamed by active players and diminishes us all.

“The property industry shrouds its work with privacy arguments, yet sale prices are a matter of public record – eventually.

The existing ABS data is of very good quality. It comes from state titles office or Valuer General data when title is transferred at settlement, typically 90 days later. It is then collated quarterly, compounding the delay.

“By the time the truth comes out, the spruikers have already walked the ground into mud and the ABS is simply providing an historical record, not information about current activity.

“I call for the federal government to mandate the Australian Bureau of Statistics to create a fresh statistical series based on Sale +3. This tramples on state obligations, but the states have shown no interest in providing their citizens with timely property sales information. Worse, NSW, TAS and NT have contracted to sell their data to private organisations – access is denied unless one is prepared to pay for it,” Collyer said.

This initiative would require agents to notify ABS the day the buyer’s deposit has cleared the bank (Sale +3 days). A handful of these sales will fail – itself an extremely useful indicator – but allowing for this is well within the capacity of the ABS. They would obscure by aggregation individual transaction data until settlement is completed to protect sensitive current negotiations.

Given the ABS already collects un-timely data from the Titles Offices, additional costs would be minimal. The sole obligation on agents would be to send one email to the ABS when the buyer’s deposit clears at Sale +3 days. That would cost about $5.00 per transaction.

“Current falling property prices only redouble the need for clear information about prices and volume.

“Despite the myriad private providers who offer data for a fee, I am amazed at how hard it is for both buyers and sellers to build a view of the market and current values. Weak vendors consistently sell too cheaply and naive buyers overpay – putting money in the pockets of stronger counter-parties and making the lives of agents a breeze,” Collyer said.

“This issue is not going away.” ENDS

Media comment: David Collyer david.collyer@prosper.org.au

About Prosper: Prosper Australia is a tax reform lobby group and think tank that is now 120 years old. It seeks to move the base of government revenues from taxing individuals and enterprise to capturing the economic rents of the natural endowment, notably through Land Value Tax and Mining Tax.

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The Australian property market ended 2011 on the ground in a foetal position after a serious assault by Harsh Reality.

Symptoms include:

• A year’s supply of unsold houses on the market
• Low and falling building applications
• Low and falling finance approvals
• Failing auctions nationwide
• First home buyer indifference
• Universal consumer deleveraging

This year will see a major downward re-pricing of Australian real estate. Further, the rate at which it is falling will accelerate.

Negative gearers will abandon the unsound strategy of subsidising tenants to rent their properties, substantially increasing the volume of stock available for sale.

For twenty years, betting on property price rises was a winning strategy. Gains were multiplied by gearing – the bigger the leverage, the bigger the profit. The instinct to home ownership has been sorely abused. Price falls will erase the investment dream of an entire generation.

Risk of government intervention with a First Home Vendors’ Boost remains only moderate. Such an initiative would fail: price falls will continue as few FHB’s take it up. Those encouraged to buy with a small deposit would quickly enter negative equity and be trapped with high repayments in unsaleable homes. This cohort would become lifelong enemies of any political party responsible for such an outrage.

Steady quarter per cent interest rate cuts that trail price moves cannot spark investor interest. The RBA has learned its lesson.

Prosper called the bursting of the Great Australian Land Bubble in April 2011. We affirm our forecast that land prices will halve in real (adjusted for inflation) terms over five to six years.

The hardest hit in percentage terms will be prestige suburbs – Double Bay NSW, Toorak VIC, Peppermint Grove WA – where selling prices were driven hard by stellar demand and absolute land scarcity. Poor returns in the sharemarket and non-mining business crimped the pool of prestige home buyers.

Prosper has been encouraging potential homebuyers to stand aside from the market ahead of future price falls. We advocate buyers instead save an outsize deposit as an equity cushion and avoid exchanging renting a house for renting money via a mortgage. Anyone acting thus in the last year has substantially improved their personal financial position compared to those who took the plunge into home ownership.

2012 is merely one year in a five to six year correction. We speak of ‘bubbles’ which suggests overinflated prices are corrected with a ‘pop’. Reality is more insidious, more brutal. The process is more like a steady leak where profit and recovery hopes are dashed again and again, year after year, until mortgage repayments equal or better rents.

It can be argued the US housing market has recently crossed this rent/repayment divide, six years after their house prices turned. Yet the vast overhang of US properties in foreclosure suggests further price falls ahead.

Land prices inflating then falling causes enormous economic hardship to smallholders. If instead, we taxed land and untaxed wages and business, the boom would have been muted and the coming costs a mere fraction of what we will be obliged to endure.

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16 December 2011

MELBOURNE:- The number of properties offered for sale and unsold in Melbourne continues to grow.

In the last 30 days ‘Stale Stock’ has risen 4.2 % to 94,467, after 6.2% growth last month. This follows a 20.4 per cent rise in September and an 18 per cent rise in August.

“Supply and demand are disconnected,” Prosper Australia Campaign Manager David Collyer said today. “This is very sad news for sellers hoping to exit at last year’s prices.

Prosper tracks Melbourne’s ‘Stale Stock’ figures – property on the market for more than sixty days and unsold – as a quick indicator of change to the supply and demand equation and as a price change predictor. The raw data is from SQM Research.

“Buyers who previously leap into purchasing the moment their sums added up are holding back. Why should they buy? Property prices are falling. Anyone who can read knows about the devastation in the US housing bubble burst.

“At say $450,000 per house, there is now $43.4 billion tied up in depreciating assets.

In the widest Melbourne and environs, the 94,467 unsold houses are up from 90,659 last month, 85,313 two months ago, 70,856 three months ago and 60,045 four months ago. In eight months ‘Stale Stock’ in Melbourne postcodes 3000-3207 has exploded from 19,800 properties to 61,514.

Notable hotspots include postcode 3021 St Albans (1163 stale properties), 3023 Caroline Springs (1399), 3024 Wyndham Vale (1454), 3029 Tarneit/Truganina/ Hoppers Crossing (3641), 3030 Point Cook/Werribee (4838), 3037 Sydenham (1151), 3064 Roxburgh Park/Craigieburn (2129), 3076 Epping (1408), 3175 Dandenong (1255), 3199 Frankston South (1421), 3337 Melton (2696), 3338 Melton West (1594), 3754 Doreen/Mernda (3103), 3805 Narre Warren (1243), 3806 Berwick (1148), 3810 Pakenham (2796), 3977 Cranbourne (3504), 3004 Southbank (1025) and 3000 Melbourne (1564).

‘Stale Stock’ has risen in every Melbourne postcode without exception.

“The volume and price trends are entirely consistent with Prosper’s prediction land prices will halve in real terms over 5-6 years, of which nearly a year has already passed. Don’t Buy Now!” ENDS

Media comment: David Collyer david.collyer@prosper.org.au

About Prosper: Prosper Australia is a tax reform lobby group and think tank that is now 120 years old. It seeks to move the base of government revenues from taxing individuals and enterprise to capturing the economic rents of the natural endowment, notably through Land Value Tax and Mining Tax.

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