The Gamblers

It is often said those who fail to understand the mistakes of the past are bound to repeat it. In one area, this holds spectacularly true: the residential real estate market. History has shown time and again the fortunes of Australians are closely linked to the housing sector, with bricks and mortar generating a great deal of prosperity and despair. Long-term trends in property prices provide for a fascinating understanding of the housing cycles that have occurred since the 1880s.

Unfortunately, commentary on Australia’s housing market has become notoriously short-termed; articles appear in the mass media on a daily basis examining equally short-term trends. The most obvious example is the RP Data-Rismark Daily Home Value Index‎, measuring capital city housing prices movements on a daily basis. Given how slowly the real estate market moves, this index appears to be little more than a mesmerizing bauble telling us little about what matters most: the long-term trend in housing prices. Perhaps an hourly index is the next ‘innovation’ to come out of the research pipeline.

The longest data series pertaining to housing prices was produced by Nigel Stapledon, a former chief economist of Westpac bank who now teaches in the economics department at the University of New South Wales. In 2007, Stapledon completed his PhD on the history of the residential property market, yielding a rich goldmine of housing-related data and analysis (well worth reading). The housing price index begins in 1880 and finishes in 2006, and I’ve continued it through to 2012 with Australian Bureau of Statistics data.

The index is a weighted composite of inflation and quality-adjusted Melbourne and Sydney housing prices, used as a proxy for the rest of Australia as both cities comprise a majority of Australia’s households and price movements very closely track that of all other cities. It is therefore more representative of the national residential property market than, say, major cities in the United States, which is composed of many more cities with widely differing regulatory and cultural environments. This index also helps to overcome the deficiencies of the popular ABS measure, which has quite a few faults that render it somewhat inadequate.

The ABS series uses a stratified methodology which controls for some compositional changes but doesn’t adjust for improvements in the quality of the housing stock, and is segmented into two time series (1986-2005 and 2002-2012), with the former series not statistically adjusted to conform to the methodology of the latter series. Neither is the series adjusted for inflation using an appropriate deflator (both nominal and real data sets would be useful) and it measures only detached dwellings, excluding apartments, units and townhouses.

Oz constant quality real housing price 660x275

The graph in full size is here.

Probably the most interesting cycle was the colossal land boom of the 1880s, followed by the equally large bust of the 1890s, a period of euphoric and very irrational expectations. A speculative mania spread like wildfire among Australians, centred in Melbourne. A bubble in commercial land prices formed, feeding into the residential property market. From 1887 to the peak in 1891, housing prices increased by 32 per cent, only to collapse by 31 per cent over the next half a decade. The bursting of this enormous land bubble resulted in the worst depression in recorded history.

Prices remained stagnant until the early 1920s before lifting by 25 per cent, only to fall once more during the Great Depression. The housing market again stagnated, tracking the rate of inflation. Price and rent controls were introduced later in 1942 during the Second World War, leading to the single largest annual escalation when they were lifted in 1949, of 111 per cent. Housing prices then fell by 26 per cent as the market later readjusted and stabilised.

It took until the late 1960s for the FIRE (financial, insurance and real estate) sector to reassert itself after its devastation during the Great Depression, laying the groundwork for a simultaneous commercial and residential property bubble. Housing prices increased by 70 per cent from 1961 to the peak in 1974, then fell by 16 per cent to 1979 during the midst of a recession. Melbourne was the primary contributor to the bubble, with Sydney playing a smaller role.

The 1980s was a turbulent period, experiencing five asset bubbles: two smaller residential, one colossal commercial, later feeding into another residential, and also the stock market bubble and collapse in 1987. Housing prices escalated by 39 per cent from 1987 to 1989 on the back of the well-known commercial bubble, again resulting in an economic downturn during the bust. The early 1990s recession was the culmination of the worst financial collapse since the 1890s depression.

The residential property market stumbled along for several years, and then quickly accelerated into the largest boom on record. From the trough in 1996 to the apparent peak in 2010, housing prices increased by 123 per cent. This run-up in prices is what has generated the debate over whether the market is either overinflated (a bubble) or based upon fundamental factors: a housing shortage, growing population, restrictions on land supply, rising household incomes, etc.

Historically, every boom in prices has been followed by a downturn, either reverting to mean or undergoing a partial adjustment. Not every bust, however, has fully reverted to the mean, which explains the gradual upswing in the index from the late 1940s onwards. If history serves as a guide, it teaches an important lesson that caution must be taken against expectations real housing prices will always continue to rise. Past trends cast serious doubt upon the constant FIRE sector claim prices double every seven to ten years.

By examining the long-term trend in the housing market, we can come to one of two conclusions. The first, unpopular conclusion is residential property is in bubble territory and ready to burst – a pattern repeated continually in Australian economic history. This position is considered a fringe perspective today, and is most notably advocated by economist Steve Keen and yours truly, among a handful of other public commentators.

The majority view among government, the FIRE sector and property owners, however, is prices are based upon fundamental factors, meaning a substantial fall or crash will not occur. In this case, it may appear “this time is different” and that “prices have reached what looks like a permanently high plateau,” quite possibly the two most poisonous phrases uttered in economic history. With the passage of time, it will be fascinating to see which side is ultimately proven to be correct.

Philip Soos is a research Masters candidate at the School of Management and Marketing, Faculty of Business and Law at Deakin University, and is a researcher for the Land Values Research Group, Melbourne.