Aussie House Prices Face “Perfect Storm”


In the States overnight everyone went gaga over the news that construction of new U.S. houses rose in February by 22% over the January rate. That’s an annual rate. So we’ll see how it goes. It had been down six months in a row.

Who knows why stocks really rally? But it probably wasn’t the housing news. Prices continue to decline in the U.S. market. Inventories are high. And there is still the matter of millions of Option ARM loans that are still nestled deep in the bowels of the global financial system. We’ll get to them in a moment. Oh yes we will precious.

First, a bit of polly bashing. –“Every single job loss in Australia is a human tragedy,” Wayne Swan has said. “It impacts on families and local communities, as well as the economy.”

Has the Treasurer never been fired? Job losses are indeed a cause for personal distress. We’ve been through a few. You have to regroup, gather your wits, tighten your belt, round up other useful cliches, and do what you can to survive?

But a human tragedy? That is utter nonsense. There are plenty of human tragedies that happen every day. Children die of cancer. Orphans are hit by trucks. Supermodels go hungry.

Job losses are a normal part of the economy. Hopefully you have an economy where new jobs replace the ones lost. This happens if you have a tax and regulatory system that rewards initiative, hard-work, and risk taking. The trouble with the emotional response to job losses, as much as it displays your sympathy and compassion, is that it encourages you to try and build a system where no one ever loses their job.

If you do this, you end up with a system that creates fewer jobs and less wealth. We won’t go into it in more depth. But if you’re keen on the subject, we recommend this essay by Charles Murray.

What about the Aussie housing market, you say? Glad you asked…

“The Australian housing market is facing the prospect of a ‘perfect storm’ of financial pressures, including high mortgage debt, overvalued homes and rising unemployment, which could see prices eventually fall by as much as 30 per cent, investors have been warned,” reads a story in today’s Age. Read it and weep.

There is a lively debate in the comments section over at our website about Aussie house prices. We don’t have much to add. It’s true the market has shown surprising resilience. The Canadian research group that the Age report cites says it can’t last.

“The housing market is looking particularly vulnerable, with over-inflated prices, deteriorating affordability and slowing household income growth…There is an increasing possibility of a major housing bust in Australia.”

It does feel a bit like the eye of a hurricane, although we’ve never been in one. The sky is blue. The sun is out. The wind is down. Let’s have a picnic. We’ll bring the cricket bat and stumps, you bring the food and beer.

On a more serious note, as we’ve written in the introductory article to the March Diggers and Drillers (scheduled for release this week), the only good news in all of this is that you have a pretty good idea of where all of this is headed (huge inflation) and one way to prepare for it (metals and energy shares).

If more bank losses are head (see below) then monetary expansion is on the cards to try and counter it. Deleveraging leads to lower asset prices. The Fed wants to fight it. We’re not saying it will be successful. But there’s no doubt Big Ben will try.

“Bernanke May Need `Massive’ Asset Purchases to Counter Deeper Contraction,” reports Bloomberg. “The Federal Open Market Committee, gathering today and tomorrow in Washington, needs to redouble its efforts after the central bank’s balance sheet shrank 17 percent from a $2.3 trillion December peak.”

Here’s a thought though. The Fed may choose to expand its balance sheet by buying Treasuries. But it may not prop up markets at all. As Peter Schiff noted in a pod-cast last week, the Fed may end up being the only large buyer of Treasuries while everyone else sells. U.S. interest rates will rise and the U.S. dollar will…not rise.

Peter’s suggestion a much more rapid dollar crisis than seems possible at the moment, given the casual way through which officials are waltzing through the crisis. But this G20 meeting in London next month should be interesting. We expect there to be social unrest and violence. We also expect that the world’s investors may realise the markets overseers have no freakin’ clue what they’re doing. After that?

Well, your guess is as good as ours. But we’re looking to gold and oil. More on that later this week.

Now about those mortgages…You remember the good old Option ARM don’t you? That’s the loan that allows you to choose the size of the payment you make on your monthly mortgage. Typically the loan begins with a twelve month introductory rate. After that, you can choose the minimum payment option.

If you choose the minimum payment option, you actually pay less each month that the interest on your loan. That interest is deferred, but it’s added to your principal. That means your principal is growing all the time. This is why these loans were also referred to as negative amortisation (or neg am) loans. You weren’t paying it off. You were actually growing it.

We hope you’ll bear with us for a moment as we go through this. The reason? There’s a slight sense of relief in markets right now. Everyone is throwing stones at AIG. And with the market putting a few good up days, people are losing the sense that our financial system faces serious problems. But they are trillions of dollars serious. And no amount of pleading by the U.S. Treasury Secretary for bankers to lend will change that. More losses are head.

But what size will the losses be? Another trillion? Another two trillion? Well let’s exclude commercial property and loans securitised with credit card receivables or auto loans. Let’s just look at Option ARMs.

Remember, an Option ARM loan “recasts” after five years to a new principal. The interest rate might even stay the same. But if the loan has been negatively amortising (growing as deferred interest payment are added to the principal), then the size of the loan is going to be much larger (an average of 30%, by some estimates).

Even if you’re paying the same interest rate, households at the margin are going to have a much harder time making minimum payments on loans that are 30% larger. And we’re not talking a small amount here. The Washington Post reports that between 2004 and 2007, over US$750 billion in Option ARM loans were originated. The scary part is that, as of late December last year, 28% of those loans were either delinquent or already in foreclosure.

And that’s before the “recasts” have even hit the borrowers. Most “recasts” don’t happen until five years down the track. That means mortgage holders wouldn’t confront the prospect of a higher monthly payment until 2011 or 2012. The chart below from Credit Suisse shows the pig in the python problem.

Source: Credit Suisse

Bernanke has solved the interest rate problem for home buyers with adjustable rate mortgages by slashing short-term rates to zero, effectively. What’s more, he’s conducted purchases of mortgage backed securities by Fannie Mae and Freddie Mac in an attempt to bring down mortgage rates directly.

The looming trouble, however, is that negative amortisation ads to principal. It does so at a time when home prices continue to fall and unemployment is rising. Making a much higher payment is pretty shocking to begin with. It’s near impossible when you’re out of a job.

The trouble will hit sooner than the Credit Suisse chart suggests. Option ARMs automatically recast at the higher principal level once a predetermined loan to value ratio (LTV) is reached. For example, say you take out an Option ARM at an 80% (LTV) and immediately begin making the minimum payment. Your loan automatically recasts at an 85% LTV ratio. In other words, your loan recasts sooner than the five years you expected because of negative amortisation.

This is why the Credit Suisse chart shows a swelling amount of recasts beginning in April of 2009 and peaking in December of this year. It turns out many of those who took out Option ARMs chose the minimum payment. This led to much faster growth in the loan principal, thanks to neg am. And now, it’s going to lead to a much sooner recast of the loan.

As you may know, the current mortgage relief plans in the States, as feeble as they are, do not allow you to refinance your home if you already have negative equity. This means that in the coming months-starting next month-you have millions of home owners who will face much higher monthly payments on their mortgage.

Do you think they’ll pay them? Can they afford to? What will happen to house prices as this wave of neg am Option ARMs goes into default and foreclosure? There could be some real bargains in the housing market.

But for the banks, there will be some real pain. The banks, the insurance companies, the usual suspects, these are the institutions that stand the most to lose from losses on that $750 billion wave of Option ARM recasts. We’re not saying all those loans will go into default. But at the very least, the losses are certain to be taken, even though no one knows how big they will be.

Now maybe all this is “priced in” to bank shares and financial stocks. It’s pretty hard to price in what you don’t know, though. What seems certain is that banks would want to hoard capital in the coming months, not lend it. They face hundreds of billions more in losses, and that’s just from residential real estate (not commercial real estate or corporate bonds).

How will credit recover under those conditions? We reckon it won’t. In fact, the second contraction of the credit crisis could be worse than the first. You should consider that as you ponder your decision to get in our out of the stock market. Think of the number of companies that are already locked out of access to capital and credit. Will that improve in the coming months?

There’s a very real chance it could get much worse. Of course we hope that’s not true. But if it is, it means all those clowns holding press conferences about bailouts and recoveries are just whistling past the grave yard.

If they were smart, they’d be storing up cash and keeping their monkey yaps shut, or better yet, setting up a warehouse to settle all the CDS AIG has underwritten so it doesn’t continue to be a giant conduit between the American tax payer and AIGs counterparties (investment banks and commercial banks that bought CDS from AIG).

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. I think a 50% drop in house prices (maybe not in every area) in the next 2 years is becoming a more and more likely scenario in Australia. We are just sitting at the tip of the iceberg at the moment and already listings are rising. When the second credit crunch does eventually come, hitting a market dealing with unemployment and wage cuts there is only way for house prices to go..

    My housing deposit is still growing nicely, just waiting for opportunity to knock.

    March 18, 2009
  2. I really feel sorry for the first home owners that have been encouraged by the FHOG into this market. I also wonder how many investors? will jump into the market as prices fall say by 10% thinking this might be a bottom only to discover their newly purchased property keeps falling in price. Just my opinion but I think we will test median house prices at 4 times average income at some stage in the future, the pre bubble ratio compared to income.

    As some of you may know I’m a farmer and a residential property investor who sold his investment properties in 2008. To me my houses where telling me to sell when my rental yield versus current market price was unacceptable as an investment. I learnt a long time ago a true investor looks at yield, relying on capital growth to make a profit is for speculators, nothing wrong with speculation, I do it myself, hell I’m a farmer but what is important is that you know thats what you are doing. I doubt that many so called housing investors really know they are just speculators.

    Like I’ve said before the unexploded bomb in the Australian economy is the largest housing bubble in the world. Will it go off no one really knows for sure but I’m not going to sit on it and wait to find out. Too much risk for very little reward.

    I’m better off to keep producing that wheat so you guys can eat.

    March 19, 2009
  3. The U.S. tell us that construction of new U.S. houses rose in February by 22% . Has anybody read that book called “How to lie with statistics” ?

    Maybe 2 houses got built in Januray, and 10 houses got built in February. Hey, that’s about a rise of 22% :-)

  4. Ps- if I make $1 income today, and then the next day I make $2 income, hey presto, I can say that my income has risen by 50%

    The U.S. can say anything they like with statistics ,but it doesn’t mean it’s true

  5. Your stats are a bit off Christina. Your point is valid though.

    The Real Estate Institute of Australia (REIA) has been unashamedly and continually releasing stats like this for years now. Do not believe a single statistic they release unless you can verify it yourself. Also ensure that you look at the entire range of statistics, not just the one they choose to report on. Too many times I see them report on growth, when their lone positive statistic is all they could pick out from their entire range of negative ones. It doesn’t take much effort to write a marketing piece on that one positive statistic though. A gross case of lying by omission.

  6. beyondtool – can you explain why you suspect a 50% drop? You’d need to have an extreme volume of forced sales for that kind of drop to happen.
    It’s not impossible but so far the market is defying D&G predictions. I’d agree a correction is to come but 50% – that’s a bit of extreme D&G.
    Why shouldn’t Oz values be some of the leat affordable in the world? It is one of the nicest coutries to live in.

    Employment is going to be the key but even if we hit 10%, it still means 9 out of every 10 people will have their jobs.

  7. Pete, I have posted Part 1 of my look at the house prices debate. I have picked up a few of your ideas and worked them into the blog. So far I would say the case for prices falling is really based on a significant and long term recession in Australia, but I am yet to finish looking at the other side of the debate so I will hold fire for a while.

  8. I think there are a range of factors coming into play. In the future banks are likely to shrink credit, wages will stall while inflation takes over, unemployment may rise marketing in Australia as we are so dependant on imports and exports which are falling. We have no manufacturing sector in Australia to get things rolling again. Interest rates cannot remain this low for much longer, I think they will be rising by early next year if not before. Overseas investors are drying up, whilst imigration has hits the skids due to government regulation (no influx of new buyers). Then there is the physcological impacts of a sliding property market, people might decide to wait it out.

    Cost of living is set to rise markedly this year oil will be going up, food is rising already and inflation is on the horizon.

    As it is people are spending far, far too much of their income of housing. When people see it is not an investment anymore the rapid selling of investment housing will trigger a price collapse.

    My then again that’s just my 2c.

    March 19, 2009
  9. Guys, too much information about the USA.
    We have a different situation happening over here.

    Give us some useful information about Aus!

    I don’t really care about the US story!
    It’s all about me!!!! (not them damn yanks….)

    March 19, 2009
  10. Uh, sorry, Technibyte, we don’t have any really scary Australian data to cite. We have to rely on completely irrelevant US and UK data…. sorry! :)

  11. Yes technibite..Over it a bit too… but when the crisis hit in USA the aussie dollar went south in a big hurry regardless of what was happening here at the time. China’s requirement for our commodites depends significantly on exports to USA etc. The flight to “safety”!! was to the US dollar. The main game is still with the USA and the “gravity waves” reach here and elsewhere big time.We have to interpret those gravity waves and there likely impact on our economy and do so in conjunction with our own homegrown issues.

  12. Yes Gerry, I guess the impacts are felt here. However,I thought the article was about Australian housing, but it didn’t seem to be about that at all (Option ARMS??).

    I’m just starting to tune out guys. You’re losing me with all of the US-focussed stuff. Sure we feel gravity waves from the US, but we need some information about our situation over here. Isn’t our situation different to the US experience?

    March 19, 2009
  13. Graham Dyer is an Australian “elliottwave technician.

    His website is While I disagree with his position that a depression started in 2007, he has some interesting observations.

    I speculate in my article “1930s and 1970s for Today: Contraction – Expansion – Contraction?” that we may have anywhere from two to five years of Expansion, as a result of the stimulus due to the first contraction, before the next Contraction, that will be as severe as, or severer than the Hoover Recession – the first contraction of the 1930s.

    But back to Dyer and some of his comments in his January 2009 newsletter in regard to where Australian housing prices are heading:

    “The level of the stock market and the level of house prices have nothing to do with what people think or do or see or hear in the “news,” and nothing to do with interest rates or any other economic fundamental, no matter how difficult you may find this to grasp at first, having been brainwashed all your life into believing the opposite. Both the share market and the
    property market are determined by the mass social mood at the unconscious level, which is the unseen force that drives the economy as well. Interest rates are irrelevant. Supply and demand
    is irrelevant. Immigration levels are irrelevant. There is no such thing as a “shortage of houses”
    in Australia, despite economists’ blah, and “location, location, location” is just another trap (the
    best located properties around Sydney Harbour fell 75% in 1989-92). Even though it is obvious to the most diehard bulls that the economy is under threat, very few can conceive of house
    prices falling very far in Australia. Why? Because they haven’t seen it happen before. (Had you
    seen a 50% drop in the share market before?)

    As you will see later, the property boom in Australia has been one of the most extreme in the world, rivalled only by Spain and Ireland. The bust will be similarly extreme. Just this week a
    study by international group Demographia said that Australia had the most expensive houses in the world relative to income, and predicted a house price crash. But good old Commonwealth
    Bank economist Savanth Sebastian came out and rebuffed that “nonsense.” He said falling interest rates and the first home buyers’ grant would prevent a housing collapse here (he forgot
    “shortage of houses.”) He obviously hasn’t been to Japan in the last twenty years…


    If you wish to continue believing that the earth is flat, then you will believe the baloney fed to us in the media, mainly by economists, that Australia will not suffer the same fate as property
    markets in the US, UK, Ireland and Spain. Their “reason?” There is a “shortage” of houses in Australia, interest rates are crashing, and there is a generous first home buyers’ grant. Any Japanese readers should, by this time, be rolling on the floor laughing.

    On the chart on page 21 I projected Australian house prices with Elliott Wave analysis, as closely as I could, given the limited accuracy of the data available. What this means is that
    house prices in Australia will fall back to 1992 levels at a minimum. That means a fall of at least 50% from the peak valuations reached a year or so ago.

    That sounds impossible? Official figures show house prices as having only fallen a few percent in the last year, perhaps 10%, more in some areas, less in others (see late news at the end).
    Already some “experts” are talking about the “bottom” of the property market, and what a “buying opportunity” this is. The Government’s first home buyers’ grant and lower interest rates
    make real estate a great investment now. Believe all that at your own peril.

    For one thing, none of these fundamentals (including a “shortage” of houses, even if we had one) is what drives house prices. Like all financial markets, and the economy, house prices are driven by the socionomic force that creates within us the unconscious urge to herd.

    For another, anyone who thinks house prices in Australia will defy the trend in Japan, the US, UK, Ireland, and Spain, where a crash has already unfolded, or is well and truly under way, as
    sellers dropping their price 50% still can’t attract a buyer, really does not deserve to be protected from loss.

    Only a few months ago, our Government and their advisers were telling us that Australia’s “strong economic fundamentals” would protect us from the global downturn. Then, when the “financial crisis” was staring them in the face, they acknowledged that we would not be “immune,” but we still would not fall into recession because China would save us, etc. Now China has fallen, and the emperor has no clothes. Yet still mainstream economic thinking is
    preventing the players from realising that we are at the beginning of this downturn, not the end.

    Similarly with the real estate market. A year ago there was complete denial that the property market was in any trouble. Now the realisation is beginning to dawn that something potentially
    serious is under way, but again the belief (hope) is that it will be a “soft landing” and short lived.

    Does “the bigger the boom the bigger the bust” ever cross their minds? The property boom that began in 1996 was long and slow, but in the process turned out to be one the biggest ever. The bust looks like being the same.

    I said the share market is way ahead of the property market. Has anyone looked at the REITs index lately (chart below)? The index for Australian listed property trusts has fallen 68% in the
    last two years. Yet commercial property values have not fallen anything like that – yet. They will.

    And this is no doubt a leading indicator for house prices in the future.”

  14. I have to agree technibyte.

    I have been enjoying Dan Denning’s posts lately because they have mostly been directly related to Australia. And very good articles too. Looks like he’s taking a break in this one though? (and the last one)

    I wouldn’t tune out yet if I was you though… :)

  15. Labor will cut the 1st homeowners subsidy when they realise they are on a sure bet to have remade NSW Labor’s Homecorp. Not one of those people will ever vote Labor again and it is a big reason they lost Western Sydney to Howard.

  16. Not sure I get why “Any Japanese readers should, by this time, be rolling on the floor laughing.”?

  17. Japanese laughing? Well, he might mean that rents (income) in Japan continued to rise, while interest (costs) fell to zero… and remained there for many years. Japan’s ‘zero-growth’ is one of those highly useful examples unwittingly trotted out by hopeful doom’n’gloomers. Overseas dramas often serve as performance indicators, but those who are banking on a property crash here haven’t considered that in this market, Aussie investors need no capital gain whatsoever. Only a sustained intervention by government to support home construction (the very thing you _most_ fear) can limit rental increases and capital appreciation. Catch 22, ce n’est pas?! :)

    Biker Pete
    March 20, 2009
  18. Dont need capital growth what a classic, think about if no growth you loose the same amount as the inflation rate each year off the top of your purchase price (like Japan ask my wife), buddy even at say a modest 4% of the original purchase price it doesn’t take long to make a good size loss. I’m still laughing, dont take my word for it do the math, it never lies. Ah no capital growth required, do we have the smartest housing speculators in the world or what. Here is another little tip negative gearing doesnt work unless you get capital growth. House prices are supported by supply and demand ON MARKET, you do realise that you dont need to even build a single house to create a glut, just the number of sellers to exceed the number of buyers. Thats how all the SHORTAGE markets turned into gluts, UK etc. Your concern should be the falling number of buyers and the ever increasing listings this is what will drive this market. No capital gains, I’m still laughing.

    March 20, 2009
  19. Greg: I was thinking the other night (gasp) about the notion of ‘comparing other countries to Australia is not a good enough reason to expect a housing downturn here’.

    We discussed this in a previous comment, and I agree that neither can provide a direct correlation due to the difference in circumstances.

    So that is a good argument ‘against’ a people expecting a real-estate fall here.

    However…it occurs to me that exactly the opposite notion is being used by Real Estate bulls here. Essentially the argument that ‘because we have not (yet) experienced the falls that other countries have, means that we are strong and won’t have falls’.

    I have seen that excuse a lot, however it is just as pointless as the first point. I think they call that falacious reasoning or something like that, where people draw causal conclusions from different factors that cannot support causality.

    Drew: You can’t argue with Biker, he has 30 years experience living inside a real-estate bubble (sarcasm).

  20. Yeppers … there’s a parallel in state of denial belief systems.

    “This time it’s different” equates to “This country is different.”

    However, I’ve read, contrary to above comparisons, that NZ is even worse off than the land of oz in terms of most expensive housing. But rubbery figures abound everywhere.

    Btw, people should also be reading Steve Keen’s site.

  21. Someone please convince me with hard facts that we are heading for a 50% crash. Until then, all I can see is that with the Aussie dollar down, our houses are not that unaffordable for many who are right now thinking about moving to the lucky country with the second best currency (and by that I don’t mean the exchange rate) and one of the strongest economy and banking sector currently in the world.

    I can also see that rental yields are in harmony with interest rates, making residential property a good investment once again, and that that supply does not exceed demand, nor is it likely that it will in the near future, so where are the arguments for such a substantial drop in values?

    Of course commercial properties are a different kettle of fish.

  22. Pete you will not get any arguments from me regarding the “it won’t happen here” defence. We have heard this all before when people were saying Australia would ride out the GFC because of China, then because of our banking sector etc. If you look at our stock market it is hard to see how we have done any better than anyone else, apart from Iceland ;) It makes me remember all those experts who were talking about how the global economy was now decoupled from the U.S….bah humbug! But I also do not automatically see any logic in thinking our real estate market should follow the U.S property market because…well just because. Maybe if we had an Australian version of Fannie Mae and Freddie Mac I would think differently.

  23. Yeah yeah I Know its completely different here and could never happen. Australian investors are much smarter, arent they biker.
    Please read the last paragragh a couple of times, just to make sure you get, the take home message.

    FOURTEEN years ago, Yoshihisa Nakashima looked at this sleepy suburb 20 minutes from downtown Tokyo and saw all the trappings of middle-class Japanese bliss: cherry-tree-lined roads, a cozy community where neighbors greeted one another in the morning and schools within easy walking distance for his two daughters.

    So Mr. Nakashima, a Tokyo city government employee who was then 36, took out a loan for almost the entire $400,000 price of a four-bedroom apartment. With property values rising at double-digit rates, he would easily earn back the loan and then some when he decided to sell.

    Or so he thought. Not long after he bought the apartment, Japan’s property market collapsed. Today, the apartment is worth half what he paid. He said he would like to move closer to the city but cannot: the sale price would not cover the $300,000 he still owes the bank.

    With housing prices in the United States sinking after years of spectacular gains, it may be helpful to look at the last major economy to have a real estate bubble pop: Japan. What Americans see may scare them, but they may also learn ways to ease the pain.

    To be sure, there are several major differences between Japan in the 1980’s and the United States today. One is the fact that property prices rose much faster and more steeply in Japan, partly because speculators used paper profits from previous house purchases to invest in even more property, insupportably leveraging the prices higher and higher.

    Still, for anyone wondering why a housing bubble in the United States preoccupies so many economists, it is worth looking at how the property crash in Japan helped to flatten that economy, which is second only to that of the United States, and to keep it on the canvas for more than a decade.

    And as American homeowners contemplate what happens as their property values fall -particularly as they fall hard – there are lessons in the bitter experiences of their Japanese counterparts like Mr. Nakashima.

    JAPAN suffered one of the biggest property market collapses in modern history.

    Now land in Japan is worth less than half its 1991 peak, while property in the United States has more than tripled in value.

    Homeowners were among the biggest victims of the Japanese real estate bubble. In Japan’s six largest cities, residential prices dropped 64 percent from 1991 to last year. By most estimates, millions of homebuyers took substantial losses on the largest purchase of their lives.

    Their experiences contain many warnings. One is to shun the sort of temptations that appear in red-hot real estate markets.

    Most of all, economists say, Japan’s experience teaches the need to be skeptical of that fundamental myth behind house prices: that prices will keep rising forever. Like their United States (Australian) counterparts today, too many Japanese homebuyers overextended their debt, buying property that cost more than they could rationally afford because they assumed that values would only rise. When prices dropped, many buyers were financially battered or even wiped out.

    March 22, 2009
  24. Lets talk about this bubble with some facts.

    Lets leave the high fallootin US/UK central banks and what commodity prices will do to the Australian Dollar discussion for those who obviously ‘know’ about these things. Here are some facts about Sydney and the property price bubble. I purchased a three bed investment unit (one year old) in a middle ring Sydney suburb for long term investment in Oct 2002 for $275K. I would be able to realistically sell this same unit for $295K today including the FHBG. Rental return over the last seven years =$250 starting in 2002 rising (quickly in the last 2 years) to $350 today.

    The fact is the bubble has been fizzing for seven years since Oct 2003 in terms of sales price. The prices are static and have been for years. This is the reality. Forget the statistics.

    Oh – by the way – its a nice unit. It has been empty for a whole 5 days in the last 7 years. High empolyment area, good infrastructure, jobs, restaurants, facilities , schools, shops, transport. You get the picture.

    Here is your property bubble. Its a bit flat.

    Now, I know you have already done the figures! Why wouldn’t my tenant buy a unit like this if they can get the FHB grant and a loan with repayments at about $330 (taking into account all purchasing costs) with the current interest rate deals. It seems a no brainer. Why rent when you can own?

    The answers in the two little words, they ‘rent’ – I ‘own’. I’m a boomer! I’m the King of the World (to quote another boomer).

    I will not sell, no siree, not me, no way. My neighbours will not sell either. Where INVESTORS!

    Have a real close look at the market. There is very little out there. 70 FHB buyers arrived at a purchase ($304,000) last weekend down the road from my apartment – I was there. 70, with mum and dad in toe. It was like backyard blitz was filming. What do you mean? I hear you say – very little stock. Have a look on for anything decent at this price. Have a close look at what you get.

    Sure, old units that were built and purchased 25 – 35 years ago, where the boomers are old and have made their gains. They are selling them to the FHB like hotcakes. The old boomers kids have power of attorney by now and these kids have lost a bundle on their shares. “Poor ol grandma will have to be convinced to sell that flat she’s owned for yonks”. “Who’d live there anyway. And besides, we are palnning that trip to Europe”. “It needs alot of work”. Lets ofload it to someone elses kids.

    These flats need total renovation, kitchens, bathrooms etc etc, but hey – Daddy will help out there. Now everyone, this is all OK. Its human nature. As Elton John said (another boomer) “its the circle of life”.

    Look at the bright side. Whatever happens the FHB will have a roof over there heads, a unit albeit, one they can call their own, have there first child, or buy a dog (if that’s your thing), and will be secure, have birthdays and go to the shops and not focus on the deal once its been done because life will move on. It will become there home. Not their property portfolio. Go the FHBuyers.

    If it does go belly – up and they loose their job, they can just move back home and rent it out. This will happen to a about 80% of the properties when little Sally realises the expense of looking after herself.

    Rents will flatline. And so they should. I wouldnt pay the rent I’m getting for whats on offer.

    So why will I not sell,? And thousands like me not sell. Well, being at the end of the baby boom and watching the greed of my fellow boomers I understand these people (“the great generation”) they will do anything to hold their assets, to increase their assets – even after retirement – (why, don’t you know they all deserve the pension). Its about accumulation. Its all about bequething the assets to the family. “I want my children to inherit this property, I want them to have it all and more – the government owes me – I made this country what it is today”.

    That my friends is it in a nutshell. Greed. The ol Gordon Gecko syndrome (he was a boomer). You have thousands of apartments bought over the last decade rented but will never be for sale. This is where cashed up boomers (they have assets to survive this crisis)have not realised a capital gain. “I ain’t sellin” is the catchcry. “I’d rather leave it to the dog then give it away”.

    You’ve met them – you may be one of them.

    “We will just sit on it and wait, it will be worth a fortune in the future – just like that comic book uncle Stan gave us or the tonker toy we bought for our son 40 years ago – you know the one Mable – the one we put in the attic. The one untouched by human hands -its still in its box – a limited edition. It was lucky we didn’t give it to our son to play with – he would have destroyed it!”

    You see dear audience – this crisis is all about greed and saving face.

    The property prices will not fall by much, nor will they increase. Property will only dribble onto the market as each boomer is sent to the big RSL in the sky. The one with disounted travel, subsidised medical scans, free glasses, meat raffles where everyones a winner and where everyone can get a CAT scan and their favourite cardiac specialist travels 350km from home to pay them a house call whilst they relaxing in their holiday home on the coast.

    This is not a financial crisis. Its a re-evaluation of what the tonker toy is really worth and what its intended use was all those years ago.

  25. Pete, when I was looking for an apartment to buy here in Japan I came to the conclusion very quickly that it was pointless to try and compare home prices between two countries. There are too many variables such as interest rates,property laws,government grants and local taxes etc. It was hard to even compare prices in the same city! It gets more complicated when you factor in exchange rates and my head spins when I see tables comparing property prices across the world…often they simply convert everything to $USD, like that means they think we all earn $USD?

  26. Sorry factual, but you do contradict yourself a few times.

    “If it does go belly – up and they loose their job, they can just move back home and rent it out. This will happen to a about 80% of the properties when little Sally realises the expense of looking after herself.

    Rents will flatline. And so they should.”

    Wouldn’t this indicate that rents would in fact drop?

    If rents drop, will those rents be able to cover the interest on the loan? What if interest rates rise?

    In the worst case scenario, where rents drop, house prices drop, interest rates increase, and unemployment increases, every single new home-owner is in big big trouble. They will be lucky to get out of this mess with bankruptcy early on.

    It might not come to the worst case scenario. But even just some of those things can drastically affect the dependability of buying a home.

  27. One very very big thing that barely gets covered on this topic is the RATE at which people expect change in real estate prices and volume.

    For instance, I argue that real estate in Australia is in a bubble and current major forces in the economy will drag the market downwards.

    Others disagree and argue that we are doing fine and compare the CURRENT SITUATION with what is expecting in a market fall. Clearly, the market is not falling anywhere near its peak level.

    So does that make them right?

    No. The point is that the market will fall. Will it change drastically in one day? No. Markets rely on human will to make trades happen. This relies on confidence, hope for the future, people that feel secure in their jobs, people with access to money, etc.

    Currently, Australia has fairly low unemployment, pretty good access to credit, and quite a few of us are completely blind to any recession (erm, Depression) that might be coming, and the REAL effects it will have on us all.

    For the real estate market to drop, it will take time. It is already turning, but – like trying to turn a giant ocean liner – it takes time to get momentum.

    This momentum relies on human will to change. People don’t go from real estate bulls to bears overnight (some might). But once sentiment really starts to change, the whole market will. Human nature is interesting like that, moving in a giant senseless mass, feeling safety in agreeing with whatever trend is driving everyone else at the time.

    The housing market drop (like those in other countries) will be slow at first. A drop of 5% still means that people were BUYING houses at 5% discount.

    Consider the ‘bigger fool’ theory. The theory that if you buy something (eg real estate) that the price will go up and you can sell it to someone even more foolish later on. How many ‘bigger fools’ are left? As sentiment towards real-estate turns, they will become much harder to find.

    So, if people argue that property prices have not dropped in suburb X or town Y, (yet) so what? Give it some time to gain momentum, these things don’t happen overnight – and mortgages don’t get paid off overnight either.

  28. One other thing to consider in real-estate: If you take out a mortgage, you do not own your house. The bank does. You don’t own it until you have paid it all off.

    The idea of buying a house in the face of financial armageddon is interesting – because you will still own the debt, while the bank owns the asset.

    For those that like bankruptcy as a fall-back option – this might be a problem in the future. As banks become more selective to whom they will lend to, bankruptcy will put a big black mark against your name (although I think this expires in time?).

    It is a simple notion, a mortgage is borrowed money. It is not ‘your’ money, it is someone elses, and you are using it. You pay that money back to the lender (eg: bank) over time, at a premium (interest rate).

    Why purchase something with someone elses money?

    That notion is simple enough. Because:
    1) we ‘want’ or ‘need’ something right now (rather than later)
    2) we are trying to make money (where our returns are higher than the interest rate plus tax)
    3) we are afraid that purchasing something later will cost a lot more (more than the interest charged over time)
    4) we would rather own something than rent it (that way we can modify it, feel secure, etc)
    5) we are really bad at saving money, and a loan (mortgage) is like a forced savings
    6) we see interest rates are so low that the interest on a mortgage is similar to our rent payment

    For anyone making the decision to get a loan, it would be a good idea to figure out what exactly is motivating you (eg, from the list above).

    Figure out which points motivate you, and then decide whether it is reasonable to take out a loan based on them.

    I will go through each quickly:

    1) we ‘want’ or ‘need’ something right now (rather than later)
    Want vs. Need vs. Is it really a ‘need’?

    2) we are trying to make money (where our returns are higher than the interest rate plus tax)
    30+ years of positive real estate trends can’t be wrong…can it?
    Consider: How old was the Lehman Bros company before its collapse?
    When it comes to trends – consider why it was a trend, and why that trend would ‘definitely’ continue. Why do things go in cycles? Why will it be the same now? Why might it be different?
    Also, will interest rates change dramatically?

    3) we are afraid that purchasing something later will cost a lot more (more than the interest charged over time)
    Emotional purchases are dangerous. Fear is just one emotion that can cloud our better judgement. Regret follows.

    4) we would rather own something than rent it (that way we can modify it, feel secure, etc)
    Hard to argue against someones preference here.
    Consider: You don’t OWN the property until it is paid off. How secure would you feel living on the bread-line? Unemployed with a mortgage? Financial security is also a consideration.

    5) we are really bad at saving money, and a loan (mortgage) is like a forced savings
    This seems a bad reason to get into a lot of debt.

    6) we see interest rates are so low that the interest on a mortgage is similar to our rent payment
    For now it is. If todays interest rates continued on for the next 30 years, that would be fantastic. Will interest rates stay low? If so, why will they? If your answer included the letters RBA then you are mistaken. Consider the impact of interest rates doubling by next year. Consider them tripling. Quadrupling. What if they stay low for 4 years, and then high for another 4 years? How much principle would you have paid off in 4 years?
    Yes, this is the problem with borrowing amounts that are barely servicable – changes in the economic environment that you borrowed the money in can tip the scales out of your favour quite easily.

    Ok, sorry for the long post, i’m done.

  29. Edit: Point 2) should have include “and higher than inflation” (duh ;))

  30. Don’t apologise
    Post should be long to cover what angle you are coming from
    Are you a high income earner
    Middle income earner
    Lower income earner
    Are you a Property investor
    Family man
    Young gun

  31. interesting article in the AFR Market section today about ARMs, I swear I’d read almost the same thing somewhere else a few weeks back…hmmm

    RonPaul for next Aussie PM
    March 31, 2009
  32. What a fascinating blogroll. I am a bear on real estate prices, and maybe you will too with an objective look at what current prices mean.

    The most useful measure it to relate purchase prices to income. Historically this has hovered at between 2.5 and 3 times income. It is currently at six. Before you shrug, think on what this means: anyone buying now commits to thirty years of principal repayments of 20 per cent of their gross income. Not interest, principal – interest is, ahem, extra. And that’s pre-tax, pre-super, pre-HECS, pre-eating, pre-clothing, pre-living.

    Commiting to a large mortgage at these prices means a lifetime of slavery – scrimping and saving and self-denial.

    Don’t lose your job!
    Dont get divorced!
    Dont have children!

    And if house prices can fall suddenly from these peaks elswhere in the western world, they can here too.

    I pay $22,000 to rent a house worth $700,000. The owner probably makes 1.5 to 2 per cent after paying the outgoings – all for the privelige of owning a rent roll.

    This madness cannot continue.

    David Collyer
    April 18, 2009
  33. David Collyer – Yes, I don’t think you’ll find too many residential property owners are making much of a % return on rent. So pull capital gain out of the equation and real estate is not an attractive investment at all. But speaking quite generally, the same goes for stocks I guess. Would anyone really want to own BHP stocks if they didn’t think they’d get some capital gain over time? (Except an active stock trder perhaps.)
    I did glimpse a big eye catching add in the top right corner on some internet site recently wanting to pay me 7.25% pa (or some such) on some company’s bonds (or some such) I think? – My “too good to be true” alarm bell went off so fast I ran rather than looked, so can’t provide specifics. But that’s just me. PS: I think Australian residential property prices are way more likely to go down than up at this time as well.

  34. Landlords in many parts of Sydney have been doing pretty well.. like so many things do with real estate it just depends on the location. (I would say that last year was much tougher because of the high interest rates)

    One worrying trend in this whole discussion is we all tend to make general sweeping statements about the property market when in fact there is no one central place that homes are bought and sold. The so called property market is actually a collection of thousands of different markets all with their own characteristics.

    So what I say for example based on my knowledge or experience in a certain area will often not apply to the situation in another area. This might sound pretty obvious, but if you read many of the posts here often it is not even clear what state we are talking about let alone what city, so quite often people are probably talking about vastly different real estate locations.

    For example a landlord getting $22k on a $700k property sounds like madness to me and would not happen often in the markets I know, but that does not mean it does not happen often in other areas.

    For some people now is probably a good time to buy, for others it isn’t. For some people renting is the best option whereas for some people getting the FHOG and buying their piece of Oz is the way to go. (and if they are happy good luck to them!) You know it is possible for people to live in a home, be happy and not worry about if they could have achieved a better capital gain if they lived in another city :)

    There is simply just no “one” correct way to go that suits all people no matter how bullish or bearish you are regarding real estate. But I am sure the debate will rage on :)

  35. Greg Atkinson – Three of the real basics re housing prices (interest rates, the FHOG and negative gearing/CGT legislation) are pretty much the same for all of us regardless of where we live I think? And those basics are going to be impacted by commonwealth government perceptions of whether the Australian economy as a whole is looking OK to them or not. So even though as you do very correctly point out, the degree of any possible property price rises and/or falls in different locations will certainly reflect specific localised factors, a lot of the big picture stuff is also the same I’d say?

  36. Ned S I see your point but actually first home buyers may or may not also get some extra goodies from their state governments. In addition there are state programs such as Buildstart in the NT. Then across the states we have different levels of stamp duty and land taxes, not to mention local council rates. So all these start to bring in differences even before we even consider wages and household incomes. So maybe the only big picture we really have is one we create, and perhaps this does not reflect accurately how things are on the ground?

  37. Greg Atkinson – I agree with all your points. (Except the last one perhaps? – I’ll need to ask you more on it.) I guess to a certain degree at least, I was thinking in terms of the State differences you mention as being “localised” ones? Very poor choice of wording on my part “State/Regional/Local” would have been way better.
    But re your last point: “So maybe the only big picture we really have is one we create, and perhaps this does not reflect accurately how things are on the ground?” – I didn’t fully understand but it did cause me to think immediately of Roosevelt’s 1933 statement “The only thing we have to fear, is fear itself.” Were you implying something similar to that concept or was my take on it wrong?
    Either way, you do seem to be more bullish on Oz RE than me generally. (Which even though I agree that State/Regional/Local differences make a lot of difference – Eg I think(?) parts of the US RE market have continued to grow despite the whole GFC thing to date – I still do think is a useful starting point.) So I’d value your thoughts on my prior post re the Oz Housing Shortage argument if you have time to read it please:

  38. Ned S, During much of the Vietnam War the “big picture” view held by many in the Pentagon was the the U.S. was winning the war. To support this view they have graphs and statistics that could show for example how much of South Vietnam was under their control and also the number of enemy that had been killed. As more of South Vietnam came under their control it seemed logical to say they were winning. But as we know the Tet offensive highlighted the flaws in this thinking and as they say, the rest is history.

    So my point is that by rolling up statistics, trends etc. so that we can have a “big picture” view can often result in poor assumptions being made and the wrong conclusions being drawn. This is because the data is smoothed over and even if you have areas going against the trend these facts are often lost when you look just at the “big picture” level.

    So in the real estate debate we are doing the same thing. The big picture is that prices in the U.K. and U.S. etc. have tumbled and so since Australia is also entering (in) an economic downturn then our real estate prices should also fall. But the fact is that last year they hardly fell at all, even though prices in the U.K and U.S. fell by around 20%. Then when we look at real estate prices across Australia we lump everything together into the big picture view and there is little discussion around such things as:

    – What areas bucked this trend..what does this tell us?
    – What areas were hit hardest..and what does this tell us?
    – What areas seem unaffected..again what does this tell us?

    Also why did prices only fall 3% last year in Australia? Why didn’t we see bigger falls? After all our stock market got hammered just as much as other markets. Could it be because we have different loan conditions and are banks are more stable etc? If so then why should our home prices tumble this year? Yes they may be flat or decline somewhat (due to the recession) but where do people pull figures like a 20% or more nationwide decline from?

    I also read your comments and I question the old housing shortage story as well but feel what is more likely is there is a shortage of houses in areas people want to live. So in certain areas prices will be supported because people simply want to live there and there is simply a limited number of homes in the area. This is why the property market is complicated… because it isn’t just numbers, buying a home and deciding to where to live is a very personal thing and we just cannot wrap that up nicely into a set of numbers. By the way, how are holiday and second homes handled when they look at total housing numbers etc?

    Anyway I am not a real estate bull. I am not saying that real estate is the place to invest and I have no rock solid evidence that says prices will not fall significantly this year. I am just trying to balance the whole debate a little.


  39. Greg Atkinson – The Vietnam analogy is an extremely good one. Because to my way of thinking at least, it illustrates that:
    1. The true situation can and does change over time, and
    2. Appearances can be genuinely deceptive, and
    3. That governments (like individuals – Hey, governments are just made up of individuals anyway) can certainly fall into a trap of choosing to believe what they would like to believe, and
    4. Propaganda is an important tool of governments – Sometimes used honestly to beef up support for their efforts in a “war” they genuinely are winning, or sometimes have just genuinely chosen to believe they are winning, but sometimes in somewhat less honest ways to either assist them to maintain support for a “war” they are not quite at all sure if they are winning or not whilst they come to a more considered opinion, or when they even incline strongly to the view they are losing but want to buy time as they back out as gracefully as possible using all possible forms of “damage control mode.”
    I relation to that, apart from the RBA’s ability to raise and lower official interest rates, the main impact the RBA can have on the economy is through “jawboning” (another word for “propaganda” I think?); Although in desperation I certainly imagine the RBA could use QE someday as well if it felt it was required.
    I guess I may differ to you (correct me if I’m wrong please?) in that while you seem to incline more to the view that the “big picture” can be quite deceptive, I incline more to the view that the “big picture” gives us broad trend regarding where we are currently heading – At least if we can get any sort of a reasonable handle on it??? (And that has actually become most especially difficult of course over the last 8 months in particular.)
    Regarding your comment “when we look at real estate prices across Australia we lump everything together into the big picture view and there is little discussion around such things as:
    – What areas bucked this trend..what does this tell us?
    – What areas were hit hardest..and what does this tell us?
    – What areas seem unaffected..again what does this tell us?”
    => All I can personally say on a general note is that I have tried to consider such things in the past prior to property purchases. And on a more personal note, I can say that I am still choosing to hold property I own rather than sell (despite my overall “bearish” inclinations at this time) – At least partially because I did consider such things going in and don’t see myself as being exposed to the degree of risk that would have arisen if I had not. (And can only HOPE I am right?)
    Re your comment “Also why did prices only fall 3% last year in Australia? Why didn’t we see bigger falls? After all our stock market got hammered just as much as other markets. Could it be because we have different loan conditions and are banks are more stable etc? If so then why should our home prices tumble this year?”
    => While your suggested reasons contributed much (or even most) of the cushion I suspect, a couple of other possible reasons I’d suggest are:
    * Australia lagged the world going into this recession – So far as I know we aren’t even officially in one yet are we? Hey, we actually even dodged that bullet last time altogether – And could again. But I personally doubt it a lot – I think this might be a “real deal” so to speak – If not “the” real deal. (But have been wrong before and will be again no doubt.)
    * Unlike stocks, which are a leading indicator of the health of the economy by anywhere from 6 to 12 months up front, and consequently get hammered or boosted first, residential RE prices are very much more dependant on just exactly what is happening in the real economy at the current point in time (I suspect?) – And Oz is currently only at 5.7% unemployment. The malls are still quite “fullish” so speak. And very few people have even done things like switch off their hot water systems because they cost too much to run or any more such drastic measures I’d suspect?
    Not that things feel at all good if you are a Qantas employee who recently got laid off. Or if you are a self funded retiree relying on bank interest to live and has seen your yearly income drop by more than 50% before tax over the last 6 months or so of course!
    But those typically aren’t the people lining up at the bank saying can I have a mortgage to buy a house please? And hearing the bank ask back What is your yearly income etc.
    Where do people get figures like 20% overall nationwide drop from you ask – Guestimation/Intuition/Experience re what has happened in the past/Balancing worst case and best best case possible scenarios I’d say.
    The housing shortage story – Yes it will be high in some areas (but never discount the ability of people to live like “rats in holes” if absolutely necessary I still think?) But absolutely non-existent in others I’d say – Basically because relatively few people actually want to live there anymore as you imply.
    As to how will second homes and holiday homes fare – I think we’ll see extreme disparity in the price performance of those properties. If it is a small acreage property miles from anywhere that the owner bought because they wanted to run a few horses on it then I can only say that I hope they didn’t pay too much for it because lots of such properties can be created and probably not all that many Australians really love the smell of horses nowadays? (Even though the owner does.) While at the opposite extreme, if it is an absolute beachfront property with 180 degree sweeping views of Sydney Harbour and within an easy commute of the Sydney CBD (not that I know Sysdney – Do such properties exist???) then the owner is probably in very good condition – They aren’t making any more more of them as they say. While if it is maybe 2 streets back from the water on the QLD retiree paridise called the Sunshine Coast I’d be way more worried. But I’ve never touched such properties personally – Because I’ve inclined to the view that most other Australians don’t love horses (even though “I” might?), and I’ve never had the money to buy absolute Sydney harbourside water frontage stuff and I’ve thought that a “few blocks back” in a retiree’s paridise where lots of these retiress are going to end up in nursing homes and their heirs will say Bugger that – I need to be close work – Just mightn’t really cut it as an investment given my personal retirement timeframe.
    I’m a pretty nuts and bolts type of person when it comes to property I guess – No huge profits are necessary and all huge losses are to be avoided if at all possible – Who just happens to be way more bearish rather than bullish at the moment and simply isn’t buying any possible government/RBA/REI “jawboning” re any general Australian property shortage to push me into purchasing right now. (Although I reserve my right to change my mind at any time based on new information that might to hand.)

    Cheers to you to – It’s been a pleasure!

  40. Re: Viet Nam

    Statistics and probabilities are only useful when the correct ones are used. I read the book by Robert McNamara written years after the war. The proper statistics to focus on were not bodycount or area controlled, but supplies required by the North Vietnamese to continue prosecuting the war. The supplies needed could be brought in easily irrespective of how much bombing the US did.

    This is a fundamental constraint of a guerilla war. As an occupier, you have to take into account that if the opponent has the means to continue fighting, if you can’t change this and your bombing does not eat into their population level significantly, they may indeed continue resisting longer than you can guarantee that the war will be prosecuted. Murphy’s law dictates that if they can resist, they will.

    If you read my posts you will notice that I focus on constraints/ bounds, and how close measures are in relation to them. The important thing is that constraints can’t be exceeded, and from that you can figure out what is possible in a market. I (and I don’t think anyone else) couldn’t predict whether house prices will fall by 3% at the beginning of 2008. But that is irrelevant – you may as well try and predict when a geiger counter is going to exactly make a ticking sound in the next second. However, over a statistically significant time you can make a good judgment as to how many ticks you will receive.

  41. Thrifty, did you see McNamara in Fog of War? I thought he made a lot of sense in that..he sure is a smart chap.

    Do you believe in reversion to the mean in that price movements for stock and property for example follow a long term trend, and will correct up or down to that trend when they move too far away from this trend?

  42. To interrupt your question Greg: I believe in reversion to the mean. But that depends on the timeframe the mean has been tested against. If we use a 10 year mean, we can say that house prices have crashed already and are due for another boom. Obviously that is ludicrous, but it’s still a point.

    So when we talk about a longterm mean, what is longterm? 30 years? 50 years? 100 years? 1000 years? (that gets a bit tricky)

    And what is that mean measured against? Is it inflation adjusted? Is it adjusted for anything else?

    I believe in reversion to a longterm mean, in the same way that I believe bubbles are unsustainable in the longterm. However, it depends on exactly ‘what’ is reverting to a mean.

    Things to consider, and their behaviour:
    – Oil
    – Real Estate
    – Gold
    – Food
    – Water
    – Energy

    There are a few factors involved there. Some have (seemingly) infinite supply, others have a much more finite supply. Then there is the ‘rate’ of supply, and whether that will change over time.

    A lot of factors to consider. I probably missed half of them.

  43. Pete, deciding what is long term is the trick I reckon. If you start drawing trend lines on graphs they can vary a lot depending on when you start. Sometimes I think to myself maybe we can get ourselves into a tangled mess of data when in reality the market will do as it wants anyway, no matter how good our logic is :)


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