Falling California House Prices a Lesson for Australia
On the subject of bubbles, California provides a nice object lesson for Australians who refuse to believe home prices can ever fall. “Californian homes are overvalued by as much as 40 percent and stricter lending standards will probably contribute to ‘material’ price declines,” according to a Bloomberg recap of a Goldman Sachs report.
California—the land of milk and honey—is an excellent example of the psyche of Americans (although not all Americans are like Californians, thank goodness.) What we mean is that nowhere in the world are expectations for a worry-free, convenience-driven standard of living higher than they are in California.
In California, the difficult jobs like growing food and building things and cleaning toilets have been outsourced to Mexicans—some illegal, some legal. And in California’s division of labour, that has freed everyone else up to become an actor or a real estate agent.
For now, the idea that you can’t actually get rich trading houses with your neighbour refuses to take hold in the psyche of Californians, bro. But like, you know, sooner or later, nature is going to be nature, which means a bust will follow the credit boom.
Still, we admit that we saw our two favourite bumper stickers in California. “Question Reality” was one. The other – seen at the time the Regan administration was secretly and illegally backing the contras in Nicaragua - “US out of North America!”
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). Dan draws on his network of global contacts from his base in Melbourne. He’s the managing editor of resource newsletter Diggers and Drillers and the editor of The Daily Reckoning Australia.
Comment by Maggie on 23 October 2007:
My husband and I are saving to buy a house. I often comment to friends and colleagues that hopefully, by the time we have enough of a deposit to buy, house prices will have come down to a more realistic level. Without exception, every person I speak to assures me that "No, house prices will never come down". Ever. Period.
It doesn't matter how much I argue to the contrary, they just shake their head at me either pityingly, or with a touch of scorn. I'm beginning to think they're right and I'm wrong, such is their conviction! Did I dream double digit interest rates in the eighties?!
Comment by Coffee Addict on 24 October 2007:
I can never fully get my head around the fundumentals of the Australian real estate market. It can certainly go downwards and it can stagnate for years (I've experienced both).
If the cost of delivering a serviced suburban block of land is about $90K (upwards) and construction of a standard brick venerial is about $150K the total cost should be in the $240K zone - perhaps with a land value premium of another $100K in choice areas. That adds up to realistic value around the $350K mark.
The Sydney premium for this sort of property is at least $100K more than this but I can't find the value or justification for this anywhere - except that bank/institutional lending practices combine with buyer competition to realise the higher prices.
In Sydney and other major cities, buyers will continue to compete with whatever funds the intitutions are willing to lend them. Thus if interest rates go up, prices will drop significantly (over time as real estate tends to be downward inelastic). The same principles apply in the US.
You won't hear this from representatives of the Real Estate Institute.
Comment by CMT on 24 October 2007:
Maggie, I totally understand how being a contrarian is difficult, especially when it comes to making an opinion on the aussie real estate market.
The "Core Belief" of houses will never fall in prices are too deeply entrached in the mind of fellow Aussies. It would be difficult, if not impossible, to change their way of thinking around this.
I've given up explaining to them a long time ago, especially during a discussion with friends on social occasion.
(else we could get into a heated argument 
)
Comment by Neotrader on 24 October 2007:
My wife and I are looking to buy our first home as well - and are blown away not only by the prices, but also by the disparity to our incomes. Back in the 70s (I'm told) the price of a decent home was just about twice an individual's annual income. Today, its easily more than 5 times - and that's just for a 'shoebox'.
Earlier this year, I thought that the 'virus' from the subprime market in the US would find its way here as well, and bring some rationality back to prices (although, regrettably, that would cost many people their homes).
However, with housing starts at 30 year lows, occupancy rates in the cities at 1-2%, the best scenario I can hope for is that home prices stagnate for a few years and incomes to go up.
Being a renter is not going to be easy next year - rents will climb to bring yields back up towards 5%, inflation through fuel and food is going to hurt the pocket - and an interest rate hike next month isn't going to help either.
Unfortunately, the response so far from the government and the media has been "let them eat cake" and "sh*t happens" respectively. Haven't seen anyone offer solutions or an action plan yet - which makes me think someone's asleep at the wheel.
Comment by Coffee Addict on 25 October 2007:
The "wild fires" may increase values in California as those with insurance payouts in hand go looking for new accomodaton.
Comment by Zaphod on 26 October 2007:
"Rent money is dead money"
Not any more it aint! I'm a renter and in my town where the median house price is $300,000 we're just sittin pretty. Why? because we do the sums. I love crunching on those online calculators (ING's got a good one), savings loan repayments etc. Let's do the math on this one. On your 10% deposit paid (in theory)you're left with a 270,000 loan.After 25 years you've paid out over $335,000 in interest at 7.65%. So that's about $260 per week in interest and $240 per week to pay off the principal bit (but houses go up right?;).Ok so let's rent for $240 per week and chuck that $260 per week into a crappy 6.5% compounding account on top of your $30,000 that we already have.After 25 years you end up with just over $1,000,000. Ok so whack off 30%tax, you've still doubled your money, hang on I forgot to add in all of the other mortgage expenses! ahh not to worry. Or wait 12.5 years and pay cash for the damn thing!
And that's my bit:)
Comment by M Smith on 28 October 2007:
High prices are caused by lack of supply. They need to build more houses.
http://www.policyexchange.org.uk/Issues/Housing.aspx has an interesting article about this which has a chapter discussing Australia's housing situation.
Comment by Jack on 15 November 2007:
How many huge multi million dollar houses are sitting vacant along the Australian coast, held just as investments. Its not the lack of supply, its peoples willingness to take on massive debt with the rationale that the increase in value will make it a worth while risk. Its a vicious cycle that has made a lot of people wealthy, the boost to the economy from personal debt has raised wages and the equity has allowed even more borrowing. It has nothing to do with the actual material value of the property, just a combination of greed and fear of being left behind. Once the values stop climbing relentlessly like the rest of the world the investors will pull out, the loans wont be so attractive and theres going to be a hell of a lot of people tightening belts and complaining, especially when the oil doubles in price. The one hour commute from the estate on the edge of the city with no public transport will cost a fortune, because everyone was getting rich quick instead of thinking about the future. Those houses wont be worth much then...
Comment by JP on 17 December 2008:
I am from the UK. I have seen all this before
They will fall, i know it
There is no lack of housing, that is just a scare mongering tactic they use in the media to try to keep the market flowing. They tried this in the UK before the market crashed.
For me this is just history repeating, wait and see!!!!!