The Easy Property Road to Riches Could Be a Dead End

Property Market Gap

Last week, ex-RBA governor Glenn Stevens admitted during his exit interview to the Australian Financial Review that, ‘Sydney house prices were causing him discomfort’.

And it is not the first time he has warned about property prices.

Last May, in a conversation with Fairfax he said, ‘the easy road to riches through leveraged holdings of real estate it strikes me that however much that may have succeeded for some in the past, that is not a great strategy and prices can fall’

I have to admit, Australia’s property prices are making me feel uneasy too.

A cottage at 27 Kingston Road in Camperdown, NSW sold over the weekend. Several developers, who had already built duplexes in the area, were at the auction. Their hands on their wallets, ready to draw.

The bidding turned into a frenzy.

By the end of it, a home owner won the property over the investors. But the win came at a price. He paid $2.1 million — $150,000 over the reserve — for a dump.

The scene above is not uncommon. And properties are selling well over the reserve price. Sometimes even surpassing it by a whopping $1 million.

In Australia, unlike Europe and the USA, the belief in property hasn’t been shaken…yet. People feel rushed to buy now, before prices rise and they are priced out.

Yet many locals are already priced out of the market. In the last six years, the percentage of first home buyers is the lowest in the last decade. And auctions are filled with parents buying property for their kids. Because their kids cannot afford it.

The fact is, there is a lot of cheap money going around. And, with low interest rates, there are few investment opportunities giving high returns. So people are turning to property.

Property Gains

The Australian Financial Review recently published an article on a two bedroom apartment in Bondi beach. The apartment sold last August for $2.155 million. Mind you, an apartment.

The seller had bought the property five years before for $1.1 million. So, in five years, the seller had almost doubled his investment money.

Seeing those kinds of returns, It is not surprising people are rushing to get into property! With interest rates at historic lows and a volatile market, property seems like a great investment.

The fact is, Australian capital cities are the least affordable in the world. And you only need to look around you to see that construction is booming.

Everywhere you look there is an apartment building going up. And even though construction is thriving to increase supply, property prices are still soaring.

Take a look at the following chart, which details the median property prices per territory:


Source: Business Insider

In Sydney, the median house price has reached 1 million and in Melbourne, it is around the $800,000 mark. In the last 10 years, Melbourne and Sydney have doubled their property prices.

And while house prices are at historic highs, wage growth is only increasing 2% per year. Take a look at the following chart:


Source: NSW Parliament

Real housing prices (adjusted for inflation) have had an impressive rise since 2000, with just a minor dip during the GFC. Yet real average weekly earnings have barely increased in comparison.

A combination of foreign investors, high immigration, a low housing supply and cheap debt have been to blame for the increase in prices.

Yet Australia has recently tightened lending rules for investors. As investors struggle with financing issues, there are fears that many will walk away from properties. And that prices will tumble.

Immigration is also starting to slow down. The number of people with working holiday visas fell by 8% in 2012–2014. And the number of temporary work visas fell by 22% during the same period.

According to ABS, in 2014–15, net overseas migration (NOM) increased by 168,200 persons, 9.8% less than in 2013–14.

And the housing supply is almost reaching demand. Take a look at the following chart. According to the BIS Shrapnel report, 2016 Building Industry Prospects, we will finally reach oversupply by 2017.


Source: Domain

In the last few years, there has been a construction boom in most Australian capitals. A flood of apartments and units.

And the report estimates that the increase in construction will create oversupply for the first time in more than a decade.

Yet the housing demand is also driven by access to house finance and cheap debt. Australia has one of the highest household debt to GDP ratios in the world. And house prices will keep soaring, as Australian’s are still able to increase their debt.

High property prices are concerning. Especially because salary increases have stayed at record lows. Australians are not getting richer because their salaries are increasing, but by inflated property prices.

And this has caused housing affordability to deteriorate since last year. In Melbourne, the amount of income spent on the mortgage has gone up from 27.5% to 30%. In Sydney people need to spend a whopping 35.6% of their income to cover their mortgage.

And this is with low interest rates!

As buyers stretch their finances to buy an overpriced home, the risk of defaulting on their debt only increases. Now an increasing number of Australians are already falling behind on their mortgage payments. As published by the Australian:

A report from ­ratings agency Standard and Poor’s has found arrears in June were 12 per cent higher than at the same time last year. The number of people falling behind in their repayments is far from its peak, but the result was surprising given the official cash rate was just 1.75 per cent when the report was compiled. The cash rate now is 1.5 per cent.’

We are already starting to see the effects of high house prices combined with low salary growth. And if defaults on mortgages are already increasing, what will happen when interest rates go up?


Selva Freigedo,
For The Daily Reckoning

Selva Freigedo

Selva Freigedo

Selva Freigedo

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