Why Australian House Prices Are Set to Crash

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Let’s begin the day looking at Bank of Queensland’s (ASX:BOQ) $91 million first-half loss. People who think housing can never crash in Australia (because it’s a cultural thing, you know) will be quick to point out that the bank got hammered on commercial and residential property in Queensland. It’s a local thing. All real estate is local, just like all politics, right?

Well, not quite. It’s true that there’s no such thing as a national real estate market. There’s our little neighbourhood in St Kilda…there’s the Gold Coast…and there are the thousands of other little neighbourhoods and pockets of houses. The economics of each neighbourhood are different. There are many markets, not one.

But to paraphrase Tolstoy, every real estate market is different in its own away, but they are all alike (and unhappy) in one important way. Real estate may be local, but mortgage finance is national. The concentration of mortgage finance in a small number of banks is how local disruptions in the real estate market are transmitted across the country until you have a national problem.

Take Bank of Queensland, for example. Its losses are concentrated in the Gold Coast. Even the most hard-headed of housing Pollyannas would concede prices there are falling. But losses in one market are going to lead to lower lending everywhere. The bank will be forced to raise its loan loss provisions and grow less quickly (or contract) in places like Victoria and New South Wales.

And remember BOQ is not even one of the Big Four. Smaller banks can’t compete with the Big Four. They have fewer sources of funding and less margin for lending error. That’s why the Big Four banks have actually increased their share of mortgage market to over 85% since 2008. The risk of falling house prices is now heavily concentrated in a small number of very large banks, banks that must weigh risk aversion in lending versus the need to grow earnings.

There are two final points we’ll make on this – before the reflexive defenders of the housing market start flooding our inbox and cramming our message boards with their passive-aggressive gibberish. First, houses are so damned expensive and unaffordable in Australia that we suspect a lot of people are barely making ends meet.

To be sure, our suspicion is highly subjective and non-scientific. But there are external signs that confirm it. Credit ratings agency Fitch reports that late payments on mortgages began jumping in late 2011. Granted, the jump in arrears was small, from 1.52% to 1.57%. But the jump wasn’t even on marginal home loans. It was on so-called “prime” residential mortgages.

Mortgage stress does not discriminate based on race, gender, or class. The housing affordability problem is a problem at the top end of town AND for the battlers. It’s a problem any time you have to borrow huge amounts of money to get into the market and bank interest rates have decoupled from the cash rate set by the Reserve Bank of Australia.

In fact the decoupling of bank interest rates from the RBA’s bogus price of money is already being used as an excuse by some developers for poor financial performance. Property developer Stockland’s (ASX: SGP) shares fell nearly 4.5% yesterday. The company’s Managing Director Matthew Quinn said housing affordability in Australia is a “major issue“.

He also said that business is down for him because of Australian banks. He said that the weak sales trend will continue and that a recovery is “likely to be slow unless we see a reduction in bank interest rates to improve affordability and buyer confidence.”

So there you have it. It is the banks that are to blame for the lack of buyer confidence. It’s funny how no one ever blames the banks for rising house prices. But they should, which brings us to our second and final point. The whole country is over-invested in housing.

Greg Canavan did a good job of connecting Australia’s poor productivity performance in the last 10 years with its housing bubble. Aussie banks participated in the global credit boom by creating their own very profitable little housing bubble. Business investment and productivity growth were neglected.

The result is that house prices are unaffordable, mortgage delinquencies are rising, prices are falling, risk is concentrated in the banks, and the country is headed for a giant reckoning with the idea that higher house prices are a “cultural thing”. They were a “cultural thing” in the UK, the US, and Ireland. And they still fell when the credit expansion ended and prices became too high for the punters.

The investment bubble in housing has had real economic side effects. The banking sector simply poured too much money into one asset class. The inevitable happened. It will happen again, only this time it will be a correction. The correction is not a “cultural thing”. It’s an “economic thing”.

Regards,

Dan Denning
for The Daily Reckoning Australia

From the Archives…

Gold Money: A Once-in-a-Generation Buying Opportunity
2012-03-23 – Greg Canavan

A Question Australia Might Have to Answer
2012-03-22 – Joel Bowman

Australian Tax: Running Government at a Profit
2012-03-21 – Nick Hubble

China: Why All Feasts Must Come to An End
2012-03-20 – Satyajit Das

Greg Smith – A Former Goldman Sachs Insider Finally Speaks Out
2012-03-19 – Eric Fry

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.
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36 Comments on "Why Australian House Prices Are Set to Crash"

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Rob CA
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However, never get between an Aussie and an investment property.

Biker
Guest

…or a CA and his commissions!~ ;)

Technofreak
Guest

…and we wait…and we wait. I really do hope it crashes but I am tired of waiting for the carnage.

Biker
Guest

That’s understandable, TF. We’ve been promised these half-price homes (some here said 80% off! :D ) since December 2006.

It’s a little like those cargo cult promises of the South Pacific. Whole generations have expired since WW2 ended, but apparently many still look to the skies, expecting a shower of free white goods, jeeps and other consumer items… .

Joe
Guest
When lending returns to 3 times earnings or 2 and a half plus one, then you will end up with a big correction. So, using the UK as an indicator. Average price of a house is now 165K. Average earnings are 24K. So, we have a population with a 10% deposit requiring 148K loan to buy, needs a Loan to Earnings ratio of over 6. This is unaffordable debt. No wonder the UK housing market is not expected to recover for a generation. They have dropped rates as much as they can to put a floor under house prices, whilst… Read more »
Biker
Guest
There are a few more alternatives than those, Joe. Rents rising dramatically is just one of them. Trying to explain why Steve Keen was right recently, a DRA contributor commented: “Steve Keen was looking correct – 2008 saw house prices falling rapidly… but of course (?!~) he didn’t count on the Rudd government pulling out all stops to reinflate the housing bubble, like tripling the FHOG, bringing in hordes of immigrants and relaxing the laws on foreign ownership. Along with these, interest rates were slashed, and all the while, we had first home buyers competing with subsidised investors for property….this… Read more »
John Ellison
Guest

Biker.
“…. the reflexive defenders of the housing market start flooding our inbox and cramming our message boards with their passive-aggressive gibberish.”
Please take the hint.

“Real estate may be local, but mortgage finance is national.”
The tide of credit is receding, taking all real estate markets with it.

Will you be one of the lucky few ponzi early adopters who get out in time?

james
Guest

unfortunately for me, along with a huge percentage of Australians,
a crash will be directly catastrophic.

Whilst it’s easy to point out negatives and the cause (of which I don’t disagree) what’s your solution ?

realistically if house prices drop 40-50 % what’s your solution for the average home owner
who’s bought a 400-500 k home, and will then have $200k + in bad debt ?

Steve Keen has suggested a debt jubilee, but will this realistically happen ?
or will we just see people hitting the wall 1 by 1, going bankrupt and the entire economy decay’s over 10-20 years ?

John Ellison
Guest

Solution?!?
Nobody, Steve Keen included, is responsible for providing a “solution”.
The debt is now far too great.
The system will purge itself of unsustainable debt.
If we follow Japan’s “solution”, at least 10 years, perhaps a generation.

Keenie
Guest

The property crash is looming. All informed investors and property owners see it. The so called property ‘bulls’ rode it up in the early 2000’s as they saw house prices rise to unsustainable and false values. Since then – it has been a steady decline for four years. It has indeed been so subtle that they haven’t noticed but their banks have. The next twist becomes more deadly. Instead of 5-10% falls per annum we will witness 20% in 2012/2013. ‘Safe as houses’ – not so sure that applies in a post credit crunch world.

Chewy
Guest
Which is why I think it is so important that a property bubble, more than any other bubble, not be allowed to be blown up in the first place. once blown up, policy makers are caught between a rock and a hard place. If pricked or allowed to prick, it hurts thousands of exisitng mortgage holders, banks holding mortgages on their books, consumer sentiment etc. If the bubble not allowed to burst, and property prices propped up to stay high for as long as possible, it hurts the country’s cost competitiveness, and increase private debt levels without any corresponding improvement… Read more »
Biker
Guest

Get out in time, John? ;)

I’m 65, happily retired and living very comfortably on multiple rents.
I’ll never receive a cent of the Old Age Pension, or any other benefit.
Nor will my wife… or my kids. _You_ just don’t get it, John.
But no doubt you’ll more-than-amply qualify for an OAP.

‘passive-aggressive gibberish'(?)

This from an anal-retentive Yank journalist turned gold salesman?

Love it!~ :D

Keenie
Guest
Great insights Chewy. Indeed the buble could and would burst if the political agenda would allow policy makers to take their hand off it (that is tinkering with policy driven to hold house prices at unsustainable levels of course)! They fully understand that they are hurting the people that they represent by not allowing house prices to revert to norm. They see themselves as protecting us from ourselves. I mean – which govt regardless of which side you sit on – will allow house prices to fall by say another 25% on their watch? Political suicide. But by not allowing… Read more »
Biker
Guest

Keenie: “…which govt regardless of which side you sit on – will allow house prices to fall by say another 25% on their watch? Political suicide.”

Correct. With 70% of Aussies participating in the property market… and 14% with at least one _investment_ property, governments of any political colour will think twice before allowing the property market, the banks and the residential construction industry to crash.

The question remains “Why did Steve Keen not factor government intervention into the equation?” That’s probably his major omission, together with a host of less critical, but very important factors he failed to include… .

manfriday
Guest

A few years back, more than 50% of new highrise apartments were being sold to chinese nationals. Houses need not be affordable to families, only investors.

Biker
Guest

They’re buying our gold, too, manfriday!

Perhaps we need to introduce negative gearing for PMs, funded by all Aussie taxpayers, to give us an edge and keep gold ‘affordable’.

Oh, wait-a-bit, we already have. :D

Nexus789
Guest
Biker has an I’m alright Jack attitude – his comments are like a righteous sermon. Debt is an economy wide problem and particular individual circumstances are not that interesting in this context. Debt permeates the whole economy with private debt still at 160%+ of GDP I believe. Like Seneca’s observation that “increases are of sluggish growth, but the way to ruin is rapid” the economy will stall rapidly. Like all the ‘things’ that have forestalled the bubble’s collapse there are many on the horizon that will contribute to a decline and in fact some of the things that have ‘pumped’… Read more »
Biker
Guest

Nexus789 has a ‘We’re stuffed’ attitude. His attitude refect’s Keen’s sackcloth’n’ashes ‘We’re all effed’ scenario. :)

N789: “It is amazing how many people ignore the lessons of history…”
How true. The main lesson most ignore is that inflation, with us since history began, helps reduce debt predictably, year-after-year. :D

Meanwhile, rents rise (currently about three times inflation in some states!)

shortchanged
Guest

I have a nephew in Germany who bought a house, his deposit was a minimum of 35%, that’s the way to keep house prices at affordable levels. Simple!!. And its the way it was in Oz, many yonks ago, remember Biker?.

Biker
Guest

Never bought / built with less than a 20% deposit ourselves, SC.

But, just as time-in-the-market is said to be better than trying to time it, time, inflation, tax benefits and tenants have helped us pay them all off in a remarkably short time.

We’re not sure about affordability. We believe we _may_ look back at this period as one in which we should have bought more… and built more… but we really do have enough property now; particularly as rents far exceed our predictions and expectations…

Expat
Guest

This all sounds very familiar to a UK expat. The same issues were being raised in the UK press in the early/mid 2000’s and we all know what happened there. When there is any doubt in the stability of the housing market there is little doubt that it is only a matter of time before something gives. Why is Australia any different from the US, UK and Ireland? I suspect Australia is currently just in a different position on the curve.

Biker
Guest
Having spent a fair amount of time in the US and UK (none yet in Ireland) it’s fairly obvious to _us_ that Australia’s situation is remarkably different. Yes, we saw the writing-on-the wall in Europe and the US. Friends provided numerous examples to demonstrate what was coming… and revisiting their cities, we’ve seen the damage which followed. Canada is different, too. Both nations have suffered little of the GFC which has brought those poor b*stards in Ireland, the UK, Europe and the US to their knees. Sadly, their corrupt financial systems have brought their economies down… the reason so many… Read more »
Stillgotshoeson
Guest

RBA Luci Ellis says: ”Paying your mortgage down before the bust is the most effective way of avoiding getting into negative equity once housing prices start to fall.”

:)

Biker
Guest

Bit of a misquote. Unintentional, I’m sure, Shoes(?)

And the title of that news item was?

“US lenders must raise standards, says RBA official”

Roy Edmunds
Guest

Yes, well, it all happens in the last five minutes…the battle goes on and on and we know whats coming but don’t know when, like the second coming but like the auctioneers hammer, the final hit only takes a fraction of a second….and its all over rover. You win or you lose. The last five minutes.

Biker
Guest

Ah, the Second Coming. Armageddon.

Sounds like you have much to look forward to, Roy.

andew
Guest

To much analysis, markets find there level due to supply and demand. At present demand has fallen, mostly due to confidence, supply will follow, developers wont keep building at a loss, once supply drops below demand prices will start to rise again. Its not a new thing.

Luke
Guest
Most property investors negatively gear, which means the rent does not cover the repayments or even the interest. They are relying upon capital gains and with the market in decline, unless you are speculating that a miraculous recovery in the economy is going to occur, then why wouldn’t you sell now before it drops a lot more? Just wait until things start to slide further and watch the panic sales. Realistically, I don’t beleive a “crash” will occur, due to the Government’s manipulative Keynesian economics, however it will be a “slide”. Australian property will continue to fall for at least… Read more »
PETER
Guest
We now fully accept the facts, that Australian house prices are inflated by any standard by between 10-50% depending on the area. And many recent buyers will end in huge debt while a lot of greedy investors would see their entire life savings wiped out. But we must not fail to know who the real culprits are, in order to pass on this advise to the next generation The real culprits – the govt, state and federal, the banks and lending agencies and the real estate agencies. Each contributed to this situation and entrapped gullible buyers. The govts have inflated… Read more »
Seene
Guest
The Banks, developers and real estate companies work hand in hand providing false belief that housing prices are going to rise for ever, and other lies that go with it. Politicians are not looking out for the best interests of the majority, only the rich are to benefit. House prices are linked to the stock exchange, just like everything else in the world, its designed to feed the rich easy money. We need a real uprising against corporate greed, they are no different from the dictators around the world, i think only worse, because their actions puts billions of people… Read more »
Mark
Guest
Australia is a small economy in a large world. The Australian dollar is now far too high making goods and tourism expensive . Young people are frozen out of the housing market and therefore putting off having kids meaning fewer Australians to fund the ageing Population who want mega bucks for there houses. But don’t panic we can always rely on immigrants who can be relied upon to have Australia’s best interests in there hearts . Many times only in your dreams! A bubble that is long long over due bursting. 22 million people on a massive island there are… Read more »
cane
Guest

its taken a while but its starting to happen housing is going down price bubble chaos some dropping from the million down to half march 2013

give it 6 to 9 months see where it is then
if it goes up its another bubble

Warren Cox
Guest

“Why Australian House Prices Are Set to Crash”

Not so much a comment but a question.
What is your opinion now April 2013 regarding house prices? Is it different from when you penned the article?

Jason
Guest
I can see how he may have thought what he thought.. But Australia has such a small population and so much land and the richest country on earth.. with taxes and red tape to go with it.( not business friendly )..The saying dumb Aussies is starting to ring true… No one wants to work physically hard and think they have a God given right to excess welfare!?..sure Australia is blessed with many riches and we waste the lot.including brain cells….No country on Earth would waste the oppurtunity that lays before every Aussie..except Aussies..You always get what you sow…Godbless and Goodluck… Read more »
Marty
Guest

What about overseas Chinese investors buying up premium properties at silly high prices (like $300,000 for a dirty old run down 1960’s flat in Genoa St Moorabbin) for old dumps, simply for their “location”.
The Aussie Real Estate Agents have alot to answer for, for ripping off gullible ex-pat Aussie & Asian Property Investors. They are paying 50% more for property, than they should!

Undercover Brother
Guest
The RBA has held interest rates steady. Jobs are being slashed across the economy. The Public Service has been ordered to kick out as many employees as possible. Unlike in the Howard the John era, Thorny A-Butt remembered to tell the APS to throw out all contractors until further notice. AUSAid has just informed all its graduate program entrants that their job offers are being taken back. The hospitality sector, the small business sector and the retail sector are bound to reflect the suffering. The moment interest rates start going up is when people should wake up – but history… Read more »
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