Why the OECD is Worried About the Future of Australian Real Estate

Real estate market

The OECD has warned the RBA not to cut interest rates over fears it could inflame the property bubble further. The OECD carries credibility as a body representing many of the richest countries in the world. Their words serve as another reminder of the dangers facing investors and the broader economy:

The continuing property market momentum adds to the risk of a sharp correction.

In other words, the OECD believe the RBA should put off lowering interest rates below 2%. Doing so could add to inflationary concerns surrounding the property market.

They’re not wrong on that. Assets like property are a hot commodity when borrowing becomes cheaper. Any interest rate cut would inevitably lead investors towards asset purchases. Home loan borrowers are the most obvious beneficiaries. Lower repayments make property more attractive to both investors and first home buyers.

If property prices grew to unsustainable levels, they’d be at risk of crashing. That would lead to rising loan defaults. As a result, average household debts could spiral out of control. The knock on effects of this could put the economy at risk of a recession.

But their assessment of the property market may be misplaced.

Australian property may be growing quickly, but it’s not doing so equitably. The rapid growth is largely confined to Sydney and, to a lesser extent, Melbourne. That’s important because it lessens the risks posed to the rest of the nation. And it means that the RBA can’t just concentrate on Sydney or Melbourne when making decisions in the interests of the entire nation. That’s why we need to closely as to whether the OECD’s assessment is correct.

How valid is the OECD’s claim that Australia has a housing bubble?

One person who flatly denies the idea is Treasurer Joe Hockey. He doesn’t think Australia has a housing bubble at all. He explains:

When you look around the world, bubbles have burst in real estate when there has been too much supply and not enough demand. Whether it be in China, the UK, Ireland or the US, that’s when bubbles burst. I’d say we’re a very long way from that in Australia’.

He’s right in one respect. Australia as a nation probably doesn’t have a housing bubble. Investor confidence in cities outside Sydney and Melbourne is lukewarm at best. By now you may have seen that property prices outside the two biggest cities are either flat or falling. Brisbane barely grew last year, while house prices in Perth fell by 1.6%.

That makes the property bubble — if there is one — Sydney centric. We can include Melbourne in that basket as well. But its 7% growth in the past year is well below Sydney’s 14%.

We’re left with Sydney as the only city the government and RBA need to watch closely. There is no doubt that Sydney house prices are growing rapidly. Median house prices are hovering around the $1 million mark. But the rest of the country is nowhere near approaching bubble proportions.

Since the government doesn’t believe we’re in a property bubble, they want to see housing affordability improved. In doing so, the hope is that it would act as a restrain on house prices.

The government’s approach for keeping a lid on house prices

Mr Hockey suggests that the way to temper house prices is to increase supply in the market. He explains:

What we’ve seen is a massive increase in housing construction in the last year. It’s up 18%, which is 30,000 more dwellings being constructed than last year than the year before. That’s the best way to respond to elevated prices.’

There is some truth to his claims. Vacancy rates in Sydney remain low, because demand remains so high. But it’s not just local investors and home owners pushing up prices.

Sydney, more than any other Australian city, is attracting the largest share of foreign investors.

Foreign investors are equally responsible for pushing Sydney’s growth rate above 14% in the past year. For the government to see house prices fall, they’ll need to curb foreign investments while increasing housing supply. How are they going to do this?

Mr Hockey points to new restrictions on foreigners investing in Australia as evidence. But he’s severely overestimating the impact of this.

Foreign investors are slugged with a $5,000 application fee for homes worth up to $1 million. Above that, the fee rises to $10,000. But let’s be honest, what’s $10,000 to a cashed up foreign investor? A drop in the ocean. If you’re going to drop five million on a harbour side property, you’re not going to make a fuss over a $10,000 fee. That’s hardly going to deter foreigners from buying up Aussie real estate.

But there is another aspect here that we’ve overlooked so far. And that’s the prospect of the RBA raising interest rates. Some economists think that recent positive economic data could push them to raise rates. That would have a downward effect on prices, as borrowing and loan repayment rates surge.

That would probably be the most effective way of clamping down on house prices in Sydney. For that to happen, the economy would need to keep growing steadily. And that’s not something we can rely on.

So for the time being, it seems certain that the housing market will get bigger before it contracts. Economists will continue to point the finger at Sydney house prices as a sign that the market is in a bubble. And institutions like the OECD will keep lumping the whole of Australia in the same basket as Sydney.

According to our property expert Phillip J. Anderson, the housing market still has a long way to go. In fact he believes we’re at the start of a decade long boom.

Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He correctly predicted the 2008 housing market crash. He also went against the trend in 2009, saying that house prices would go on to boom this decade. He was right on both accounts.

In his latest free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.

Mat Spasic,

Contributor, The Daily Reckoning

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The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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