Australia’s riches are a giant punt on property

Australia’s riches are a giant punt on property

How you think about inequality could lead to the most important financial decision you ever make.

The key asset class that’s driving inequality around the world is about to pull the rug out from under our nation’s extraordinary levels of wealth.

Australia is at the end of the property cycle.

Its property bubble is popping right now, in my view.

And the wealth statistics suggest this will be downright catastrophic, because property and its satellite industries form an enormously bloated share of our economy and wealth.

From 2010 to 2013, Credit Suisse calculated Australians to be the wealthiest people in the world.

That’s on a median basis, meaning the ‘middle Australian’ in terms of wealth was compared to others around the world.

The average Australian came in second because we have fewer billionaires than Switzerland.

Thanks to exchange rate moves, we’ve been coming second to Switzerland on both the median and average measure ever since.

But it’s the concentration of wealth that’s the key. Not in terms of inequality, but in terms of where that wealth comes from.

Credit Suisse explains: ‘The composition of household wealth in Australia is heavily skewed towards non-financial assets, which average US$303,200 and form 60% of gross assets. The high level of real assets partly reflects a large endowment of land and natural resources relative to population, but also results from high property prices in the largest cities.’

In other words, as The Sydney Morning Herald put it, ‘Most of that rise has been in the value of assets, mainly the family home, after a property boom centred on Sydney and Melbourne.’

This explains why the Productivity Commission found that income inequality hasn’t really worsened in recent decades, but wealth inequality has.

According to research from management consulting firm Capgemini, rich Aussies had 30.8% of their wealth invested in property in 2015.

The global average was 18.2%.

Legg Mason, an asset management firm, estimated that Aussies invest 11% more in real estate than other investors: ‘Property accounts for about 27% of Australian investors’ portfolios, but only 16% of the portfolios of global investors.’

Of Australia’s 200 wealthiest people, the number who list property as their sole source of wealth has doubled since 2011.

The real winners of the property bubble

It’s not just property itself that’s the issue.

Other large chunks of the Australian economy are dependent on rising house prices too.

And so are our investments. Let’s take banking first. Because you need to borrow money to buy a house, banks benefit from rising house prices. People have to borrow more.

Some argue that rising house prices are a transfer of intergenerational wealth. Homeowners benefit at the expense of those who want to buy homes. And that’s a major driver of inequality.

But consider where the wealth actually flows — to the banking sector in the form of more debt.

That’s where the true benefit of Australia’s housing bubble lies.

Given the boom in house prices, it’s no surprise that the banks have grown bloated.

The big four banks make up a quarter of the ASX 200 stock market index today, having reached over 30% in 2015.

Both figures surpass the records set by other major economies before their banking sectors collapsed.

Source: The Australian Financial Review

Aussie banks are massive.

At one point during the European sovereign debt crisis, Australia’s banks were valued at more than all of Europe’s! And for good reason. Average household debt has doubled since 2004, according to the Australian Bureau of Statistics.

Three in ten households are classified as over-indebted, and that figure rises to half in relation to wealthy households.

But all this means that a huge chunk of our stock market wealth is invested indirectly in the property boom, too. Australia’s wealth, whether it’s in the stock market or the property market, is a giant punt on property prices. But those property prices are falling.

How did Australia’s property boom happen?

And why hasn’t it driven inequality in Australia to new heights?

Australia is more like the subprime boom of America than the monetary policy mistakes of Europe.

In Australia, plummeting lending standards led to the property, debt and banking boom.

The Royal Commission and my past research have shown how. The high homeownership rates among people who can’t afford to buy a house, helped along by systemic mortgage fraud, have kept Australia equal in wealth statistics.

There’s also the forced savings of the Australian superannuation system.

A report from the National Institute on Retirement Security found that the median retirement account balance among working Americans is $0.

But here’s the key. As long as house prices rise, banks and homeowners experience no risk from mortgage debt.

If homeowners get into trouble, they can just sell their home for a profit to cover their debts.

Even if the borrower defaults, the bank can cover the cost of their loan thanks to the rising value of the house. But if house prices begin to fall, borrowers and banks will be in trouble big trouble

You can only drown when you’re in the deep end

The trouble with property is that it requires debt to buy it.

And that makes things very dangerous. Unlike stocks and bonds, property investors run the risk of their investment losing them more money than they invested.

That’s because the house price can fall below the amount of the debt. It’s a much higher risk bet than other investments in that sense.

Australia’s household wealth could fall dramatically, thanks to the opportunity for it to go negative for so many people.

At that point, whole swathes of the population could be stuck.

They’d be paying mortgage debt on a house they can’t sell because the price would not allow them to repay the debt.

Losing your ability to move around the country harms your job prospects badly.

This is what happened in Japan thirty years ago. People who were told to get on the property ladder discovered it’s the downside of an escalator instead.

They’ve been running on a hamster wheel of mortgage debt and falling house prices since, with a ridiculous commute to boot.

Add in a banking crisis like that in Europe and America, when house prices began to fall, and you can see how the punt on property is very dangerous.

It risks more than what you have at stake, even putting the government itself at risk.

I hope you can see how the inequality bubble and its driver — house prices — are connected.

If not, read about the negative gearing debate in the news. You won’t have trouble finding it.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia