When it comes to talk of property bubbles, Sydney has few international peers. The harbour city is home to one of the riskiest property markets in the world. According to the UBS Global Real Estate Bubble Index, Sydney now ranks third among cities at most danger of developing a housing bubble.
Aussie real estate watchers won’t be surprised by any of this. Many tell agree that house prices are vastly overvalued in Sydney. Despite recent evidence of slowing price growth, buying remains prohibitively expensive. Even with no growth in September, median house prices still fetch $900,000. A Domain House Price Report in July suggested the actual figure is $1,000,000. It doesn’t matter what the exact figure is. What’s important is that Australian house prices are dear, price slowdown or not.
Yet as Newton’s Law rightly suggests, what goes up must come down. UBS hold fears that overpriced markets, as in Sydney, are at risk of cracking. In Sydney’s case, it might take rising interest rates to reach breaking point. For years, the low interest rate environment helped drive up house prices. With demand for loans rising on the back of this, property prices did too. That’s left Sydney trailing only London and Hong Kong on UBS’ bubble index.
It’s true that interest rates are unlikely to go up anytime soon. Few economists expect rates to rise this, or even next, year. But there’s no guarantee they’ll stay at record 2% lows. Beyond 2017 the outlook on interest rates looks a lot less certain.
When they do start rising, there’ll be many households still locked into long term mortgages. If monthly repayments rise, it will put a lot of pressure on household budgets. You’d see housing demand fall, forcing house prices down. And with rising unemployment factored into this, the rate of loan defaults would likely rise as well. Should that happen, it might be enough to force a sharper correction in prices.
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At risk of a bubble, or already in one?
UBS went about qualifying the severity of market risk using a series of metrics. One key measure was the so called price to rent (P/R) ratio. Basically, this weighs up the costs between owning property and renting. As a rule of thumb, a P/R ratio up to 15 suggests it’s better to buy. Between 16 and 20 is generally seen as a favourable renters market. Anything above this and renting becomes more effective.
Like London and Paris, Sydney has a big problem with high P/R ratios. In Sydney, the P/R ratio is closer to 30. It’s great seeing your name sit alongside these iconic global cities. It’s less impressive when it’s on a list of ticking time bombs.
But you can see why Sydney’s P/R ratio is as high as it is. House prices have risen 30% in the past three years. Sydney’s market boomed at a time of strong demand and low borrowing costs. Yet rental and income growth never kept up. As a result, housing affordability declined. Remarkably, until last month, house prices kept rising despite this. But that’s changing now. There’s a clear imbalance between market prices and what most people can afford. And it’s beginning to show in slowing price growth.
‘House prices have decoupled from local incomes. Buying a 60-square-metre apartment exceeds the budget of most people who work even in the highly-skilled service sector.
‘Gradually deteriorating economic conditions, a slowdown in China and tighter regulations increase the risk of a significant correction in the medium term’.
There’s now plenty of evidence that a price correction is already underway.
How the property market might crash
Four factors in particular suggest Sydney house prices have already peaked. For one, we know that Australia’s economic growth is slowing. GDP growth in the quarter to September slowed to just 0.3%. That put Australia on course for growth of less than 2% in 2015.
We also know that population growth is declining too. There are fewer migrants entering Australia, lowering housing demand.
Third, APRA continues to clamp down on bank lending. Banks responded by raising home loan rates for both investors, and now owners too.
Another sign of this is the slowdown in auction clearance rates. Where a typical weekend once saw 80% of auctioned homes sold, these days it’s closer to 60%.
Finally, housing construction is still growing. There will be 720,000 new homes built across the country by 2019. Half of these will be in Sydney and Melbourne alone.
All these things impact the direction of house prices. And all of them suggest that Sydney’s market will trend down further in the coming months.
All told, we’re left in a situation where slowing house price growth is inevitable. With household debts rising, and housing supply up, it adds up to a bleak picture for Sydney’s real estate market.
As UBS warn, the big worry will be if, and when, interest rates start rising. It might be enough to tip Sydney over the edge. At that point, Sydney might stop featuring on the Global Real Estate Bubble Index. Instead, it might finds itself on a list of the worst performing markets…
An even bigger worry is what any property crash would do to the Aussie economy. Morgan Stanley recently warned the housing market risks sending the economy into recession. That came after Macquarie warned house prices would decline by 7% next year.
The Daily Reckoning’s Greg Canavan believes a recession could hit as early as this year. In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals how we’ve found ourselves in this position.
From falling GDP growth, to declining terms of trade, all signs point to a crash. Trade imbalances have been growing for the better part of a year. Government revenues are down, and household debt is up. It adds up to a recession that’s coming sooner than you think.
But there is a silver lining in all this. If you act now, you can protect yourself from the fallout of the coming recession.
Download your free copy today to learn how to protect your wealth from the coming crash. To find out how to download his free report right now, click here.
Contributor, The Daily Reckoning