2015 will go down as the year in which ‘property bubbles’ first entered public consciousness.
Bubbles emerge the moment things start expanding. But they’re only taken seriously once it’s already too late. Property markets are no different. We notice this shift when price growth isn’t supported by economic growth.
It becomes even more obvious in markets where an imbalance exists. Australia’s housing bubble was never a national problem. And that’s partly what makes it so evident.
The nature of this is summed up in the growth of national dwelling prices. Housing values rose 24% in the three years to September. Yet Sydney drove the bulk of this, accounting for 46% of total price growth.
It’s fair to say then that Australia has developed something of a two-speed property market.
On the one hand, you have the rapidly expanding housing markets in Sydney and Melbourne. Both cities saw double digit growth over the past 12 months. Prices in Sydney alone rose 17.6% year on year.
Elsewhere, price growth has been harder to come by. Canberra, Darwin and Perth all saw home values decline over the past 12 months. Others saw modest, if any, growth.
This contrast in national house price growth lends itself to concerns. The more that Sydney and Melbourne expand, the faster other markets stall or contract.
There’s a simple explanation for this.
The housing market is self-perpetuating. Like any industry, it thrives on momentum. Investors enter the market because they’re attracted by the rate of growth. They see a market in which capital gains are steadily increasingly.
That, in turn, forces up demand and prices in equal measure. Which then prompts other investors to make the plunge as well. It’s a virtuous circle that’s hard to stop once it gets going.
But somewhere along the line, the landscape changes. Economic growth shrinks. Populations stop expanding. Regulators clamp down on bank lending. New housing construction ramps up in anticipation of strong demand.
All these things, individually, can negatively impact house price growth. Taken together, they can devastate prices in a relatively short span.
In Australia, we’re now seeing the emergence of all four conditions. In a best case scenario, it means house price growth in Sydney and Melbourne will slow to a crawl in the coming years.
But there’s a potential for much. If these factors hang over the market for an extended period, we could be in for a major correction.
At that point, the bubble will have well and truly burst.
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The evidence for a bursting housing bubble
I want to spend more time looking at these four broad factors in detail. We can start by looking at the effects of overexpansion in supply.
As with anything, there’s a causal link between the supply of something, and it’s price point. High supply, backed by high demand, sends property markets in an upward direction. But high supply, low demand, has the opposite effect. If there’s too much of something, its price falls to reflect this excess.
Sydney’s property market struggles with undersupply. It’s a big reason why prices have grown as fast as they have. But all this could be about to change.
The Aussie property market is primed for a substantial increase in housing construction.
By 2019, over 720,000 new homes will be built across the country. More than half that number will come from Sydney and Melbourne.
Much of this expansion is based on real demand. At least for demand that exists today.
But consider the alternative for a moment.
When property price rise, as they’ve done in Sydney, everyone wants a piece of the action. You get a mad rush and people pay wild sums for their own share of the pie. They see prices rising and assume that they’ll continue growing.
But investors aren’t alone in thinking this way. Developers too get caught up in the frenzy. We end up with a property market in which both the number of entrants, and suppliers, is increasing.
Remember, all this happens in an environment of record low interest rates. The Aussie cash rate has fallen from over 7% a decade ago to 2% today. No wonder demand remains high.
But this rise in construction will come as a detriment to price growth. According to Goldman Sachs, an investment bank, that’s what Aussie homeowners face.
Goldman estimates the construction boom will result in an oversupply of housing by 2017. Because of this, the bank forecasts an excess of 75,000 dwellings. That’s a major shift over previous estimates projecting a 140,000 shortfall.
The issue of supply factors into the rate at which house prices grow or fall. But it’s this combination with other factors that raises the likelihood of a price correction.
As Goldman highlights, rising construction should reflect a growing economy. Yet that’s not what we’re seeing.
Take for example some basic economic indicators.
Incomes, for one, are growing at the slowest pace in two decades. Wages grew by just 2.3% in the past year. We’re seeing dwelling prices in Sydney grow by 17%, yet wages are rising by a fraction of that.
At the same time, this slow wage growth reflects the broader economy.
The Aussie economy grew at just 0.2% in the second quarter. That’s the slowest rate of growth since 2013. There have only been five quarters in the past 15 years where quarterly growth was lower. And almost all of those came during the global financial crisis.
Meanwhile, population growth is stalling. In 2014, the national population grew by just 1.4%. It’s on course to drop to its lowest level since 2006 this year too.
Finally, there are emerging signs that investor lending is slowing. Recent moves to limit investor lending growth are starting to pay dividends. Regulatory measures from APRA helped push dwelling price growth down in August. Even in Sydney price growth was a sluggish 1.1%. That was a marked shift from 7.4% growth between June and August.
Is the bubble already bursting?
Alongside slowing price growth, auction clearance rates are falling well below recent highs. For much of this year, both Sydney and Melbourne maintained clearance rates of over 80%.
Sydney saw clearances drop to 75% this week. Melbourne fell even further, to 71%. Nationally, the clearance rate has fallen to 70%, down from 80% in April. Sellers everywhere are finding that flogging a house isn’t as easy as it was even a month ago.
Much of this surely stems from recent measures aimed at limiting investor lending growth. Investor lending growth fell from 29.6% in April to 16.5% in July. That’s important because investors account for more than half of all home loans.
At the same time, rental yields are falling. According to new CoreLogic RP data, rental yields are growing at the slowest rate in 20 years. The only city where rents remained untouched was Sydney. Every other major capital saw falls in rental growth.
Year on year (YOY), rental growth dropped to 0.7% in August. That was down from YOY growth of 0.9% in July.
All this suggests that demand for rental accommodation is peaking. Just imagine what rental yields will look like with an extra 720,000 dwellings over the next few years…
So that’s the market outlook for the next few years…high supply, combined with slowing demand. What does that tell us? It says that Sydney’s housing bubble is already popping. Prices won’t crash overnight. It’ll be a slow, creeping decline. Better to think of it as a deflating beach ball instead…
Goldman says that house prices are overvalued by as much as 20%. By 2017, they might not be anymore.
Contributor, The Daily Reckoning
PS: The Daily Reckoning’s property expert, Phillip J. Anderson, is a bull when it comes to the housing market. He’s maintained all year that house prices are set to boom over the next decade.
If you’re an investor worried about property bubbles, Phil’s words will provide you with comfort. We don’t always agree on where house prices are heading at the The Daily Reckoning, but it’s worth getting both sides of the story.
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 predicted a housing market crash in 2008. He also went against the mainstream in 2009, saying house prices would go on to boom this decade.
He was right on both accounts.
In a 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.