The Australian Residential Real Estate Market

The Australian Residential Real Estate Market, by Tim Hannon of Newgate Capital, who (accurately in my view) writes

[S]o many market commentators … don’t seem to have studied the rich history of real estate crises.

We … argue against those predicting an imminent ‘housing crash’ because the Australian housing market is as oversupplied as the US housing market prior to the global financial crisis of 2008. This analysis is very wrong, there is no supply issue in Australia and vacancy rates remains low at ~3%, compared to peak US housing vacancy rates of ~11%.

The housing sector in Australia has grown fast since 1985 and is now big.

Australian housing is valued at $5.9 trillion, dwarfing the value of ASX listed companies of $1.6 trillion and the value of all commercial real estate of $0.7 trillion.

The Australian housing market has experienced compound price growth of 6.5% per annum for an astonishing thirty years. This compares to Australian equities [growth of] 5.4% p.a. over the same time period [and wage growth] of 3.5% p.a. over the long term.

Why have Australian housing prices risen so much?

Almost all buyers of housing, whether owner occupiers or investors, majority fund their purchases with bank debt. The willingness to bear this financial risk has been driven by a combination of many factors, but the necessary ingredient has been the validating nature of 30 years of steady house price rises. … There has been no recession driven shock to household incomes for 25 years … Interest rates have fallen consistently for 25 years and are at historic lows … Housing investors receive tax concessions for investment.

Investor loans have risen from 15% of all housing loans in 1991 to just over 35% today … supported by mortgage brokers, real estate agents and the media.

Parts of the residential real estate agency industry acts as unregulated ‘investment advisers’. This group unconscionably support the notion of a riskless and infallible housing market. While there is nothing illegal about their behaviour because the Corporations Law does not recognise real estate as a ‘financial product’, it is certainly being sold as such by the real estate industry. The evolution has been slow but consistent. We are now seeing some real estate agency firms establishing mortgage broking businesses, insurance broking and financial planning firms. It is difficult to think of a more conflicted business model.

Willingness to lend has been unfailing to date:

Since 1991 Australian banks have increased loans to the housing market [by] 12.2% p.a. … housing loans have moved from 20% of all bank loans in 1991 to 60% today. More concerning is that 20% of all Australian bank loans have been made for real estate investments.

Are the ingredients in place for an Australian housing crash?

The answer is unfortunately and unequivocally ‘yes’. All of the factors that have existed in every historical housing crisis are currently in place in Australia.

  • A significant and sustained increase in household leverage.
  • House price growth unprecedented in the history of modern  economies.
  • Slowing economic growth [since 2008].

What does a housing crash look like?

In their famous book on financial history, Reinhart and Rogoff studied 21 major house crises. They found the average fall in house prices was circa 35%, with declines ranging from 10% to 60%. Clearly, the term ‘safe as houses’ is utterly discredited by the historical evidence that shows house prices can and do fall significantly. The other important lesson is housing markets do not ‘crash’ in the traditional sense of the word. It is a slow process; it takes on average six years for the price correction to occur.

The final point on the history of housing crises, they normally always coincide with a banking crises: “Banking crises tend to occur either at the peak of a boom in real housing prices or right after the bust.” This relationship makes sense. It is a particularly likely relationship in Australia where the entire banking system is supported by housing prices.

What will cause an Australian housing crisis?

[The three factors above] are necessary but not sufficient. A housing and banking crisis requires a catalyst to change behaviour. This catalyst must ultimately cause credit growth to move into negative territory.

The two most likely catalysts are falling wages (“this transmission may take time; households will first cut spending in discretionary purchases before defaulting on their home loan payments”) and a reduction in bank’s willingness to lend (tightening loan approval).

Ultimately, … if credit growth moves into negative territory, the Australian housing market may begin its slow correction, with prices falling gradually over many years.

Read it all; great graphs.