Boom or Bubble? The Australian housing market
In 2008 University of Western Sydney Economist Steve Keen made a bet that Australian property prices would decrease by 40%. He lost the bet and walked up Mt Kosciusko in a shirt emblazoned ‘I was hopelessly wrong on house prices!’
If the latest data from RP data is anything to go by, Keen’s continued suggestion that an Australian housing bubble will emerge and burst suffers another hammering, as house values are rising around the country and buyer enthusiasm is buzzing. Despite this robust data, rumblings about the potential of a housing bubble have begun again.
Early signs of a recovery
After a number of years marked by a housing slump, RP data presents a positive story about the Australian housing market. The total number of national home sales is 29.7% higher in the three months to June 2013 than they were over the three months to June 2012. This amasses to 94,466 house sales and 33,394 unit sales. The graph below shows the monthly number of house sales over the last 20 years. While it is clear that we are yet to reach the highs of the early 2000s, there are good signs of a recovery.
The increase in auction clearance rates over the last year supports this excitement. RP data shows that clearance rates across the largest auction markets, Melbourne and Sydney, have averaged 69.9% and 74.1% respectively over the last three months. Even more recent data from the Australian Property Monitor (APM) indicates that Sydney and Melbourne weekend auction markets continue to hit extraordinary results. The average over September was an impressive 85.1% and 80% respectively. When compared with the 50.4% clearance rate from the previous year, the significance is clear. As the graph below shows, these recent increases have not yet reached the highs of 2009 but the trend is in the right direction. The increases in clearance rates together with increases in sales volume offer clear signs of market recovery.
To add to this promising story, the RP Data report also shows that home values across the country have been increasing with the middle section of the market performing best. Combined capital city home values have increased by 5.3% over the past 12 months, with Perth and Sydney contributing the greatest increases at 9.4% and 7.0% respectively. The notable exception here is Hobart, having experienced a decrease of 1.1%, caused by high levels of unemployment currently recorded at 8.4%. Despite this negative change in Hobart, the combined capital city index is also looking up.
The significance of these annual increases is also highlighted by looking at longer term trends. The below chart shows the average annual change over the last ten years. This shows that the annual change last year is 1.0% higher than the average annual growth over the last 10 years.
Another indicator that shows the current upward trajectory of the housing sector is the decreasing average amount of days that houses are on the market. This has decreased from 62 to 41 days over the course of the past year. What is significant is that this decrease is happening despite the increases in house values and number of houses sold. Which indicates buyer confidence in the market.
RP Data Mortgage Index also indicates that there has been an increase in mortgage activity over the last few weeks, which suggests an uptick in mortgage related activity. The graph below indicates a steady increase from March to September 2013.
Why is this happening now?
This upswing in activity is unsurprising. With low interest rates, inflation sitting comfortably within the RBA’s target range, increasing access to credit and household’s maintenance of prudent financial decisions, the environment is ripe for buying.
RP data shows that consumer sentiment has reached its highest level since March 2013. This is crucial for the continuation of the upward trajectory, as confidence has a significant influence on sales transactions and movements in home values. RP Data concludes that if sales are increasing and there is an improvement in confidence then there is likelihood that home values will be pushed even higher.
All of these things point to the same conclusion: the housing slump is over, or at least nearing an end.
Is this an emerging bubble?
Since the RP data report was released in early September there has been much speculative commentary about the possibility of a housing bubble.
Alan Kohler of the Business Spectator has tried to dampen the hype about a bubble by indicating that housing ‘values are only just back to where they were three years ago.’ He also mentioned that bubbles only occur when supply exceeds demand, as was the case in America. His point is that this does not fit the current Australian market, as we have a supply side issue. This means we cannot fall into the same problem that the US experienced. Despite his saliency, this perspective has yet to stop the housing bubble chatter.
The IMF inadvertently weighed into the debate with the release of its latest report, ‘The Macroprudential Framework: Policy Responsiveness and Institutional arrangements’. The IMF contended that low inflation, low interest rates and the appearance of a tranquil economy could create real potential for a price bubble to emerge. Although not written directly about Australia, these conditions are consistent with the current Australian context.
The IMF suggests the use of macro-prudential instruments to temper the cyclicality of the financial system and ensure long-term stability. For example they recommend that central banks should insist on higher loan to valuation ratios or increase bank capital requirements to prevent banks fuelling house price bubbles.
The New Zealand central bank showed clear leadership on this issue by announcing last month that new limits would be imposed on mortgage lending for homebuyers who are only able to make small down payments. This is in line with the sorts of macro-prudential policies that the IMF report was suggesting, as it aims to keep house prices in check whilst a central bank keeps official interest rates low to stimulate other sectors of the economy.
The initial response from the RBA was blunt: there is no housing bubble in Australia. Assistant Governor of the RBA, Malcolm Edey, suggested that the IMF report was ‘unrealistically alarmist’. He mentioned that in the last 10 years house prices in Australia have risen roughly in line with household income growth. The graph below shows that Edey may be right for the last 10 years. However over a longer term the story is a different one. The graph clearly highlights that over the last thirty years the value of dwellings has increased at a much faster rate than incomes.
Despite his dismissal of the IMF’s report, Edey said that the RBA would continue to keep an eye on the housing market. Obviously wanting to assure the market that the RBA too had its eye on the ball.
Since this initial statement, the RBA released their bi-annual Financial Stability Review. Tucked between recognition of the ongoing prudence of households and a less than stellar business report, the RBA noted concern with the activity of self managed super funds (SMSF) and their relationship with housing prices. In 2007 SMSF’s were allowed to start borrowing to invest. Since this time property investments by SMSF’s have risen from $20 billion to $80 billion. It is this growth that the RBA is concerned about. The growth in SMSF property holdings is shown in the graph below.
The RBA argues that the current legislative environment has created a vehicle for potentially speculative demand for property, which will exacerbate property price cycles, and expose investors to greater financial risk. Effectively the RBA is suggesting a link between soaring house prices and extraordinary growth in the SMSF sector.
The advice of the RBA is for buyers of all persuasions to maintain realistic expectations about the future of price growth of dwellings. They argue that unlike the decades leading up to the crisis, where prices grew rapidly due to disinflation and financial deregulation, price increases are expected to grow in tandem with income growth and not go beyond it. With this the RBA is warning, though not forcing, banks to maintain a ‘prudent risk appetite and lending practices, especially in the current low interest rate environment.’
Without using the language of a bubble, the RBA is clearly aware of the prospect of ‘imbalances’. It is important to stress that this imbalance is unlike what happened in the US and what the NZ central bank is cautioning against. Rather the RBA is focused on speculative property investment from the SMSF sector and negative gearing.
Chief economist at Westpac Bill Evans offers a discerning voice against this narrative. He indicates that the residential real estate owned by SMSF’s amounts to only 3.5% of their total investment portfolio, or only 1.5% of total housing credit. This is tiny by any standards and leads to the very basic question of how such small numbers can affect price? If we look at the property holdings of the SMSF’s again it is apparent that the residential real estate sector makes up only a small component. It is also apparent that commercial property holdings have been a much more significant focus of SMSF investing since 2008. Looking at the percentages, rather than the raw numbers offered by the RBA, offers a healthy dose of skepticism to the current media hype.
The new Coalition Government has also weighted into the debate, with Assistant Treasurer Arthur Sinodinos responding to the concerns about SMSF’s raised by the RBA. He said that his aim is to maintain competition between super funds and create a level playing field. His comments are in line with the Coalition Government’s commitment to launch an inquiry into the financial services industry, including the superannuation sector. It is notable that he did not address the housing price issue; however the push for competition in the super sector could appease the RBA’s concerns.
The latest data from RP Data shows a clear increase in sales and values of houses across Australia. This has bred concern about the prospect of a housing bubble. It is equally apparent the RBA is aware of this issue but does not want to solve any prospective ‘imbalance’ by macro-prudential regulations as suggested by the IMF. Rather they are indicating the need for legislative changes, removing the incentive for SMSF to borrow and invest in property. The government appears to be telegraphing that it intends to do just this to ensure competition between super funds. It is only when this happens that we can determine whether SMSF investment in residential property was the cause of price increases. Until this happens, discussion about SMSF and housing prices will continue into the near future. Hopefully not at the cost of the much needed discussion about how to increase supply in the sector.