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Revealed: The truth about Aussie house prices – and how the property

industry’s covered it up By Kris Sayce

Money Morning Australia

If you’re thinking of buying an investment property in Australia in the next 24 months – or even if you just own property – you need to read this report now.

Because it could be the only honest info you get on Aussie real estate this year.

Basically, there are two schools of thought when it comes to investing in Aussie property.

On one side, you’ve got a very vocal group of property spruikers – they believe things are pretty much okay and house prices are supported by population growth, low interest rates and a so-called chronic housing shortage.

On the other is a smaller group of housing sceptics – they think Aussie property is in a bubble that’s been fuelled by easy credit and stimulus (low interest rates and first-home buyers’ incentives) – and as the stimulus gets wound back the bubble will burst, sending property prices tumbling.

I tip my hat to the spruikers. They produce great spin. Take a look at these chestnuts from the OHL Group’s 2010/2011 Property Investment Report.

• ‘Massive population growth and a shrinking land supply are combining to create record price growth and auction clearance rates’

• ‘Australia’s population growth continues to surge ahead, creating unprecedented demand for Australian housing’

• ‘A recent government decision just massively reduced the amount of land available for residential development in the designated growth corridors’

• ‘The best strategy in a rising market is to buy at a fixed price off the plan. You are effectively buying a property at today’s price, but not having to pay for it until it has already had significant growth’

If you feel a bit sceptical about those facts, you’ve good reason to!

But if you read that in the OHL report – and didn’t know any better – you could easily be tempted to rush out and buy a rental property right now. And why not? The thought of getting something ‘rare’ for ‘cheap’ today and selling it to a foreigner for a tidy profit tomorrow is very appealing.

I’d do it. (That is, if I didn’t already know property is a riskier investment than shares right now!)

You see, there are people out there – unscrupulous salesmen and women – with a vested interest in selling you property.

Special Report

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They’re money lenders, property developers and real-estate agents who make a living flogging you loans and houses...

And they’ll say anything to convince you to buy...

• ‘Retire knowing you’ll have a steady stream of rental income to rely on – because people will always need a house to live in...’

• ‘If you own an investment property portfolio it’ll show your friends and family you’re a real success!’

• Or this, a quote from David Airey, president of the Real Estate Institute of Australia, in The Australian on 29 July 2010 – ‘Australians value property so highly as a means of security and haven for their families…’

And then they say things to help rationalise your decision to buy. Some of their favourite choruses include ‘property doubles in value every 7–10 years’ and ‘housing prices won’t tumble because they’re propped up by population growth’.

But it’s a bunch of lies – as I’ll show you in a second.

Here’s an example of the property spruiker’s logic in action... take a look at these news articles...

House prices set to soar

An undersupply in the Australian property market will force residential property prices up by 30%, according to a BIS Shrapnel chief economist

International Business Times 27 July 2010

Housing Shortage Makes Australian Home Prices Almost Twice U.S.

... a shortage of 200,000 dwellings... is helping fuel Australian home prices, which are 82 percent higher than in the U.S.

Bloomberg Business Week 5 July 2010

Would you believe this data is based on statistics that include HOMELESS figures and immigration numbers? (Which don’t account for whether people are moving to Australia to live with their families or buying their own homes?) Well they are. It’s madness.

But in the property spruikers’ minds, a population increase means more demand for houses which means higher house prices, which means, ‘Buy before it’s too late!’

These catchcries are parroted by real-estate ‘experts’ across Australia. And most of us readily accept them...

That’s why I’m writing today. To show you – using plain old common sense – Australia is in the midst of a housing bubble. Then I’ll show you why the property experts believe Australia is different – and show you why they’re wrong. Finally I’ll show you where to go to get the best contrarian advice anywhere in Australia.

Right, first things first...

Are Aussie house prices in a bubble?

According to the NSW government’s Centre for Affordable Housing –

‘Housing is affordable when households that are renting or purchasing are able to pay their housing costs and still have sufficient income to meet other basic needs such as food, clothing, transport, medical care and education... housing is affordable if it costs no more than 30% of a household’s gross income.’

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As you can see, property in Melbourne Victoria hasn’t been anywhere near that level since 1997.

According to this chart, a median-priced property will set you back 7.8 times the average Aussie salary... or to put it another way, if you’re earning the average $68K wage over 85% of it will be spent on your mortgage!

But it’s not only Melbournians who suffer.

According to the ‘2010 International Housing Affordability Survey: Rating for Metropolitan Markets’, Australia is home to 22 of the top 58 most unaffordable metro housing markets in the world.

I’ve underlined them in red.

 

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The most affordable Australian metro area to buy in on the list will still set you back 5.4 times the average annual salary!

And that’s before you take into account some of the hidden costs of housing.

‘If you buy an investment property, you’re paying maybe 4 per cent stamp duty on the actual total price, not just your investment. Say you’re buying a $500,000 house, so you’re paying $20,000 in stamp duty. If you’ve only got a $50,000 deposit, you’re paying $20,000 transaction cost on the $50,000 that you have invested... You also have your interest and maintenance costs along the way, which can also be very substantial.’

Ron Bewley, Woodhall Investment Research – The Australian, 28 July 2010

So what is a housing bubble?

The word ‘bubble’ gets bandied about so much that it’s almost lost all meaning. Here’s a quick definition...

A housing bubble is what happens to house prices in a residential market when valuations increase to unsustainable levels – quickly. Like say, 7.8 times the average annual salary!

Take a look at the chart below for a clear picture of what I mean. It’s a comparison of US, Japanese and Australian residential house prices from 1980 to 2010.

 

Once prices peak, a correction follows – bringing house values into line with average incomes.

You can see how it happened in Japan in the 1990s and the US around 2007. Look at the sharp drop of the US decline, compared to the long, drawn-out Japanese one...

It tells me one thing. The higher prices climb, the further – and faster – they fall.

And Aussie house prices have a long way to fall!

And if you believe what you read in the news, it could reach its tipping point any day. Take a look at these stories from 30 July 2010...

House prices post largest fall since April 2008

In the three months to June, all capital cities experienced virtually no growth or a fall in values, with

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the exception of Adelaide, the RP Data-Rismark Hedonic Home Value Index has found.

www.news.com.au

Home prices drop after 17 months of gains

National city home prices fell for the first time in 18 months in June, as rising interest rates sent auction clearance rates lower.

www.news.com.au

Of course the property spruikers aren’t worried. They predict house prices will level off. You know... until the economy sorts itself out. And then prices will start soaring again.

It’s as if they don’t understand why prices are as high as they are. They talk about population growth and land shortages as if that explains everything. But that’s not what’s driven the median house price in Melbourne up by 243% since 1996...

How the government increased your mortgage by 109.9%

Here’s the skinny.

Government stimulus is the central driver of the over-heated property market.

It started in the year 2000. The first-home buyer’s grant artificially stimulated demand for properties by pressuring first-home buyers to jump into the real-estate market before they were ready. Because they had to claim the handout before the government decided to take it back.

So they got their ‘free money’ and started buying up property... and the fierce competition for properties (along with the free money) made them feel free to overpay to seal the deal.

This buying frenzy – stirred up by first-home buyers desperate to start climbing the property ladder – pushed house prices at the lower end of the scale up quickly.

This prompted home owners to sell in order to cash in on their property’s inflated ‘value’. They then became a part of a group of second-home buyers, looking to upsize to a bigger, better house…

And so on and so forth.

It’s the greater fool theory. Up until recently the Ponzi has been allowed to grow because of the belief that someone else will overpay for the house that you overpaid for.

And it helped push the median property price in Melbourne up from $249,800 to $524,500

Things really heated up in the months leading up to the highly publicised pull back of the first-home owner’s grant (30 December 2009). Interest rates were still at or near an all-time low 3% – and nobody wanted to miss out.

Just take another look at that massive jump from 2009–10 .

But still the property bulls refuse to believe Aussie house prices are overcooked.

 

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These two headlines from 18 June 2010 might catch your eye.

No housing bubble Australian Property Investor.

Housing bubble? Not here. RP Data – ‘Australia’s #1 Property Data Provider’

Or there was the speech given by Luci Ellis, Head of Financial Stability at the Reserve Bank of Australia (RBA) at an Australian Financial Review sponsored conference on housing on 18 May 2010.

‘Recent data suggest that we do not have a credit-fuelled speculative boom on our hands. It would not be desirable for the current situation to turn into one.’

So what ‘recent data’ was Ms. Ellis referring to?

I mean, it could be the Australian Bureau of Statistics (ABS) chart she used to open her presentation:

 

But it has bubble written all over it... Well, our version has anyway!

 

And obviously she hasn’t noticed the numbers contained on the RBA website which provide an insight into the ‘non-existence of the “credit-fuelled boom”’.

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560% increase in household debt

 

Those numbers are in millions. And residential borrowing has increased 50% in nearly three years.

But no matter what the facts are, our home-grown Aussie property pundits seem to believe one of two things. Either property prices will continue rising forever or fall temporarily – allowing investors to snap up a bargain before they soar again.

But history tells us that’s not how bubbles work...

Why the Aussie Property Boom is not ‘Different’

Jeremy Grantham – chairman of the board of Grantham Mayo Van Otterloo – had this to say on a visit to Australia in June 2010...

‘Bubbles have quite a few things in common but housing bubbles have a spectacular thing in common, and that is every one of them is considered unique and different.’

‘Housing market a ‘time bomb’, says investment legend‘ The Australian 16 June 2010

Before the Japan bubble burst back in 1990, economists argued that rising house prices in Japan reflected the country’s rapidly growing wealth. They said the price growth was sustainable because there was a land shortage in Tokyo. Then the bubble burst.

At the peak of the bubble, the Japanese Imperial Palace in Tokyo was worth more than the entire state of California.

Afterwards it was worth considerably less.

On 31 December 2006, Peter Schiff, the president of Euro Pacific Capital, said this on US TV...

‘Today’s home prices are completely unsustainable. They were built up to these artificial heights by a combination of temporarily low adjustable rate mortgage [(ARM)] payments, by a complete absence of any lending standards and by speculative buying.

And what’s going to happen in 2007 is that a lot of these artificially low ARM payments are going to be re-set upwards.

 

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You’re going to start to see both the governments and the lenders re-imposing lending standards and tightening up on credit. And you’re going to see a lot of the speculative buyers turn into sellers. And these sky-high real estate prices are going to crash back down to Earth.’

People argued that ‘land shortages’ in US states where the property market was booming would sustain house-price growth... then the sub-prime mortgage implosion popped the US housing bubble... and that led to the major downturn of 2007...

In Q3 2007 the median price of a home in Long Beach California was $602 900 – in Q3 2008 it was $391 400

Schiff was right. There was a major correction in the house price. And the US real-estate market still hasn’t recovered. (You can still buy property in Detroit for less than US$5 000!)

But his argument – that only the ‘paper’ value of real estate had increased and it would crash when rates rose and easy credit was wound back – was ridiculed by other ‘experts’.

In much the same way that housing sceptics are shouted down by property spruikers in Australia.

Ultimately, Schiff was right. Just as the sceptics here will be proved right. Easy, no-doc loans and low mortgage rates combined to entice a lot of people into buying property. Some buyers borrowed 95+ per cent loan-to-value ratio – and these people were forced to sell when interest rates inevitably rose.

Take a look at these two charts.

 

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I don’t know about you, but to me it looks like low-interest rates sucked a lot of people into the market – pushing real-estate prices up. When people could no longer afford to get in, demand dropped – and when demand dropped so did the prices.

So why couldn’t the same thing happen here?

Is there really a housing shortage in Australia?

On 3 May 2010, published author and respected US financial commentator Edward Chancellor said Australia was in the midst of an unsustainable housing bubble.

‘If house prices were to revert to their historic long-term average (ratio of average price to average income) they would fall quite considerably. It’s the rising interest rates, particularly with real estate bubbles, that tend to generate the collapse.’

But Commonwealth Bank economist, Michael Workman had a different idea: that foreigners couldn’t possibly understand ‘the growth outlook here [in Australia or] the under-supply of dwellings’.

Workman pointed out – just like many spruikers before him – that Australia is in a unique position. One in which he believed strong population growth, a housing shortage, low unemployment and historically low interest rates would keep driving house prices higher.

Other local experts chimed in with their two bob’s worth...

Macquarie interest rate strategist, Rory Robertson, said in The Age –

‘According to RP-Data/Rismark, house prices rose at a 5 per cent annualised rate over April and May after gaining 13 per cent on average over the year to March... [so] wave “good-bye” to the earlier double-digit growth rates that excited so much silly talk about “bubbles”.’

And – according to Bloomberg – Australian Property Monitors said a shortage of 200 000 dwellings in Australia had helped to put a floor under house prices.

But in spite of this, The Economist released its ‘fair value’ calculation of housing prices on 14 July 2010 – based on the comparison of the 2010 house-price-to-rent ratio to historic ratios. And it found Australian property was overvalued by 61 per cent.

Here’s another chart used by the RBA’s Luci Ellis which unwittingly should help to dispel the myth that rising population growth is necessarily linked to house price growth:  

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Prof. Steve Keen pointed out in an article for Business Spectator that if population growth running faster than new dwelling growth leads to rising house prices, why didn’t house prices fall between 1955 and 2004 when dwelling growth exceeded population growth?

The simple answer is that the real driver of house prices is easy credit. Plain and simple.

How cheap money creates credit bubbles

Just in case you missed it, Australians were enjoying historically low interest rates over 2008–09 – and property developers and advertisers used this as a key point to sell first-home buyers and investors on housing.

 

Take note of the low of 1997 – at that point, interest rates were the lowest they’d been since the 1970s. It played a part in helping fuel the boom that pushed Australian housing to new levels of unaffordability.

And when that stops – which it hasn’t yet, remember... POP!

But the ANZ Bank’s head of property and financial system research in 2010, Paul Braddick, has another theory… house prices have risen mainly because interest rates are lower. So because of that, there is no bubble and houses aren’t over-priced.

‘International comparisons of house price to income ratios have been wide ly used to suggest that Australian house prices are significantly overvalued. These analyses are not only dangerously simplistic but explicitly ignore a key component of the housing affordability equation – interest rates.’

He continues:

‘In Australia, the house price to income ratio rose from an average of around 3 in the 1980s to an average around 5 since late 2003. That is, the median house price in recent years represents 5 times the average household’s annual disposable income compared to 3 times in the 1980s.’

Then he follows it up with this chart:

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There’s the proof. Interest rates averaged about 14% in the 1980s, and only about 7% in the 2000s.

But what strikes you about the chart? No rush, take your time.

Well, I’ll tell you what strikes me. If the chart is supposed to be the justification for high house prices, or rather that house prices aren’t high, that they’re just normal, how come house prices in the US and the UK fell?

The fight against the misinformation spread by the mainstream press is an ongoing battle. Particularly when it seems to be falling over itself to perpetuate the myths dreamt up by the property spruikers.

On the one hand, foreign parties are telling you that the Aussie property market is a bubble about to burst – sending house prices falling – because it’s happened in other countries… their countries.

On the other, you have local experts claiming that Australia is a ‘special case’ and that there are unique strengths underpinning the housing price.

What happened to the housing shortage? You know the one I’m talking about. The ‘chronic’ housing shortage. The one where Australia is short by 135,000... sorry, 200,000 homes.

The housing shortage which will reach – what is it – 400,000 homes by 2020?

According to a report by Stuart Fagg on ninemsn... ‘Australia must build an additional 500,000 houses by 2020 or face a crippling rise in house prices that will make home ownership out of reach for many.’

But suddenly no one is talking about it. I’ll tell you why. It’s gone up in a puff of smoke.

We’ve final proof that it never existed. And as far as we can tell, barring a man-made or natural catastrophe, there won’t ever be a housing shortage.

I don’t think I’ve laughed so much in a long time as when I read this headline in The Age recently: ‘Flood of property listings to hit Melbourne market.’

‘Flood’. That implies a lot. It’s the opposite of a ‘drought’. According to the Microsoft Word dictionary, flood is a synonym to deluge, torrent and overflow. On the other hand, a ‘drought’ is nothing. Hope you’ve got

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that.

According to the story, ‘The Real Estate Institute of Victoria is predicting 1210 auction listings over the next two weeks...’

But here’s the bit that had us rolling on the floor in laughter, ‘A 50 per cent increase of new home listings expected over the next three weekends comes as auction clearance rates begin to falter on pricier home loans and weaker buyer confidence.’

In other words, despite the so-called housing shortage of 200,000 homes, the property spruikers and mainstream press have had the crap frightened out of them by an extra 400 houses hitting the market over the next two weeks.

Or to put it even more simply, if we average those numbers out, an extra 200 houses hitting the market in one weekend is considered a ‘flood’. And it’s causing panic because it’s seen as a ‘flood’ of supply.

Are these people insane?

One week they’re saying with a straight pen that there’s a 200,000 housing shortage and the next week they’re worried the whole market could topple over due to an extra 400 homes being offered for sale.

Does that make sense to you?

By our calculations, 400 homes equals around 0.2% of the number of homes needed to address the so-called housing shortage.

We’d have thought the spruikers would be cheering that the supply has increased. After all, with a shortage of 200,000 homes, surely an increase of just 400 properties isn’t going to burst the bubble.

This is the capacity increase they’ve been waiting for. Isn’t it?

Of course it isn’t. The housing shortage has been the biggest myth, furphy... and dare we say it, lie so far in the twenty-first century.

It has never had any factual basis to it. All they had to do was say it enough times and people would believe it.

Now they’re panicking.

They’re panicking because they’ve known all along that the housing shortage claim was just a massive hoax. And now it’s been exposed.

Spread by every vested interest going around – the real estate industry, the property spruikers, the over-leveraged property investors, the over-leveraged banks, those allied to the property industry. You name them, they’ve all had their nose in the housing shortage trough. Conning buyers into paying top-dollar for a super risky asset.

But as owners realise their mistake they’ll start to sell. That’s when you get the real flood of sellers, not a piddly 400 extra ones. Sellers who are eager to get out before everyone else have the same idea.

You see this kind of price action on the stock market all the time as sellers leapfrog to get out of a position. They do the same to get into a position. That’s how the bubble forms. The rush to get out pushes the prices even lower until the price is oversold.

The only – and it is the only – difference is that because housing is less liquid than share trading it takes longer for this effect to occur. It doesn’t happen on a second-by-second or minute-by-minute basis like the stock market. It happens over the course of many months.

And perhaps, just perhaps, the first stage of the flood is beginning. You can see the impact that just 400 extra house sales is having on the psyche of property spruikers, just wait until that trickle becomes a real

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flood.

But still the excuses come.

That’s all they are, excuses. Nothing the spruikers or bankers come up with has any basis in fact or logic. It’s a constant stream of excuses. They know that each one only has a limited shelf life and so they have to quickly think up another.’

What happens when the excuses run out?

Well, the mail is in. Since the first-home owner’s boost was brought to an end and the RBA raised interest rates from 3% late last year to the current level of 4.5%... the proportion of first-home buyers among purchasers has fallen from around 28% to about 16%.

According to Veda Advantage’s Consumer Credit Demand report,

‘The first home owner loan market has cooled considerably in the first half of 2010, with mortgage applications down 20% compared to the same April to June period in 2009. This follows on from a 15% fall in the January to March quarter of 2010 year-on-year.’

A 15% fall in the March 2010 quarter. A 20% fall in June. This could be the pin that finally pricks the property bubble.

So what should you invest in now?

Well, that’s the $64,000 question.

I’m not saying that property is always a bad investment. What I am saying is that it’s a bad investment right now.

But I’ll be blunt, I’m not going to go into specifics here. Besides, do you really want to follow the financial advice of a bloke you’ve only just met? I know I wouldn’t.

So, rather than that I thought it would be much better if you got to know me first, and then you can decide on whether what I’ve got to say makes sense... or not!

Look, I’ve been in this game a long time, starting out working as a broker in the City of London 15 years ago. Boy, was that a wake-up call to someone fresh out of university!

But – even though I do say so myself – I wasn’t your average broker. Over the years I figured out that most brokers were in the game for one reason – themselves. They loved telling everyone that they’re a ‘Stockbroker’, as if it really meant something.

They loved flouncing around in their sharp, pinstriped Zegna suits and crisp Thomas Pink’s shirts... double cuffed with cufflinks of course.

But I also realised something else, most stockbrokers just parrot everything their research analysts tell them. If the analyst says a stock is a buy then that’s what the broker tells his or her client.

The trouble is, the broker – and most importantly, the client – doesn’t know what kind of relationship the analyst has with the company. You don’t know if the analyst is really doing a proper analysis or whether their opinion is clouded by investment banking deals the broking firm may get from the company, or freebies the analyst may receive.

Fortunately, the readers of my newsletter know that the firm I work for is completely independent. Our only customers are people like you. People who either receive our free newsletters or who pay for our investment and trading services...

And it’s as a subscriber to those services that you’ll read about the kind of investing ideas you won’t read anywhere else. While mainstream brokers and financial planners are loading up their clients’ portfolios

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with bank shares, property trusts and infrastructure funds, we’re telling our readers to stay well clear of those investments.

Instead, we’ll show you how to make long-term gains from the resources sector, small-cap stocks, and gold. Plus, for short-term traders we show how to not only make quick profits, but also how to minimise losses too.

It’s all part of the service we provide to readers of our subscription based services:

• Australian Small-Cap Investigator

• Diggers & Drillers

• Australian Wealth Gameplan

• Slipstream Trader

• Swarm Trader

But look, I’ve already given you a lot of information. Perhaps too much.

Anyway, I don’t want you to feel overwhelmed by it all so over the next few days, in addition to your daily issue of Money Morning I’ll also send you more information on who we are and what we do. Then you can make up your own mind about whether what we do is something that interests you.

If it is, great. If it isn’t, well no hard feelings.

So, watch out for your first issue of Money Morning in your inbox in the next few days.

Regards,

Kris Sayce

Editor, Money Morning

© Port Phillip Publishing Pty Ltd 2010. The past is not a guide to future performance. The value of any investment, and the income derived from it, can go down as well as up. Investments in smaller companies involve risk and may not be suitable for all investors. For any investment, never invest more than you can afford to lose, and keep in mind the ultimate risk is that you can lose whatever you’ve invested. If in doubt of the suitability of an investment please seek independent financial advice.

Money Morning Australia is published by Port Phillip Publishing Pty Ltd.Registered Office: Port Phillip Publishing Ltd Pty, Level 1, 10 Fritzroy Street, St. Kilda, VIC 3182

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