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Bubble

By Paul Nees

A number of people have asked me recently my thoughts on whether the Australian property market is in a bubble, as a number of media commentators have suggested in recent times. This is a complex question but here are my ideas on the topic.

First I think it’s important to define what an asset class bubble is. The main characteristic of a bubble is mispriced assets. This occurs when increases in prices drive demand beyond the normal equilibrium, typically through speculative investment. This is typically enabled by easy credit, which includes low interest rates, financial innovation introducing debt enablers like interest only mortgages that allow people to borrow more and also low credit check thresholds when lending.

Two of the more recent asset class bubbles that come to mind are the US real estate bubble and perhaps more memorable locally, the tech bubble in the 1990s. Pricing of internet stocks was distorted beyond any sensible earnings multiple and was driven by herd mentality. The narrative was it doesn’t matter that they don’t have profits now – they will and don’t be late to the party.

So does the Australia property market have these characteristics?

1. Inflated prices through speculative investment
Basically this means speculators are buying properties in the hope they’ll keep increasing in value. However this isn’t the behaviour we are noticing in the market – most activity is driven by people buying their principal place of residence. Our empirical evidence shows only 30% of properties are bought for investment, consistent with historical averages. In fact the Australian Property Council estimates that with current population growth Sydney will face a housing supply deficit of 190,000 homes within a decade, if this is accurate it really destroys the theory that there is a imbalance between supply and demand.

2. Easy Credit
Interest rates in Australia are at historical lows, currently 2% with potential to drop even further. It’s hard to argue that we don’t have access to easy credit at these rates, however compared with US lending policy prior to the sub-prime crisis, Australian banks are much more conservative in their lending. The US property bubble was caused by banks creating products to enable people that couldn’t afford to buy properties to do just that. It all started to unravel when low introductory-rate mortgages converted to regular interest rates, putting people in positions where they can no longer service their mortgages. In the Australian market these products do not exist, or are not accessible to the average borrower.

So is it a bubble? Property is certainly expensive but I’m not sure it could be called a bubble. Investment properties can still be purchased with profitable yields and mortgages can be serviced with household incomes. The key risk I perceive that could cause a severe decline in house prices is if the RBA was to raise interest rates aggressively, but they’re just not likely to do that – they understand the impact such actions would have on the property market and the overall economy. So for now my view is that it’s not a bubble. At least not just yet. History will be the judge.

Author: Paul Nees, Principal Ray White Lane Cove

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