LAST year, world residential property prices fell considerably, helping to create the sub-prime credit crisis in the US.
It seems beyond doubt that there are further falls to go. If you jump on to a bank website, you can see more properties for sale than any major real estate agent can offer.
Why is Australia so different from the rest of the world? How long until the Australian property market devalues in line with global residential property trends? What factors might contribute to this? Boom time or bust?
There is a widely held belief that Australian residential property cannot fall in value.
While those bankrupted in the property crash of the late-1980s may not hold this belief, the rise upon rise of residential property value in Australia has left many economists scratching their heads.
I first wrote this article late in 2007 and the rapid interest rate increases have possibly brought forward the downturn.
It is hard to find any arguments to suggest that Australian residential property is not grossly overvalued. Rental yields are still at historic lows; the price of property, as compared with income levels, is higher in Australia than any other place in the world.
Eventually, we will reach a point when people simply cannot afford mortgage repayments, especially if the economy weakens or interest rates continue to rise.
The first point to note is the residential property obsession in Australia; the great Australian dream. This is unique to our shores; a sizeable majority of the world's population is comfortable with renting.
As interest rates fell in Australia, more people could afford to pay higher prices for a property, so residential property buyers increased bidding up prices. But if the market is overvalued, when will it stop?
Unfortunately, the answer to this can be a little scary. Bubbles in a sector of the economy can build over time and the longer they build for, the greater the pain when they burst.
If we saw an increase in interest rates to levels that made it impossible for people to fund their mortgages, many people would be forced to sell.
However, most Australians would give up food and clothing to pay their mortgage.
The real hit will come if we have an economic downturn. If people lose their jobs, they will not be able to pay the interest.
Home owners will be forced to sell, property will decline in value, people will not have the confidence to take on loans and the banks will not be lending, so the buyers will dry up. If this is matched by a period of increased development and supply, this could be devastating.
Those who have built up property portfolios by gearing up on each property and buying another can see everything they have built wiped out in one hit if the banks foreclose on them.
The most commonly quoted price monitor for property prices is the medium sale price. There are so many distortions to this measure that at times it can be way off actual current market price levels.
For example, it does not take into account improvement done to a property. If you purchase a house for $500,000 then spend $200,000 fixing it up and sell it for $750,000 there is a 50 per cent increase in the sale price of the house, but a profit of only 7 per cent
Also, the medium sale price does not include properties that do not sell. I have been to auctions lately when no one bids and there is no interest at the vendor's minimum asking price.
As most people do not sell in such a situation, it does not show in the median price figures. In reality, they may need to drop the price by 20 per cent to sell, but this will not show up.
Therefore, to see a true picture of prices, we would need to see vendors who must sell at any price. This is usually reserved for defaults, where banks want to sell to get their money back.
The RBA constantly monitors the rate of inflation. In fact, this is their primary focus. The inflation that is most closely followed relates to the prices of goods and services.
Putting too much of our hard-earned into property has negative economic implications for our great country.
These funds could be spent on building infrastructure or new businesses and industries that would create jobs, exports and long-term wealth for our country.
Bubbles and busts have very negative impacts on the economy.
First, it wastes resources, sending them to the wrong areas. In addition, when the party comes to an end, panic can set in and this can have very negative economic and social consequences.
Don't get me wrong, property can be a wonderful investment and a sound property investment strategy has been one of the best ways to build wealth over time.
However, one must question if we need a degree of unwinding until property again offers the opportunities it has in the past.
When something goes up too fast, it must either fall or grow at a sub-par rate in the subsequent period.
Many will remember the 500-500 rule. This was the standard not that long ago, which referred to $500 a week equating to a property value of $500,000 (That is, $26,000 rent for a $500,000 property). This is certainly no longer the case, where a decent property would need to be worth about $800,000 to generate $26,000 rent. Something simply does not stack up.
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