Lord E, Congrats on one of the most well mannered threads on HC I have read for a while. You have kept it under control well. Okay, you have put out the challenge and I am always up for a challenge. Background: I’m not a property investor as I prefer the liquidity of shares.
How to tackle the question? Initially I thought I should identify the three major drivers of the property boom (yes I gave this 2 minutes thought and only came up with three) to see if these will be unwound causing a property price decline. First driver: tax cuts. These led to increased disposable income and thus an increased capacity to borrow (people need to stop comparing property price growth with wages growth. The comparison is with disposable income and thus capacity to repay). Are tax increases likely? No. In fact tax cuts are coming. Definitely not the answer.
Second driver: First home owners grant. Same economic impact as an interest rate cut for first home owners and thus stimulated demand. Problem is no Government will have the nerve to remove it even though it was lousy policy.
Third driver: Cheap credit. It’s already been unwound via numerous rate increases. Looks promising. However, defaults are low as already indicated and rates are either at their peak or very near. Falling property prices are bad for banks and the Reserve Bank is not going to sit back and watch property prices start falling in the current credit crunch environment. RB also has much more scope to move on rate cuts and has far higher reserve capacity than the Feds in USA right now. Okay, this isn’t an answer. Not doing very well am I.
Okay, then I thought what external shocks could I think of that were going to wipe property of the earth (did I say that?). Chicken flue and a dirty bomb terrorist attack. Didn’t really think that was fair though given they are not property market specific and will take out all asset classes, not just property. The only external shock that I can put up credibly is the current subprime crisis in USA and its capacity to worsen and spread further thru the world. We do not know for certain that Aust/China is delinked from USA and even if it is, we do not know the strength of that delinkage (its never been tested). If you are fair, you cannot discount that scenario with 100% certainty. However, it still fails the test in that it is not property market specific. It will take out all asset classes. Shoot me dead, I’m not doing very well at all.
Okay, if it’s not the unwinding of past drivers and its not exogenous (ie external) shocks, then what about endogenous (ie internal) impacts. There are only two endogenous impacts that I could credibly foresee. The first is if there is a change in Government policy that recognises that the housing crisis (for some) and the transportation/congestion problems in our cities are linked. IMO, you address housing not by reactive policies like the home owners grant but rather by long term solutions that are based around a regional development policy. You basically have to get business out of the cities (I would suggest a CBD commercial property tax) and people will follow the businesses into the suburbs and surrounding regions where land can be opened up and infrastructure built. But I think you have already accepted this idea and rightly pointed out there is no such policy initiative on the horizon. If mums and dads ceased bequeathing their assets to their children that could also have an impact, but it is not even a remote short term likely outcome.
My second and last (yes I had to save the best for last) possible explanation relates to the self fulfilling nature of price expectations. If enough people expect property prices to fall then it becomes self fulfilling – they will fall ie the expectation is realised. So the question is do enough people expect property prices to fall such that they will? The answer is not yet. It is too early in the cycle (prices are still near the peak in many centres) for that to happen. However, I think you could credibly create a scenario that property price growth will slow and flatten (credit squeeze, interest rate increases have been overdone and destroyed consumer confidence and over did it on the reduction in price expectations). It is from that part of the price cycle that a different perspective re negative prices might arise. Remember, negative gearing property is no different to operating a margin loan. They are both lousy products in a flat or even slightly rising market. If prices flatten long enough, investors might begin to unwind their positions (before someone else does) and you develop an environment of self fulfilling expectations.
How did I do? I failed. But only because someone has called big time negative way too early in the price cycle, because you have already accepted the credibility of a change in government policy and because a 40% decline is going to take a long long long time to develop (if it does at all).
My expectation for property. Nominal (ie advertised) price growth will slow and eventually flatten. Price expectations have taken a hit from a range of factors. Price growth will stay flat for several years, leading to moderately falling real prices. Affordability will recover and a new sustainable equilibrium formed before the next price expansion/bubble. Negative 40% - very very low probability, but not totally implausible if expectations become self-fulfilling.
Hopefully, some (and I said some so give me a break!!!) of the younger generation will also get over their sense of entitlement. Just because mum and dad live in a big house, close to the CBD, with all the goodies – does not mean they are automatically entitled to it as well. Mum and dad typically acquired their assets over a life time of saving and this will be the same for most of the younger generation as well. It’s just that things are stacked up against them right now. But that will change given enough time.
To pre-empt criticisms: I accept a flat market will have pockets of value in property just as would happen in shares. Just more caution needed.
