australia's unique property bubble

Australia doesn't have the explosive ingredients that will cause a US style crash. Australia's housing bubble is more sustainable and will collapse in its own unique way!

The US had two important ingredients missing in Australia, sub prime and government demand for CDO's. Australia does have sub prime loans (low doc loans) however they don't include teaser rates. Australia doesn't have Fanny May and Freddy Mac buying CDO's.

The sub prime teaser rates created a class of mortgagees who would default after a few years when the rates reset.

The government backed entities Fanny and Freddy created an almost unlimited demand for CDO's. With cheap money from the fed, the fire triangle was complete and the US housing industry was consumed by an unstoppable fire storm.

Complete one hour presentation from a US economist in Nov 2006 explaining the collapse of the US housing industry:
http://www.youtube.com/watch?v=jj8rMwdQf6k

Also, unlike the US, nearly all mortgages in Australia are floating and not fixed rate. The reserve bank can cut interest rates over night and this cut is passed onto almost every mortgage holder (including low doc loans) in Australia.

So all combined Australia's housing bubble is more sustainable and can keep growing for longer.

Currently in Australia, houses remain on the market for an average of 2 months. In the US, it wasn't until the average reached over 6 months that the market collapsed.

I think the price decline right now in Australia is simply the result of a drop in demand because today's demand was brought forward in previous years with the government's grants and tax concessions. Thus, today's demand was in fact realized 1-2 years ago.

Every article about prices concludes prices will remain flat for at least a few more months. This is exactly what happened at the peak of the US market. As more houses came onto the market and remained unsold the number of houses available to buy grew until sellers started to reduce their prices. This created the 'top' of the market. The 'top' lasted a good 12 months.

Based on the US experience, right now could easily be the top of the AU market. A drop in Australian property prices will bring prices back to the long term trend price. Not exactly a shock, prices rise and fall whilst maintaining a long term trend!!!

http://www.aireview.com.au/images/dynamic/20101125/graph04.jpg

The 'National Housing Supply Council' thinks prices will remain stable and above the long term trend. This idea is simply bizarre when you consider the most basic facts of 100 years of economic history in Australia and around the world!!! Prices have never ever stayed the same. They go up and they go down.

http://theage.domain.com.au/home-investor-centre/a-decade-of-flat-property-prices-ahead-20110520-1ew2n.html

Australian house prices have been bid up relative to incomes with govt investment programs like 'negative gearing'. House prices have risen relative to income. Household debt has risen relative to income.

http://www.aireview.com.au/images/dynamic/20081114/graph01_141108.gif

This basically means many households in Australia have based their future net wealth v.s. debt obligations on what other Australian's will pay them in the future to trade houses! Talk about the faithful!!!!!!!!!! Aussies are so faithful about future prices paid to trade houses they have built a bigger empire of debt than the yanks!!

http://www.smartcompany.com.au/images/stories/Features/household-debt-to-gpd.gif

The unique aspect to Australia's housing bubble that will bring it down, in my opinion, is a drop in foreign student rental demand!

Today, education services are Australia's third largest export behind Coal and Iron Ore. This export success is due to a number of factors; a growing middle class in Asia, more Asian airports with airlines flying direct, low value Aussie dollar to other western currencies, similar geographical time zone and technology (skype, facebook) helping student's stay in touch with friends and family at home.

Australia's share of the international student market is disproportionately high by international standards. Today Australian universities have over 15% foreign students. American Universities have less than 4% foreign students.

I think this education export boom is the main driver behind rents in Australia?s capital cities rising. The small, isolated, far away cities of Sydney and Melbourne are now amongst the worlds most expensive for residential property!

House prices since 2000: http://tiny.cc/oepem

In 2005 instead of prices declining, the empty investor properties filled with foreign students. The increased foreign rental demand was so high investors continued buying existing houses. Despite the ever increasing supply of investor rental properties; rents have increased with booming foreign student demand.

I think the boom in education exports for Australia is ending because of the increasing value of the Aussie dollar over other western currencies, especially the US dollar. Unlike natural resources and agricultural products, Asians can buy their University educations from someone else!

http://www.theage.com.au/national/education/foreign-students-in-retreat-20101013-16k03.html

At the end of this year and the start of next year, when the current decline in foreign student numbers materialises in lowering rental demand in Melb, Syd and Bris, I think investor sentiment will change and rental investors will start selling. When middle class property tycoons start selling, look out below.

The reason investors will sell due to falling rental income is rather simple. These people want $30K a year in rental loss to off-set their income tax. When the mortgage loss increases to $35K they realise buying a depreciating asset on leverage is not the way to build wealth and so they all start selling at the same time. The bubble bursts!

Time lag between foreign student enrollments and rental demand:

In 2010 foreign student enrolments declined for the first time. This means the number of first year foreign students in 2011 was down. The first year of an Australian university course is studied at an affiliate university in China or Singapore or Hong Kong and so on. The second year of a course is the first year the student travels to Australia. So the enrollment decline which started in 2010 doesn?t result in less people until 2012.