Don Stammer From: The Australian February 16, 2011
Put a low probability on prospects of an impending housing crash that would provide housing bargains of a lifetime
THE housing boom of 2009 and much of last year has cooled. Average house prices have slowed from a gallop to a crawl; auction clearance rates have slumped; and lending for housing, especially for investment housing, has declined. But views on what comes next for house prices are as wide ranging as ever.
Housing bulls emphasise rapid immigration, the generally buoyant economy and supply shortages in construction caused by too few re-zonings and tight credit. They suggest house prices will return to double-digit growth in a year or two.
In my view, the next cyclical upswing in average house prices will take longer to get going, because housing has become unaffordable for many would-be buyers and because some impact from the under-supply of housing is already incorporated in average house prices.
At the other extreme are those who suggest Australian housing is a bubble waiting to burst. They argue that average house prices are too high relative to average incomes, rents, the long-term trend in house prices and/or house prices overseas. The high level of debt and the predominance of variable-rate mortgages leave existing borrowers highly vulnerable to further increases in interest rates.
And they suggest Australia can't expect to defy the harsh adjustments other countries have been through. For example, the US average house price is 30 per cent below its 2006 peak and about where it was in 2003.
As I see things, people who say a housing crash is likely are not allowing for some key features of the housing market in this country. Because we allow negative gearing on investments, including housing, rental yields are low relative to those abroad. Here, housing loans are "full recourse"; borrowers can't simply hand keys back to the bank, default and walk away. Credit standards are generally higher. We don't have an over-supply of spec-built houses. And with Australia so urbanised, average house prices are bound to be higher than prices in most other countries.
The middle-of-the-road view, and the one I find appealing, is that Australian housing is overvalued but not in a bubble. Yes, average house prices seem to have run ahead of influences such as affordability and population growth; and some house buyers, particularly those who borrowed heavily and bought a house late in the boom, would be hurt should interest rates rise markedly. But are we on course for a housing crash -- or an adjustment that is extended and gradual ?
At the end of the 1980s average house prices also seemed overvalued. Despite housing interest rates rising to 17 per cent (presently 7.7 per cent) and unemployment going above 10 per cent (5 per cent), the housing market didn't collapse. For a run of years thereafter, average house prices were fairly flat (even falling a bit if discounted for general inflation); and affordability was re-established through the trend increase in earnings and the cyclical decline in interest rates. There's a good chance we'll see house prices adjust in a similar way.
For people looking for a house to live in, the messages would seem to be these: put a low probability on prospects of an impending housing crash that would provide housing bargains of a lifetime; recognise that a soft housing market gives opportunity to prospective buyers more time to research the suburbs or towns they're interested in; and, given the structure of interest rates, consider taking out a part of the mortgage as a fixed-rate loan as protection against adverse moves in interest rates.
For investors in residential housing, we seem to be at the stage of the investment cycle where, on average, residential property is likely to underperform shares for a while -- just as happened during the 90s and in the middle years of the past decade.
But it's always important to distinguish the phase of the cycle we're in from the longer-term trend. As Shane Oliver of AMP Capital Investors, puts it: "Over the long term, the returns from housing and shares tend to cycle around each other at similar levels . . . While housing is less volatile than shares and for many seems safer, it offers a lower level of liquidity and diversification. The bottom line is, once the similar returns of housing and shares are allowed for, and these characteristics are traded off, there is a case for both in investors' portfolios over the long term."
Don Stammer chairs Praemium and the advisory council of FIIG Securities, and is an adviser to the Third Link Growth Fund. The views expressed are his alone.
