why property prices will/ won't crash

Why Property Prices Won't Crash
Thursday, 26 March 2009 - Melbourne Australia

By Kris Sayce

That's the view of Dr. Anthony Richards, head of the Economic Analysis Department at the Reserve Bank of Australia.

Money Morning reader John wrote this to us yesterday afternoon:

"INTERESTING, BUT WE KNOW YOU CAN MAKE NUMBERS SAY ANYTHING"

That was with his use of capitals and our italics. John was responding to yesterday's Money Morning on the property sector.

Just in case you've missed our comments over the last week or so, to summarise our view:

We think there will be a property price crash.

However, in the interest of balancing the argument, we note Dr. Richards speech to the 4th Annual Housing Congress in Sydney.

To summarise his view:

He doesn't think there will be a property price crash.

Hopefully we'll still be friends despite our disagreement. So, why does Dr. Richards believe everything will remain fine and dandy for Australian house prices?

Let's take a look and see.

For a start, Dr. Richards tells says that a fall in house prices has already happened. And that it has taken place in the high end bracket. As the chart below shows - based on RBA data - prices for the "Most expensive suburbs" have fallen by around 15%. While prices in other suburbs have fallen by a more modest 3%.

The ANZ Property Outlook recently made a similar point. They suggested house prices may fall by another 3% to take the total average price fall from peak to trough of around 6%.

The inference is the RBA doesn't believe house prices will fall significantly further. He went on to explain this further.

One reason given is the improved levels of affordability. As the chart below shows, based ABS, RBA and REIA data, the ratio for dwelling price to income is just above four times. And looking at this chart there's an argument to suggest the ratio will improve further.

Dr. Richards stated:

"The recent sharp improvement in affordability clearly mostly reflects the sharp fall in mortgage interest rates over the past half year."

No arguments there. It's a fact. If you've been on a variable interest rate then your mortgage repayments should be significantly less today than they were twelve months ago.

According to the Housing Affordability statistics shown above, the current ratio of 4 is at the sixteen year average. And we know that in most statistics, things very rarely stay at the average. So we could expect the Housing Affordability ratio to fall even further, perhaps down to three, which is where it was during the mid 1990s.

What else does Dr. Richards have for us? What about non-performing housing loans...

This chart clearly shows that bad loans in the US have sky-rocketed recently, thanks in large part to sub-prime loans, higher fixed interest mortgage rates, and undoubtedly the non-recourse nature of many mortgages in the US.

By comparison bad loans for Australian banks are much lower, only around 0.5%.

This would suggest the greater ability of Australian borrowers to continue paying loans as mortgage interest rates have fallen. Will this continue? Of course that depends on whether interest rates remain low. But if they do - and the odds are favourable for interest rates to remain low until at least the end of this year - it is doubtful that we would see a spike up in the number of bad loans.

Finally there is the point of first home activity and the supply of and demand for housing.

This chart indicates a recent big spike in the number of first home buyer grants...

On top of this Dr. Richards also quotes the estimate for housing demand at around 180,000 to 200,000 dwellings per year, which he says:
"Means we would have needed to build significantly more homes than has actually occurred."
So, what does your editor take away from this, and are we now convinced there won't be a property crash?

First, we remind ourselves of Money Morning reader John's comment: ""INTERESTING, BUT WE KNOW YOU CAN MAKE NUMBERS SAY ANYTHING." "

The main problem we have with the statistics is that they are startlingly similar to the arguments put forward by stock market analysts over the last two years - "that stocks are cheap because based on future earnings forecasts."

Those analysts fell in a hole because they forgot the earnings forecasts were just that - forecasts. Or to use a better word, guesses.

The same argument was used about infrastructure funds that had a "strong asset position." They forgot to look at the liabilities side of the balance sheet that wasn't so strong.

Similarly with most of the statistics quoted by Dr. Richards there is an equally valid argument that they point towards cheaper house prices.

Perhaps housing will become more affordable not because of lower interest rates and higher wages, but because of lower property prices.

And perhaps the spike in first homebuyer grants at a time of record low interest indicates an artificial increase in demand for housing while house prices are still down only 3% from the peak. Is it really possible that so many first homebuyers have suddenly saved $20,000, $40,000 or $60,000 in the last few months to give them extra equity in their new home?

Or have they taken the plunge now whether they are ready or not for fear of the grant not being around in six months or a year's time?

Regardless of whether any of the above views from your editor or Dr. Richards are right or wrong, the main point of the argument is whether the first homebuyers grant and artificially low interest rates are distorting the laws of supply and demand?

Any subsidy in any industry distorts supply and demand. There is little reason to assume that the property sector alone is immune to a 'correction' once the distortions are removed.

Cheers.
Kris.

http://www.moneymorning.com.au/