Traditionally house prices in Australia have equated to approximately five times average weekly ordinary times earnings (AWOTE) as published by the Australian Bureau of Statistics.
Currently house prices are anywhere from six to nine times AWOTE (depending on which city you look at).
The real estate listings in Australia are littered with houses that cost $1 million+ and we are not really talking about prime properties here. Very average houses that happen to be reasonably close to a city centre now command sale prices of $1 million+.
Those who have a vested interest in absurdly high property prices will come out with all sorts of nonsense to justify the prices being paid: limited supply, zoning restrictions, immigration etc.
The truth however (as always) has got to do with interest rates – cheap credit, similar to the cheap credit that was available in many other countries prior to the collapse of their housing markets.
The seeds of the housing bubble (as in the US) were sown after the dot com crash when the Reserve Bank of Australia (RBA) foolishly followed the US Federal Reserve in lowering interest rates to artificially low levels.
The fact that Australia had very few dot com companies, that the Australian share market declined by nowhere near what the US market did in that period and that Australia was not about to have a recession (like the US did) seemed to have been lost on the RBA.
The top officials at the RBA are paid a fortune in comparison to their US counterparts and yet they get it wrong as often as they get it right.
When people can borrow very cheaply, what do you think they are going to do? It’s not a trick question.
They are going to borrow more than they previously could have which then allows them to pay more for housing. There is of course no free lunch – house prices increase in proportion to the availability of credit. As Buffett famously said, when everyone watching a passing parade decides to stand on their tip toes, no one gets a better view.
As the Australian banks source approximately 40% of the funds they lend offshore, there is always the risk that they will at some stage be forced to act independently of the RBA in raising mortgage rates (as they have already done on a few notable occasions).
The RBA and many politicians will protest vehemently about that but it’s precisely their policies that have caused the problem: The RBA for keeping rates at artificially low levels for a prolonged period causing a borrowing binge and successive Australian Governments for discouraging savings through punitive tax policies, while at the same time encouraging speculation in the housing market by allowing ludicrous practices such as “negative gearing”.
This offshore funding dependence is why Moody’s recently downgraded the credit ratings of the big four Australian banks.
There are only two things than can happen to Australian house prices, they can collapse dramatically like they have done in the US, the UK, Ireland and Spain or they can go through a prolonged period (perhaps 10 years) of practically no price appreciation. I would favour the latter, but no one can rule out a price collapse.
What is absolutely clear to me is than anyone buying a house today in Australia (who doesn’t have to buy one) is not investing – they are taking a gamble for which they are more likely than not to pay dearly for down the track.
Yes, it’s not conventional wisdom, I know, but I’ve made a lot of money ignoring conventional wisdom (or what some fool at the Housing Industry Association is telling another fool in the media).
It is somewhat amusing to see people (who understand nothing of financial mathematics) who think that house prices can keep doubling every 7-8 years (as they have done in Australia over the past 7-8 years). This is simply not possible over long periods of time because the point will be reached where practically no one can afford a house – and that won’t happen, prices will correct before that point is reached.
No one can be certain when this party will come to an end and it might very well end with a whimper rather than a bang, but end it will.
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