The mad, mad world of the Australian housing market

Some time ago, Adam Schwab wrote an article for Crikey.com titled: “The property market is completely bonkers and so are you to buy into it”. In this article, Adam relates the following story:

On the weekend I popped around the corner to see an auction of a nicely kept property in Albert Park, Melbourne. The three-bedroom, one-bathroom residence had some nice touches (wine cellar, cinema room, garage stacker) but was relatively small and in a second-tier street. Half an hour later the property had been knocked down for $3.755 million. The buyer was a cocky-looking 35-year-old with slightly bleached hair — he looked more in place shopping for surfboards than multimillion-dollar inner-suburban properties. Such is the state of the current property market, after the hammer went down, the couple next to me were congratulating the buyer on his purchase. “Good on him,” they quietly noted.

It is truly a bizarre situation when a 35-year-old can pay 50 times the annual rental for a property and be congratulated by onlookers for his foresight.

I couldn’t agree more. The story is crazy, but this is what is being played out all over the country.

Late last year, the Australian Financial Review featured a story on a house in Rose Street, Chatswood (pictured at the top of this article). This house sold for $3.91 million ($1 million above its reserve price), and to be honest, it looks like it belongs in a shanty town somewhere.

It should go without saying that this house is not worth anything remotely near $3.9 million. Oh, and please note that the buyer of this decrepit property had to pay approximately $200,000 in stamp duty (on top of the purchase price) to the government, making the actual cost of the property about $4.1 million!

The two stories above are symptomatic of the enormous bubble that has formed in the Australian housing market, but more specifically, the housing markets of Sydney and Melbourne.

There are a number of reasons for the situation we find ourselves in:

• The Reserve Bank of Australia (RBA) sustaining rates at artificially low levels for far too long and for no good reason and without any tangible improvement in the economy;

•  Negative gearing; and

• Allowing non-citizens (large numbers of mainly Chinese) to purchase Australian property which has simply exacerbated an already existing problem.

But, as I have written on this site previously, the overwhelming reason is at dot point one above. The RBA under Glenn Stevens acted in an insane fashion and eventually, Philip Lowe (the current Governor) is going to have the unfortunate task of attempting to deal with the fall out.

Australia now has $1.6 trillion in mortgage debt which is around 100% of the country’s GDP (a figure which is simply not sustainable). To put this in perspective, this figure was approximately 15% of GDP 40 years ago and about 58% of GDP 15 years ago. 

What is even scarier is the fact that much of this lending has been subject to interest only terms (for set periods). This means that when these periods end, we have the potential to see default rates rise quite significantly.

Back in 2011, I said on this site that:

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.

In 2011, prices were still at a level where a price collapse could be averted, however, six years later, they have escalated to levels that make a price collapse more likely than not.

The Australian banks are also funding about half their mortgage books from offshore, making them very vulnerable to any changes in those markets. As I wrote last year:

Our banks are heavily dependent on foreign borrowings to finance their mortgage books and with the increase in foreign bond rates in recent times, the banks are going to start having to lift rates independent of the RBA in order to continue a viable existence. 

This has already started to happen.

So the question is, how do you “play” this situation?

Here are some things I would suggest:

•  Limit your exposure to Australian banking stocks (my exposure is currently 2.5% of my net worth and that may go to zero - with bank stocks going up recently, I have taken the opportunity to sell call options over about half my holdings);

• Take a good look at your super fund. If your fund invests largely in Australian shares and hugs the index, you are likely to have a large exposure to Australian banks, you may want to take steps to change this;

• For those who don’t already have it, avoid (as far as possible) any direct (or indirect) investment in Australian residential property;

• If you have a mortgage, pay off as much of it as possible while rates remain at insanely low levels;

• Ignore stories about “ordinary” people with multi-million dollar property portfolios. These people are involved in a pyramid scheme that only has one ending – bankruptcy;

• The time is coming where there may be opportunities to short banks and then later the companies that rely on booming housing markets like Harvey Norman, JB Hi fi and others. This of course is always very tricky and caution should be exercised. I haven’t myself done this yet, but I’m watching and waiting;

• Putting some of your funds in “hard” currencies like the $US (or gold) is something you may want to consider. I keep a proportion (albeit small) of my liquid investments in $US.

Don’t be fooled by the recent strong performance of the major banks. There is absolutely no rational reason why they should be rising like they have.

This rise commenced very shortly after Donald Trump’s election as US President. However, while Trump’s policies may end up assisting US banks, they are not in any way, shape or form going to assist Australian banks. 

The banking environment in the US is very different to what is currently the situation in Australia, but we have so many idiots operating in the Australian market who simply “ape” whatever happens in the US, as if their brains had been removed from their heads.

I believe that Australian bank performance can only go downhill from here (although their share prices may keep rising for a while).

I hope all of what I have said above turns out to be false, but I feel the clock is at two minutes to midnight and when it strikes 12, many will be turned into pumpkins and mice.