Dire predictions from doom-sayers, or reality about to bite?

property-market-updateIn a media market that seems to be flooded with dire warnings about the Australian property market where we hear of the potential for housing prices to drop up to 60%, what’s really happening? Den does a bit of research, and chucks his own two cents’ worth in too…

I was recently asked to respond to a letter from one of our listeners who seems to have relocated most of his investments into gold and silver. Dramatic move, maybe, but one that is understandable given all the press about the doom facing both property and share investors for 2012. Europe seems increasingly unstable and Greece (and Portugal, and Spain, and Italy, and Ireland, and…) are about to go under… While I’m not an expert in share investing, or in European economics, I’ve had a fair sniff around to find out the real state of the Australian property market, and to make a prediction for 2012.

According to RP Data’s latest figures, Australian property values softened slightly in December 2011 after rising in November. Overall, however, December’s drops did not wipe out November’s gains. Sydney was the only capital city to record gains in December, and Sydney’s prices have risen 0.7% over the quarter. On the other hand, Melbourne and Brisbane fared poorly (but keep in mind that two years ago Melbourne had a bumper year, and Brisbane spent most of last January under water and is still recovering).

RP Data analyst Tim Lawless suggested that the decline in the housing market was slowing – the December quarter’s decline was the smallest for the year. At the same time, rents are increasing (up 6.3% for the year).

None of this data suggests to me that we’re about to slip into a nose-dive. So what about reports that Australians are over-extended with their income-to-mortgage ratio?

One organisation that produces this kind of “property values versus household income” data is the American-based Demographia. According to Property Observer, Demographia’s most recent findings have some data which is inconsistent with the Australian Bureau of Statistics, suggesting that some of this data might be flawed. Ultimately it depends on whether you would prefer to use census data (I would) or data produced by other means.

Either way, I’m not saying that Australian property isn’t expensive – even with the “corrected” data, Sydney is the world’s 10th most expensive city. Melbourne ranks 24th, along with the pumping metropolises of Telford and Shropshire in the UK. Thinking about the quality of life in most Australian cities, I reckon we’ve got a pretty good deal!

Still no alarm bells here for me… But I’ve heard that in real terms, Australian property is amongst the most expensive property in the world…

In real terms, Australian property values have increased dramatically compared to US values over the past three years. I believe the reasons for this are two-fold and have nothing to do with an impending crash in our markets.

Firstly, we are all aware of the US sub-prime mortgage crash. This was brought about by US banks and US-based mortgages on US property – not Australian mortgages on Australian properties. Our banks, love them or hate them, didn’t get into this kind of crazy lending. This kind of lending artificially inflated house prices by making money available where it shouldn’t have been, and to the wrong people. As soon as the lending was exposed, and the “super-bankers” realised they couldn’t keep inflating property values, prices crashed. They had to. To paraphrase, it was the correction that they had to have.

Secondly, the Australian dollar has increased dramatically in value over the past few years. I remember getting $US0.46 for my Aussie dollar. Yesterday I could have bought $US1.06. More than double. When we compare any prices in Australian to the USA, Australia will have become more expensive without us knowing or even feeling it. This increase in value of the Australian dollar will make Australian property more expensive for overseas investors, thus decreasing the demand slightly (and I mean very slightly) but an Australian, in Australia, earning Australian dollars, won’t really feel this. It just provides data banks with some statistical fodder which makes Australian property look very expensive.

The other major factor I haven’t mentioned yet is housing supply. One of the reasons for Sydney’s strength at the moment is an apparent undersupply of new houses. Government grants seem to be making little impact when it comes to building new dwellings, and that could be because the cost of building is still very expensive. Terry Rider from Hotspotting highlights this by mentioning that ABS statistics show that the average new home costs $70,000 more than an existing dwelling, and in some Brisbane areas this figure is around $120,000. If it costs this much to build, why would you take a $10,000 grant and still suffer a huge loss? Better to buy an existing dwelling and save fifty grand!

People need houses to live in. For house prices to continue a decline, the supply-versus-demand ratio has to increase (i.e. we need lots of houses that nobody wants). If this is going to happen then either people need to move to another place, or we need a massive amount of new housing. It’s unlikely that we’re about to see a massive population shift, so that leaves us with the question of where this new housing is going to come from.

I’ve already said that building materials are still expensive. So are builders. With the costs of building being so high, certain prices need to be obtained for building to be financially viable. If prices are to drop much more, building won’t be viable anymore and therefore the supply of new housing will dry up. Sure, we may still find quite a few apartments (as their cost-to-build is lower) being built, but not so many houses.

Finally, it looks like interest rates are relatively stable here, or even dropping slightly. This has made housing more affordable. Further interest rates may increase affordability more without housing prices dropping.

Looking at all these factors I think it’s extremely unlikely that we’re in for a catastrophic crash in 2012. In fact I think our decline is slowing to a point that it’ll turn around. I’m not saying that we’ll be looking at a bumper year for property investing, but property will hold its own. Value increases between 2% and 5% seem to be reasonable. Of course, some markets will perform better, and others worse, but if we’re going to throw a blanket over the entire country then I’d say modest gains.

RP Data – Sydney’s housing pushes ahead while other markets remain soft
Property Observer – Sydney and Melbourne more affordable than Demographia suggests
Hotspotting – Old is better than new

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