Tuesday, January 21, 2014

A New Sustainable Housing Boom?

Bank lending is on the increase again and the housing market is back in boom territory. My prediction  last year was that the housing market would boom and then crash. The question is how long this play will take to work itself out. Too long a delay means the prediction is almost worthless. My guess is that the boom will continue over most of 2014 before crashing in 2015 as the economy tanks due to declining demand from China and the difficulty of increasing credit as a percentage of disposable income.

From the RBA:

The renewed boom has been associated with increasing concerns about housing affordability for younger buyers. According to a report in The Australian, the wealthy account for a growing percentage of housing stock, with "the top 20 per cent of income earners owning 36 per cent of Australian homes".

Another question is whether increased home lending is 'crowding out' business lending. To answer this we would need to understand whether the problem is one of supply (the banks) or demand (small business). I'm guessing that if banks can make easy money lending for houses it decreases their willingness to lend to risky small business.

One simple solution that would help affordability and possible crowding out: get rid of negative gearing.

From Leith van Onselen at Macro Business:

While it is clear that the mining boom has ended, my conjecture is that a new housing boom is unlikely to have long legs. This view is reinforced by the high levels of household debt as a percentage of disposable income.  One possible mitigating factor could be foreign purchases of Australian houses. Although there are restrictions on foreigners buying houses in Australia, these seem to be regularly bypassed by foreign investors through a variety of means. According to Martin North:
One factor which is driving the residential property market, especially in the major centres of Sydney, Melbourne and Perth is a rise in overseas purchasers. They may be Australian residents, overseas purchasers buying property for investment through an approved development, or locals acting for overseas purchasers, who are attracted by the sustained house price growth and relative economic stability. China is often identified as a major source for potential purchasers.
The ratio of debt to income increased enormously over the 1990s and 2000s and it is hard to imagine it repeating these increases over the next 10 years. A similar level of growth would see household debt to income increase to well over 200 per cent. (Such a ratio is possible, however, as The Netherlands shows, but it does set a country up for an inevitable rebalance as debt becomes unsustainable.)

Australia has benefited from a virtuous circle as the credit boom interacted with the mining boom. This is likely to turn into a vicious circle over coming years as commodity prices, particularly iron ore prices, decline over coming years.

Australia has been lucky in the timing of various booms - credit, consumption, housing and mining - over the past 10-15 years and who knows what new factor could intervene to damn all predictions and continue the luck.

The major factor affecting Australia given our growing export dependence will be the trajectory and form of Chinese growth. A less investment intensive Chinese growth model will lead to lower demand for resources and have negative effects on Australia.

The left field factor that I think will be very important over coming years is the fossil fuel revolution that has already had significant impact in the United States, putting it on the path to energy independence.

Rising prices and new technologies have made previously economically nonviable sources of supply viable. These technologies will eventually have an impact throughout the world, lessening the prices Australia receives for gas. Increased demand increases prices, which in turn increases supply, which eventually leads to lower prices. We are approaching this stage for many of our key resources. What Australia needs is continuing and sustained demand to balance lower prices with increased export volumes.  Over the longer term, lower prices mean that further supply is less viable and the cycle begins again. However, given the sustained nature of this commodity super cycle and the massive increase in supply it has encouraged, it is likely that it will be a while before there is a new investment boom, especially given Australia's status a high cost country.

While it might seem a long shot to connect these factors to the housing market, lower prices for Australian resources, particularly gas, could lower Australian incomes and expose high levels of indebtedness.

The saving grace for households (as the chart above shows) has been low interest rates leading to a lower ratio of interest paid to disposable income. Given the low level of inflation and the uncertain prospects for the world and Australian economies, low interest rates are likely to continue for a while.

The major reason for the absence of a crash in the Australian property market has been the simple fact that we've avoided a recession and thus avoided the development of a negative spiral where increasing unemployment leads to declining demand and increased difficulty in households meeting debt repayments, which leads to further declines in spending and further declines in demand. And so on.

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