The Housing Market Once Again

I've long realised that one should not take many 'news' story on housing too seriously. A lot of them involve unashamed real estate industry spruking with either spokespersons for the industry putting them together or lazy journalists taking their line as fact.

I think there are just too many variables to be absolutely sure about where property prices will go in the next year, let alone the next 3, 5 or 10 years. But at the moment things look increasingly sour for property prices.

The most immediate variables are related to housing supply and housing demand. On the supply side: how much new housing is being supplied, do government regulations make it easy to build new houses and so on. On the demand side population growth and the availability of credit are vital factors, but population growth is more complex than many seem to realise.

Basic things such as the amount of people per dwelling is a vital but often forgotten factor.
When things get tougher economically, people in large houses might take on a border or older children might go back to live with their parents. So a rising population might not mean a proportional increase in the demand for housing. One of the big factors behind the property sprukers is the view that immigration will keep the housing market buoyant, but let's be realistic about newly arrived immigrants they are likely to have a higher occupation rate of housing units than other sectors of the population (at least initially and are likely to be renters of low cost properties).

Economy-wide variables are vital as well, starting with overall economic growth and extending to credit expansion and the level indebtedness. Some times the linkages can be difficult to fathom for many punters. Australian property prices will no doubt be linked to Chinese economic growth over the medium term. If Chinese growth falters, it will reduce prices and demand for Australian exports, which will in turn have a negative effect on Australian GDP and especially income. One of the key potential worries is the Chinese property bubble and what its eventual bursting will mean for Chinese growth.

Also vital to understand the housing market is the fact that different sectors of the market are likely to follow different trajectories. This is the case for coastal and inland markets and city and country ones. There are of course also key differences between cities and within cities (inner city, inner suburban, outer suburban, fringes etc).

As I've noted before one of the best writers on housing in Australia is Leith van Onselen who writes for Macro Business, which is a must read super blog for those seeking alternative economic views to the mainstream media.

In a recent post Leith pulls apart the sort of puff piece on property that media organisations love to put together. It should be required reading for all. 

Ponzi Dynamics

Leith van Onselen

An article in Friday’s Australian Financial Review (AFR) entitled “Getting a foot in the door” neatly highlighted the ponzi-like nature of the Australian housing market and the unsustainability of current housing values. Below are some extracts from the article along with some commentary of my own.

It took Lee Palmer two years of trying before he emerged from an auction, but in December he finally got his first house – all 40 square metres of it. The humble one-bedroom terrace in Darlinghurst, Sydney, set him back $641,000.

Actually, once you add $24,900 in stamp duty and transfer fees and deduct the $7000 first home owners’ grant (FHOG), the purchase price rises to $658,900 for the “humble one bedroom terrace”… bargain!

It was a lot of money, but for Palmer it was worth it because he had a foot in the housing market. Now he is on the other side of the fence, where rising prices are in his favour…

In his favour how exactly? Presumably Mr Palmer will want to upgrade to a larger home at some stage. And any rise in valuations across the Sydney property market will only make the upgrade more costly. Not only do stamp duties rise with property values but the monetary difference between his and the next level of home will also likely increase.

“It’s better than paying rent”, Palmer says. “Over the years I have looked at Sydney property it has never really dropped so [I thought] I might as well get in some time”.

“It’s better than paying rent”. Really? A quick Realestate.com.au search of one bedroom rental properties in Darlinghurst turned up the following results:



So Mr Palmer could have rented a one bedroom studio for between $275 and $320 per week or a larger one bedroom place for between $395 and $500. If we assume that Mr Palmer’s home would rent for $500/week, renting would cost him $26,000 a year – representing a gross rental yield of only 4% on the purchase cost. If you compare this rental yield to the current discount variable mortgage rate of 7.1% and add on a bit extra for body corporate fees/rates, maintenance, etc, then the cost of renting in Darlinghurst is likely around one half the cost of owning.
Has Mr Palmer also not heard the phrase: “past performance is no indication of future performance”? Just because Sydney’s prices have risen in the past in no way means that they will continue to rise unabated in the future. One only has to look at housing markets overseas to see that housing values can fall. Beware false axioms.

Property speculation has been a fountain of wealth for decades, and as baby boomers seek to retire and cash in, they are hoping young professionals like Palmer will take the baton. And many are going to great lengths to do just that.

So the baby boomers, who comprise around a quarter of the population and own around half of the housing stock (see here and here), somehow expect that Generation Y (slightly larger in number) will have the ways and means to pay overinflated prices to the boomers as they “cash out”. Good luck with that.

Palmer leveraged his advantage as an employee at a major national bank, which enabled him to get a loan of 95% of the house’s value, without mortgage insurance, and with no fees. It allowed him to bid higher than others with the same finances.

Seriously, if a skilled professional like Mr Palmer has to borrow 95% to purchase a “humble one bedroom terrace”, then how much more upside is left in the housing market? What’s next, young buyers borrowing 100%, 105%, 110%…? Oh well, I’m sure his bank employer is happy to have his business. What better way to tie someone to their job than enslave them in debt.

Others have had to be more resourceful. Like many first-time buyers Lauren Killmister had a little help from her parents. She saved  a 10% deposit and they put in another 10%, enabling her to buy a one-bedroom apartment in Melbourne’s prestigious suburb of Hawthorn. She is living there now to qualify for the first-home owners’ grant, but will move back with her parents as soon as she has it in hand, and rent out her apartment. Maybe she will share house somewhere in a few years.

Does this look like sustainable behaviour to you? Many young buyers are now having to turn to their parents for support and are gaming the FHOG in order to make ends meet. How exactly do the boomers expect Gen Y to “take the baton” when so many are unable to buy on their own?

Janusz Hooker of national franchise LJ Hooker calls the new wave of Gen Y buyers the “folio investors”, building up their portfolios from a young age. “We’ve got lots of cases of this… the older generation is seeing prices will be flat median term, selling out to cash in and the folio investors are jumping in. What they are doing is instead of buying their home and living in it, which they can’t afford, they are buying an investment property because of the tax benefits… They rent it out and hopefully get a large portion of their debt and interest repayments sorted through the rentals”.

So Gen Y can’t afford to live in the homes themselves and are instead choosing to buy-to-let in the hope that the capital gains more than offset any income losses. Sounds like a ponzi scheme to me as the only way these Gen Y buyers can make a profit is if they offload their properties onto other buyers at a higher price (the ‘greater fool’ theory).

Mortgage adviser Catherine Lezer says it is common for parents to help them buy by putting some equity from their own home up as collateral… “Property goes up and rents go up, so the quicker people can get in the better”, she says.

Ah yes, the old “property only goes up” claim. Once again, beware false axioms. Past performance is no indication of future performance.

Plenty of others call it a raw deal, paying such high prices for houses that previous generations bought for a much lower proportion of their income.

Like the 21st speech where the speaker says some nice words after talking 10 minutes of smack about the birthday boy/girl, this is the token bit of the article where the reality is acknowledged. But don’t worry, it doesn’t take long for another industry representative to say everything’s ok:

But Justin Doobov [mortgage broker]… has been hearing the same complaints for years. “Five years ago they said it can’t go up any more, crazy prices, it’s too expensive, but then it went up further… People would prefer to pay their mortgage before they put food on their table”.

Yeah right, I guess they are going to eat dirt then.

“Australia has such a low arrears rate”.

So did Spain, the UK and the US prior to the bursting of their housing bubbles (see the below RBA chart). Ireland, too, had mortgage arrears below 1% before its housing market imploded. Arrears are a trailing indicator, not a predictive indicator.

“There is going to be huge migration and a lot of them are coming with money and they’re buying property. That’s just going to fuel more demand and push up prices”.

That’s funny, I thought immigration was falling (see below RP data chart).



With arguments like those, what could possibly go wrong?

For an alternative view arguing that there is only a possibility of a slow decrease in price rather than any chance of bursting bubble see the very good economic commenator Jessica Irvine.

Shark Attacks

I'm sure most people would think that there are way more shark attacks than these statistics outline ... now for some stats on croc attacks? Notwithstanding the terrible loss for those who know someone who has been taken, you don't have have a very high chance that you'll get taken by a shark given the amount of people who go in the water every year in Australia.

Just a little over one a year ...

More Bad News for Housing?

 

From the ABS. 

Expect lending standards to drop and expect to get more unsolicited credit card offers!

Class Warfare

The rich often accuse the middle classes and the poor of engaging in class warfare, but as Jon Stewart explains the rich seem to be better at it. Maybe because they own most of the tv stations. All I can say is thank 'god' for Stewart and Steven Colbert.

The Daily Show
Tags: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

If you want to try to persuade someone that maybe the US is a little unfair there might not be a better video than this.

House Price Interactive Graphic

The Economist has a new interactive house price graphic ... well worth a look to see how Australia compares and just whose bubble hasn't burst yet!

This is a screen shot of a couple of comparisons ... you can also vary the time period!

Make sure you play with the percentage change graphics (to adjust go to top left hand corner)

And just for fun check this graphic on alcohol consumption

Inequality in the United States

It always amazes me how inequality seems to be 'accepted' by Americans, almost as an essential part of an entrepreneurial or 'can-do' society - an ethos that supposedly drives American prosperity and global dominance. It should be harder to make these arguments in the States now, but this doesn't appear to be the case. Instead it appears that government is getting the blame for the crisis, rather than the real culprit a lack of effective regulation (i.e. government).

It was possible to believe in 2008 and 2009 that the financial crisis would shock Americans into doing something about inequality - the bailouts and then the quick return to obscene bonuses in the financial sector gave hope to those who saw the crisis as a possible catharsis on the road to a more equal society ...

Aaaah no ... what we got is a President who sees no option but to give into the plutocrats and cut government programs that benefit the poor. The real question here is whether Obama's pragmatism is a step on the path to better outcomes or a continuation of a rightward shift that seems to have as it logical conclusion an even more divided America that will make governing even more difficult in coming years.

One wonders whether the widely quoted critic of economic liberalism Karl Polanyi's words from his magnificent Great Transformation apply to the US:

Our thesis is that the idea of a self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society … Inevitably, society took measures to protect itself, but whatever measures it took impaired the self-regulation of the market, disorganized industrial life, and thus endangered society in yet another way.

Polanyi's basic view was that society's need to protect itself from the market was an inevitable reaction to market society. He believed that the world would transform itself in the aftermath of WWII. In a way he was correct, advanced capitalist countries did make changes to governance that extended wealth across societies, even in the US. But in another sense he was wrong as the advanced economies had another great transformation back to market societies.  The question for the US in the 2010s is what sort of political reaction - the measures society takes to protect itself - continuing inequality will induce in the US.

For what it's worth I'm not optimistic that the societal response will produce a more just society in  the US, one just has to consider the rise of Tea Partiers to realise that the reaction is more likely to be a right-wing one than a left-wing distributionalist one. But I have no doubt that unless the US does something about rising inequality then there will be a reaction and a likely target will be globalisation.

Globalisation - particularly open trade - provides an easy target for the disaffected. It's easy to point to China's rise as a manufacturing power and argue that the solution is to restrict Chinese imports, it's easy to blame China for American financial woes, as though it's China's fault for buying so much American debt and forcing Americans to invest unwisely and consume too much.

Whatever the outcome a good place to start is to familiarise yourself with the evidence. Just how unequal is the US? Looking at these stats on US inequality in nice graphic form makes you realise just how bad social outcomes have gotten in the US. 

This graphic above reveals the extent of inequality better than any I've seen. The wealth of the top 0.01 per cent is too big to show as a relative relationship on a graphic!!  This is income remember, which needs to be distinguished from wealth inequality below (income is a flow concept, wealth is a stock concept).

This next one is particularly interesting because it shows what Americans actually think is happening with the distribution of wealth. Given that most (92 %) would prefer a more equal distribution, how does this square up with the seeming 'acceptance' of inequality. The problem probably lies more with arguments about the 'causes' and 'solutions' to the problem. Those on the right often think that poverty is individual in nature, while those on the left think that poverty is structural. The truth like many things probably lies in between - structure provides an environment where moving up the distributional ladder is more difficult (and vice versa). The fact that some people break out through sheer luck, skill and desperation doesn't negate the fact that it is extremely difficult in some societies to rise up the income and wealth ladder.





Now how did these members vote on extending the Bush Tax cuts for the rich? You guessed it they were in favour of it.

Wall Street seemingly on its knees after the financial crisis has returned to mega profit on the back of government support, meanwhile the unemployed suffer from cutbacks to government programs. Households were not bailed out of their decisions to buy houses. it seems if you're gonna make a financial mistake make it a big one, a very big one. Galbraith said years ago that the US provided socialism for the rich and capitalism for the poor.



Tax rates for the rich have come down enormously since the end of WWII. And corporate tax has also declined significantly as a percentage of total taxation, while payroll taxes (effectively a tax on employment) have gone up.



This last one is my favourite because it shows the cost impact of the changes to policy from 1979 to 2005 compared to trends in previous decades.

Now some writers believe that the shift to greater inequality is an inevitable consequence of globalisation, that politics has been forced by economics to adjust in an inequitable direction. The belief that globalisation means that economics has usurped politics is wrong in two ways. Firstly, states and societies can make positive choices about the extent to which they engage with the world economy and the ways that that they distribute the benefits and costs of doing so. Secondly, politics can intervene in negative ways, whether as a result of unsustainable political choices in the first instance, or possibly as an outcome of sheer human or societal malevolence. Globalisation needs to be managed both domestically and internationally and a failure to deal with political problems will lead to economic problems.

The great powers mould the progress of economic interconnection but smaller states also contribute by influencing the larger states and by shaping the impact of globalisation on their societies. A more socially sustainable globalisation would entail spreading the benefits of growth and openness as widely as possible by redistributing wealth and compensating those adversely affected by the continual structural change necessary for adaptation to the world economy. While most countries might have to adjust to the world ‘as it is’, the choice of adjustment strategy is shaped but not determined by the world political economy. Varying responses and outcomes are always possible: both the progress of globalisation and adjustments to its opportunities and constraints involve political choices made by citizens and their governments.

The globalisation debate has been especially important in the Anglo economies. Globalisation has been the dominant story since the end of the Cold War and a predominant narrative about inevitability reinforced its progress. The rapid pace of globalisation since the 1970s has spread the impact of the recent financial and economic crisis across the globe, although politics and luck has meant that the impact of the crisis has varied across countries and, of course, within countries as the above graphics make clear.

There are three major questions for the trajectory of globalisation over the coming years and inequality will play an important role in working out what happens. Firstly, will the major states cooperate to regulate global capitalism, particularly global finance, more effectively? Secondly, will states develop policies that distribute the benefits of globalisation widely across their societies thus maintaining support for dynamic economic integration? And finally, will the developed world see the economic challenge from developing countries through liberal or realist eyes – as an opportunity or a threat? Globalisation as a foreign policy issue will become increasingly important because the major developing states will seek to play a larger role in structuring the rules and regulations of the world economy, while developed states seek to maintain their privileged position. But globalisation as a domestic issue will also become increasingly important as voters seek to blame outsiders for rising inequality rather than the real culprits - their fellow citizens and political system.

Ultimately, globalisation’s future will require domestic support in both liberal democracies and authoritarian regimes. This support will depend on globalisation producing more winners than losers or, at least, on the winners being able to convince the losers that they stand ultimately to benefit from short-term sacrifices to their welfare. Globalisation needs to be able to produce the goods – and the services. A liberal economic policy structure and support for globalisation is not set in stone.

As the next few years will show, the imposition of market-based regulation did not settle regulatory struggles for all time. The art of government will continue to involve trade-offs between economic and political pressures and domestic and international arenas. The possibility remains that coalitions against globalisation and economic liberalism will emerge and that some groups within nation-states will continue to be amenable to protectionist rhetoric and policies.

Thanks to David Schak for showing me the article from Mother Jones

Commodity Prices Keep on Keeping on

Today the Reserve Bank of Australia released the latest Index of Commodity Prices. Not too many graphs (apart from perhaps the terms of trade) reveal so simply why Australia is doing so well at an aggregate level (let's not forget not everyone benefits equally from commodity price rises!!)

Preliminary estimates for February indicate that the index rose by 2.2 per cent (on a monthly average basis) in SDR terms, after rising by 5.3 per cent in January (revised). The largest contributors to the rise in February were increases in the estimated prices of iron ore and coal, reflecting some further adjustment towards the higher contract prices in the March quarter. Increases in the prices of crude oil and wheat also contributed to the rise, while beef & veal prices fell. In Australian dollar terms, the index rose by 1.9 per cent in February.

Over the past year, the index has risen by 48 per cent in SDR terms. Much of this rise has been due to increases in iron ore, coking coal and thermal coal export prices. With the appreciation of the exchange rate over the year, the index rose by 32 per cent in Australian dollar terms.

As indicated in previous releases, preliminary estimates for iron ore, coking coal and thermal coal export prices are being used for recent months, based on market information.

For further details regarding the construction of the index, please refer to ‘Updating the RBA's Index of Commodity Prices’ in the October 2009 issue of the Bulletin.

Banks with too much money?

Robert Gottliebsen writes this morning about how the banks are flush with cash, For me this is a worrying trend because one of the reasons Australian banks did so well during the financial crisis was because they were so tied into lending money for housing that they didn't have much speculative cash to spray around. Remember too that so far the Australian property market boom has not yet busted although it certainly seems to be flattening. 

The banking game has taken a surprise twist. In March 2011 big banks have more money to lend than they ever dreamed of, which is a hidden force behind the banking price war.
Why are banks flush with funds? 

First, last year they lifted deposit rates and attracted a lot of self managed superannuation fund deposit money.

Second, although the $130 billion required by banks from the overseas wholesale markets for the current financial year was high, they met their requirements.

Thirdly, with the Australian economic recovery the banks expected medium sized business to come running through the bank managers’ door looking for loans. Instead the borrowers are absent. 

Gottliebsen goes onto suggest that the business confidence is low, especially in retail, that business is seeking other sources of capital and that some are just plain hostile to the banks excessive margins.

For whatever reason, the borrowers are not coming through the door so the banks have more money than they need. Interestingly one area where there is demand comes from dwelling and dwelling land developers. Yet the banks are still pulling the rug under residential property developers and remain cautious about loaning money for new developments.

The question is how long the banks will remain cautious and where they will go when they start spraying their money around. 

Gottliebsen argues that Wayne Swan should take a good deal of the responsibility.

Meanwhile the extra funding is also an ingredient (not the main one) in the banks mortgage price war.

Treasurer Wayne Swan might be under carbon tax pressure but he must smile every time he reads about the antics of the big four banks. Most analysts laughed at last year’s Swan banking measures but they were cleverly designed to make home mortgage banking a commodity product with much lower margins (Swan will make banks suffer, December 12)

And they are achieving exactly that. NAB might have started the war but the CBA is taking the commoditisation trend a significant step further by making a lower cost commodity product available to all.

It’s important to remember that house financing is very lucrative for the banks because they are able to leverage their housing loans much more than, say, a small to medium business loan. As a result return on equity is high.

And Australia has enjoyed a magnificent housing boom which has virtually eliminated significant bank debts in home mortgages.

The biggest beneficiary from the boom has been the CBA. Not surprisingly the CBA showed that when the NAB challenged it to retain market share. NAB will have to go one step further. In due course they will.

Meanwhile Westpac, which led the bank deposit market with 8 per cent five-year deposit rates at the start of 2010, has cut its five-year rate from 7.2 to 6.8 per cent over the last couple of months. Banks will want depositors to pay for their price wars.

Like most of the 30 per cent of households with a mortgage the banks are hoping that the housing market stays buoyant because so much of their profit comes form home loans. A substantial decline in house prices will make things very interesting for the banks, especially given their abundance of cash.