How Scared Of A House Price Crash Should You Be?

By Peter Switzer, Switzer Super Report

Recently a subscriber was put out that I made reference to Australian house prices going higher. He thinks I have ignored that it has been a Sydney, and to a lesser extent, a Melbourne thing and as a consequence he pondered the usefulness of my report.

The facts

As a consequence I thought I’d do a special look at property, price movements and the outlook to try to work out if we should be afraid of a housing bubble.

The chart below looks at property prices since 1997 for a range of countries and what it shows is that we are always an outperformer. The Brits have done OK, but since 2012 or so we have gapped a lot of countries. Still, you will see, they have all experienced nice rises in prices and you can thank historically low interest rates.

 

[FNArena apologises for the size of this graph but unfortunately publication is limited by the source file]

Why have we done so well? Well, low interest rates are a big reason and I think we avoided a GFC recession, meaning we went into the post-GFC era without excessive negativity compared to other similar countries. We also love property and we have to pay our loans back, unlike a lot of Yanks, and so the price rises and the banks willingness to make it happen helps to explain our recent price story.

However, it has been an uneven story.

Sydney, where the biggest worry about a crash exists, really did badly for 10 years and so this is catch up time. This chart tells that story.

 

See, Sydney went 10 years with an annual average 2.5% increase, while Perth and Darwin were over 8% and did we hear house-price-crash talk then?

In fact, if you go back to my first chart note how house prices do backtrack but don’t wipe out previous gains by all that much before turning around and growing some more.

In January Fitch Ratings forecasted a 4% rise in Australian residential house prices compared to the 7% rise last year. Its 2015 Global Housing and Mortgage Outlook report found our homes are the third most expensive of the 22 countries it looks at on the level of prices compared with rents and also compared with incomes.

They explained it this way: “With almost 25 years of continuous GDP growth, record low rates and stable unemployment, Fitch expects Australian prices to remain high and affordability likely to slightly worsen in the near term before levelling off as it reaches an affordability ceiling.”

Fitch also pointed to the fact that we have the highest level of mortgage prepayments, giving many borrowers a buffer if interest rates start to rise. This is a good potential protection against a crash.

What’s going on?

Looking at recent developments and the CoreLogic RP Data Home Value Index, shows that prices rose 3% in March in Sydney, with a 5.8% quarterly rise and nearly 14% over the past year. That’s hot and now many experts agree with me that Sydney will keep rising, but at a slower rate as prices go too high for incomes out of which repayments are made.

“It’s an unexpectedly high rate of growth and I’d be quite surprised if that rate of growth was sustained,” said CoreLogic head of research Tim Lawless.

The average capital city home price rise was 9% over the past year to May and was up 1.3% over the May quarter.

So other capital cities are rising but at a slower rate and it makes me think a city like Brisbane, that has an economy that is picking up, looks poised to do OK in coming years.

Looking at the price movements peak to peak, CoreLogic says Sydney prices are almost a third higher than the previous market peak but this has happened before and it then went 10 years growing at 2.5% while Perth was at 8.4% and Brisbane 4.6%.

Melbourne is only 9.5% above their prior highs, while Perth, Canberra and Adelaide are only just higher, and Brisbane is off 2.9% against its best reading and Darwin is off 5.0% but it was on steroid-like growth for ages. Hobart is down 9.2% but seems to be on the improve.

A tale of many cities

And that’s the point, Sydney is good today but in one or two years time it will go off the boil and better value cities, such as Brisbane, will rise faster. However, remember even within cities the price rises vary greatly, with Melbourne suburbs close to the CBD booming while outer suburb price growth is more subdued.

Interestingly, the latest home price reading for May capital city home prices fell by 0.9% in May. Dwelling prices fell in six of the eight capital cities in May and even Sydney was down 0.7% and Melbourne off 1.7%.

This is not good news for all of those bubble boys in the media who are exaggerating how dangerous the Sydney house price boom is. I guess if Sydney’s price accelerates this year the boom could turn into a bust, but the real pin-prick threat to any bubble or big boom would come from a recession here which would push up unemployment.

I can’t see that happening so bubble talk looks to be outlandish. I’m not saying an investor who paid $2 million for a Sydney apartment this year might find they can’t get that figure in three years time but in ten years time I’d bet it would be heading close to $4 million!

Why? If a suburb average makes a 7% gain per annum, and there are suburbs in Sydney where that happens, then the rule of 72, where you divide 7% into 72 and you get about 10, tells you your investment should double in 10 years.  These are generalities but you get the idea.

By the way, here’s another reason why I think Sydney and Melbourne prices will ease up. CommSec’s Craig James recently reported that “In the next 12-18 months a record amount of new dwellings will come onto the market, serving to restrain growth of established home prices. Sydney and Melbourne home prices are hot now, but it may be a different question in 2016.”

One final point — have a look at this chart from the Housing Industry Association (HIA), which says if you adjust for inflation the rises, especially for Sydney, aren’t as scary.

 

Selective memories

The worries have been Melbourne, Perth and Darwin over a 10-year period but where were the bubble worrywarts then? Sydney has done well over five years but it’s 10-year growth only beats Adelaide by 4.4%!

And by the way, this is what the HIA says about the Sydney prices compared to Sydneysiders’ income: “When looking at the price to income ratio, or the ratio of median dwelling prices to average annual earnings, you need more than seven years income to buy a home in Sydney.

It also revealed: “The price to earnings ratio is at a record high for Sydney, although it is at a similar level to a decade ago, with the price to earnings ratio at 7.34 in February 2005. Nationally, the ratio has increased from 5.17 to 5.43 over the past ten years.”

Where was the bubble talk for Sydney 10 years ago? My answer is that 10 years ago, business journalists were more responsible because their newspapers weren’t battling for survival and no one went to the Internet for credible information.

To my annoyed subscriber, I hope you can see that I don’t have Sydney-coloured glasses when it comes to property. It sure is the big story today, as were Perth and Darwin during the mining boom, but as the Brisbane economy bounces back on a lower dollar and interest rates, I’m betting its home prices will respond.

And if you want a tip, my colleague on Sky Margaret Lomas, who is a property-searching expert, likes places like Logan in Brisbane but I will get her to update her favourite suburbs and towns in the not too distant future for my report.

So, how scared of a house price crash should you be? Not very. And if you are an investor make sure you buy property that tenants will always want to live in!

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

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