Australian property prices have weathered the global financial crisis in 2008 and 2009 extremely well and our nation remains the only developed country in the world that avoided a recession during that time. Notwithstanding the GFC, property prices across major capital cities in Australia have defied gravity and surged a whopping 14% over the past 12 months.
The key question is whether this upward trend will continue and be sustainable over the near future? Lets take a look at some issues and key variables.
Source: ABS, AMP Capital Investors
1. Australian property prices
The long term growth rate of real house prices over the last 80 years is 3% per annum, which is consistent with the long term real GDP growth rate. Latest figures show that house prices in general are approximately 29% above their long term average. Therefore, Australian housing are, in general, overvalued and hence deemed relatively expensive. Why is this so? Some plausible explanations include the growth in 2-income families, lower interest rates due to relatively low inflation and greater financial deregulation which has seen easier credit in recent years.
However, it fails to explain why Australian house prices are relatively very high compared to other countries with similar variables (See chart below).
Source: OECD, AMP Capital Investors
My personal view and explanation for this skewed ratio is as follows:
Being an island continent, almost every major Australian capital city is built upon beautiful seascapes, harbour, river or water views. Traditionally, the Australian population has been clustered around these capital cities and the desire among most Australians to live close to these areas have even intensified due to a variety of reasons ~ tradition of being close to the water, scarcity and prestige of water front and properties with water views, growing wealth and affluence. The lack of appropriate infrastructure such as water, transport and other public amenities in rural and regional Australia have also discouraged Australians from moving away from capital cities. It can generally be agreed upon that properties with breath-taking views or even the slightest glimpse of Sydney harbour, Yarra river, Swan river, Indian Ocean, Pacific Ocean, Bass Straits, Tasman Sea, Brisbane river and the list goes on, will command a premium in its price. Added together, the value of all these water front properties compared to a country without such natural beauty and appeal is, well, beyond comparison. However, if you take away the water views that so many Australian properties are predicated upon, you will take away all the fuss and exorbitant prices of Australian property. Coupled with the fact that the strength of the Australian economy has been closely aligned by the rise of China as a superpower in recent years, thanks to what we can extract from beneath the ground, you have a potent cocktail of wealth chasing scarcity. To me, the answer as to why Australian property prices are so high compared to other countries with similar economic variables minus world-class harbour and water views then become fairly obvious.
2. Supply and demand
In recent years, there has been, in general, a severe shortage of housing supply around all major capital cities. Further narrowing down this shortage, it is apparent the shortfall lies in well-located suburbs within these capital cities where Australians prefer to live. Therefore, it is important to not generalize the shortage as being prevalent across Australia as there is certainly good supply if you prefer to live in certain areas more than 40km from major CBDs.
This shortage is reflected in the low vacancy rates of these popular and well located suburbs which have the general characteristics of being close to major CBDs and generally have good public transport and amenities. These suburbs have withstood the test of time, adverse economic factors such as the high interest rate era of the early 1990s, Asian crisis in the late 1990s, dotcom bubble in 2000, September 11 in 2001 and the recent GFC to record strong historical capital growth. The scarcity factor of these suburbs will continue to drive prices in the future. The housing shortage is estimated to reach almost 500,000 dwellings by 2020 if current levels continue.
On the demand side, changing demographics such as the retirement of baby boomers, significant increase in net migration to Australia, aging population, single households and affordability will impact demand levels in different ways.
Points of caution
As current property prices are deemed to be overvalued in general, the downside is that any serious threat to the ability of homeowners and investors in servicing their debt as a result of say a domestic rise in unemployment or interest rates will see a likelihood of a marked fall in property prices. The imminent threat is the current crisis in Europe which is not limited to just Greece. Europe’s 5 basket cases and their respective exposure are:
1. Italy US$1.4 trillion
2. Spain US$1.1 trillion
3. Ireland US$867 billion
4. Portugal US$286 billion
5. Greece US$236 billion
How did these economies incur such huge liabilities over time in the first place? The equation cannot be simpler. Spend > Earn = Debt. Over time, these economies failed to earn sufficient income through revenue and taxes to pay for their debts which were incurred through the issuance of government bonds. It has now come to the stage where bond holders may never be repaid as a result of the inability of these countries to raise sufficient income. This may have dire consequences when investors and funds managers around the world become jittery and stocks are dumped en masse. The ASX saw this first hand when more than A$40 billion was wiped off the market on 17 May 2010. The worse case scenario for Australia is a flow-on effect onto commodity prices and a general slow down in the world economy. Australia can be seen as more fortunate as her economy is now more aligned with those of in Asia.
Evidence of over-spending in Australia
There is little doubt the Australian mining boom of recent years have increased living standards in Australia. However, this has also come at the cost of rising costs of living and the propensity of Australians to spend, have a good time and live for the day and worry later about the future. In 1990, the ratio of household debt to household disposable income was 40% and was at the low end of the OECD countries. It is 155% at present and is at the other end of the OECD spectrum.
The severe shortage of housing supply in favoured locations around major capital cities and the imminent increase in demand due to population growth will continue to support prices. At some stage, the affordability factor will have a dampening effect depending on the location of properties. If employment continues to hold up with strong income growth, then middle to high end properties will continue to grow albeit at more modest levels. My view is that good locations with good access to the CBD and good public amenities within a 15 km radius of major capital cities will see growth anywhere between 4% – 8% as interest rates move back to “more normal” levels. Selected suburbs in the second and third ring radius of capital cities may see growth anywhere between 2% – 8% as they are more affordable and less susceptible to a downturn in the economy. Rents will be strong if housing affordability continues to deteriorate. New migrants to Australia will initially rent and these second tier suburbs may be their starting point to move into more popular locations the property market at a later stage when they find their footing in a new country and environment.