Australian property prices appear to be over-inflated, and this may constitute a housing bubble. Many observers note that property values are inflated when compared to long-term trends, when compared to most other developed countries, when compared to rental yields, and when compared to average wages. This suggests that a substantial fall in prices is very likely.
Australian Property Market
The Australian real estate market has shown continuous average price increases of around 3% per year since the 1970s. Since the 1990s however, prices have risen by around 6% per year. In the late 2000s, house prices in Australia, relative to average incomes, were among the highest in the world, prompting speculation that the country was experiencing a property bubble, like many other countries.
Rising Home Prices
All capital cities, apart from Sydney, exhibited strong price increases since about 1998. Sydney property prices increased from $573,000 to $671,500 (+17%) between 2003 and 2010 while other capitals doubled in price since 2003.
The 'Housing Affordability in Australia - A good house is hard to find' report stated that "the average house price in the capital cities is now equivalent to over seven years of average earnings; up from three in the 1950s to the early 1980s." Some factors that may have contributed to the increase in prices are:
Loosening of credit standards (Loan to Value Ratios LVR of 95% still available) Low interest rates from 2008 onwards (increasing borrowing capacity) Limited government release of new land (reducing supply) A tax system that favors investors and existing home owners. Limited stock - there appear to be lower levels of existing property sales in 2009/2010 as compared to previous years, reducing supply. High population growth (now about double the world average - see Population growth rates chart). 2008 foreign investment rule changes for temporary visa holders Unregulated property investment seminars promoting the purchase of investment properties Speculative demand for housing due to a public perception of real estate as a sure bet.
These factors are stated to have increased property prices in Australia. Any one of these factors in isolation would be unable to provide the framework for the asset inflation now evident.
Influence of Tax System
Australia has a high growth rate strategy at 2.1% population growth.
Investors using their superannuation have a tax advantage compared to 'savers' who are effectively taxed up to 70% on income from bank interest or bonds.
The Reserve bank of Australia has noted that there are "a number of areas in which the taxation treatment in Australia is more favorable to investors than is the case in other countries."
Land Price Inflation, CPI and Interest Rates
Total household debt as a percentage of disposable income was about 45% in 1990 and 155% in 2009. In the same period, housing debt to disposable income increased from about 35% to 140%. During the same period of time the CPI increased by 62.7%
The increase in debt was related to the easing of lending standards, the absence of capital gains tax on principal residences, Capital Gains Tax discount (50%) on investment properties after 1999, negative gearing availability for second-hand homes, the First Home Buyers Grant and increase in household incomes.
Some of these factors added especially to the borrowing power of investors. Debt growth averaged 15% per year compounding (1998–2009). During the same period national economic growth was less than 3% with debt stripped out.
Between 1998 and 2008 inflation was about 36% and property prices increased by more than 300% in all capital cities except Melbourne (up 280%) and Sydney (up 180%).
Foreign Investment in Residential Property
In December 2008, the federal government introduced legislation relaxing rules for foreign buyers of Australian property. According to FIRB (Foreign Investment Review Board) data released in August 2009, foreign investment in Australian real estate had increased by more than 30% year to date. One agent said that "overseas investors buy them to land bank, not to rent them out. The houses just sit vacant because they are after capital growth."
In April 2010, the government announced amendments to policies to "ensure that foreign non-residents can only invest in Australian real estate if that investment adds to the housing stock, and that investments by temporary residents in established properties are only for their use whilst they live in Australia."
Under the rules, temporary residents and foreign students will be:
Screened by the Foreign Investment Review Board to determine if they will be allowed to buy a property. Forced to sell property when they leave Australia. Punished if they do not sell by a government-ordered sale plus confiscation of any capital gain. Required to build on vacant land within two years of purchase to stop "land banking".
Failure to do this would also lead to a government-ordered sale.
Surveys and Popular Commentary
Several surveys and popular commentaries have suggested that the Australian housing market is severely overvalued.
The Economist (21 Oct 2010) found that Australian house prices were overvalued by 63.2%, stating that "Our analysis of 'fair value' in housing, which is based on comparing the current ratio of house prices to rents with its long-run average, suggests that China has less to worry about than the likes of Australia, which is again the most overvalued of the markets we track. That makes it all the more surprising that Australia’s central bank opted not to increase its benchmark interest rate this month."
An earlier study by The Economist had found that Australian property was "the most overvalued of any of the 20 countries we track."
The Australian newspaper reported in May 2010 that house prices had "soared 20 per cent in the 12 months to March"
The Head of Financial Stability at the Reserve Bank of Australia has said that "If rental yields are very low, investors are buying properties without really thinking about the rental yield" and that "Buying an asset just because you are expecting the price to rise in the future, well that is actually the academic definition of a bubble."
Australia topped the 2011 '7th Annual Demographia International Housing Affordability Survey' for the second year in a row with the most severely unaffordable property market in the world. The survey was based on a correlation of median house price divided by gross annual median household income.
According to the Australia’s Institute of Public Affairs, the most recent Demographia study (2011) "demonstrated that government planning restraints creating a scarcity of housing land were the overwhelming cause of Australia's high prices... Self-proclaimed housing experts have denied that high housing prices in Australia result from our planning and regulatory system"
The Demographia survey compares Australia with five other countries and uses house price to gross income as the key measure. Other important factors such as discretionary income, credit availability, tax incentives, comparative dwelling size/quality are not taken into account. Some surveys that take these factors into account place Australian cities as being more affordable than the Demographia survey.
Government inquiries related to housing
In 2002 the government initiated a Productivity Commission Inquiry Report titled 'First Home Ownership'. The report observed that "general taxation arrangements [capital gains tax, negative gearing, capital works deductions and depreciation provisions] have lent impetus to the recent surge in investment in rental housing and consequent house price increases."
The government's response to the report stated that "There is no conclusive evidence that the tax system has had a significant impact on house prices."
In 2008, another study was commissioned – the 2008 Senate Select Committee on Housing Affordability in Australia. The report noted that "On some measures, housing affordability is at a record low."
'Australia's Future Tax System' review, more commonly known as the 'Henry Tax Review', made a number of recommendations that would have impacted on the housing market, including:
Introduction of land tax "on all land ... removing disincentives for institutional investment in rental property"; that "transfer taxes on property should be reduced, and ultimately removed"; a move to "more neutral personal income tax treatment of private residential rental investment ... through a 40 per cent discount on all net residential rental income and losses, and capital gains."
In regard to recommendations of changes to tax policy that might impact the housing market, the Government advised "that it will not implement the following policies at any stage" (excerpt of list):
Include the family home in means tests (see Rec 88c) Introduce land tax on the family home – this is a state tax and thus an issue for the states (see Rec 52 & 53) Reduce the Capital Gains Tax discount, apply a discount to negative gearing deductions, or change grandfathering arrangements for CGT (see Rec 14 & 17c)
Warnings of overvaluation
In 2003 the IMF's 'World Economic Outlook' warned that "housing bubbles in Australia, England, Ireland and the United States" would "burst".
In April 2008 the IMF again stated that Australia's property market was overvalued and close to 25% higher than could be explained by changes in underlying fundamentals. Other analysts argued that the rise in property prices was explained by peculiarities of the tax system.
In April 2010, The Economist house price indicators estimated Australian house prices were the most overpriced in the world, at 56.1% overpriced (against long-run average of price to rents ratio).
According to Edward Chancellor, a US-based investment strategist and financial author, Australia is "in the midst of an unsustainable housing bubble that could burst at any time" and "house prices are more than 50 per cent above their fair value -- a once in 40-year event."
A counter view was expressed by a senior economist with the Commonwealth Bank, who stated that Australia did not have the high unemployment levels of the US or UK and that there was "an extremely low" rate of late debt payments. He also noted that Australia's high population growth was likely to lead to "an under-supply of dwellings in the next few years, not an oversupply."
Equally, Investment Bank Goldman Sachs (GS) reported in August 2010 that "Australian housing is not in a speculative bubble but could be up to 35 per cent overvalued," explaining that there is a "very big difference between a speculative bubble and a period of overvaluation."
In November 2010, The Weekend Australian reported that "Treasury officials preparing the so-called Red Book of briefs for the incoming government were as divided as private sector economists about the strength of the property market."
In December 2010, an MLC investments strategist observed that "residential property looks absolutely obscenely overvalued and seems to offer very, very poor investment prospects."
In March 2011, Morgan Stanley global strategist Gerard Minack said that "we've had 20 years where the Australian consumers have been willing to borrow more to buy an asset that they believe always goes up in value. The classic sign of an asset bubble." and that "home prices are 30 to 40 per cent above fair value."
In October 2009, it appeared that the pricing of homes was being inflated by actions taken in October 2008 aimed at addressing the fallout from the Global Financial Crisis. Housing was identified as an asset class worth shoring up against the type of disleveraging seen in the stock market.
The government increased assistance given to first home buyers as part of its 'Economic Stimulus Strategy'. A substantial reduction of RBA interest rates also played a part in maintaining prices.
Diverting capital away from the rest of the economy
Increased residential housing costs can cause excessive lending to the residential housing sector, at the expense of businesses. This can lead to "a banking system which allocated capital away from the most productive areas of the economy — business — is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end, bad for Australia."
Mortgage and Rent Stress
Increased housing prices and therefore increased borrowings can lead to difficulty in meeting housing payments. According to Ratings agency Standard & Poor's (S&P), "Arrears for sub-prime loans backing RMBS [residential mortgage-backed securities] jumped 126 basis points to 11.45 per cent"
1985: Australian government quarantines interest expenses, so that interest can only be claimed against rental income, not other income.
1987: Negative gearing is reintroduced.
1998 to 2008: real net national disposable incomes increase by 2.8% a year on average from about $32,000 to about $42,000 per year. There is a rise in the number of two-income households, relaxation of lending standards, active promotion of real estate as an investment, population growth creating demand that was not matched by supply, planning and land release issues and a tax system that was skewed in favor of property investors.
1999: Capital Gains Tax reduced from 100 to 50 percent (for property held at least one year), while 100 percent of costs remained deductible.
2000: July - The Federal government introduces the First Home Owners Grant of $7,000 for established homes, and $14,000 for newly built homes.
2003: The government, in seeking to address rapidly rising property prices, set up a Productivity Commission Inquiry.
2004: The Productivity Commission Inquiry on 'First Home Ownership' published its findings (No. 28, 31 March 2004). It identified several factors that had contributed to the rapid increase in real estate prices, including overall fairness of the tax system, lending regulations, lower interest rates and planning issues.
2008: A Senate Select Committee on Housing Affordability was established. Its final report 'A good house is hard to find' included dozens of recommendations.
2008: October - The First Home Owners Grant Boost is introduced as an addition to the First Home Owners Grant. This consisted of an extra $14000 available to first home owners buying or building a new home, as well as an extra $7000 made available for established homes. First Home Saver Accounts are also introduced, where the Federal Government will contribute up to $850 per year towards savings for a deposit to purchase housing.
2008: December - Foreign Investment Review Board rules allow temporary visa holders including students, to more easily buy up 'second-hand dwellings'. Changes did not require notification of sales be made to the FIRB and the $300,000 cap on price was removed.
2009: October - First Home Owners Grant Boost is withdrawn. The University of New South Wales City Futures Research Center director said "the boost has resulted in inflated prices" and had created "a bit of a mini-bubble". A senior economist of Housing Industry Association said the boost has not pushed prices up significantly.
2009: November - "capital city house prices ... climbed average 10 per cent" in 2009. Melbourne led the "house price boom, with values up 14.9 per cent in the 10 months . . to an average of $481,247."
2009: December - Reporting of RE data was questioned by one source: "AVERAGE house prices have been overstated by up to 18 per cent by the real estate industry ... In September the average house price quoted by the Real Estate Institute of Victoria was $67,000 higher than the official figure, based on preliminary valuer-general data ... "
2010: January - The removal of First Home Owners Grant Boost. Mortgage applications reduce by 21.2%. First-home buyers account for 13.1 per cent of new loan applications in December, whereas nine months previously they were at 28.1 per cent.
The Economist warns that Australian prices had effectively raced ahead of reasonable rental yields stating; "In the American housing market . . homes are priced at around fair value on the basis of rental yields, but they are overvalued by almost . . 50% in Australia, Hong Kong and Spain."
2010: March - ABS declares that house prices "soared 20 per cent in the 12 months to March" - a rate that was described as the "fastest ever recorded" in Australian history. The Head of Australian economics at National Australia Bank admits "This is a shocker".
2010: April - Rules allowing foreign investment in real estate that were introduced in 2008 are withdrawn. Temporary residents are required to sell their Australian property when they leave Australia.
2010: May - 'Australia's Future Tax System' Review (aka 'Henry Tax Review') makes a number of recommendations on policies that could affect the housing market.
The government responds to the AFTS review findings with a report 'Stronger, Fairer, Simpler: A Tax Plan for our Future'.
RBA Cash rate is raised to 4.5%. Rates for major banks now vary between about 7.2% and 7.5%.
2010: November - The RBA raises interest rates 0.25% to 4.75% citing the "economy is now subject to a large expansionary shock from the high terms of trade"
2011: February - New housing loans approved by Australian banks fall 5.6 per cent to a 10-year low in February.
2011: March - Prosper Australia launches an online campaign for a "buyer's strike" in an effort to drive down prices.
2011: April - Melbourne median home price falls by $36000 (6%) to A$565,000 in March Quarter.
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