The Australian Housing Bubble

Transparent Background

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We, as Australians, seem to have developed a love affair with property over the past 40 plus years.  Property has became an investment class rather than just a provider of shelter and the consumable item that it should be. A place to park wealth rather than used to create it. This continuously raises the possibility of a bubble.

There has been a lot said, many megabytes devoted to and much news ink used in commentary about a bubble in Australian housing.

People ask me if I think that Australian housing is in a bubble. I usually answer in the affirmative saying it’s looking very frothy and furthermore tell them that Australia’s and many of the world’s housing has existed in a bubble for the past 45 or so years.

I will get back to this in a moment, but first I’d like to say that just because Australian housing is in a bubble, does not mean that it cannot continue for a while longer, although I personally believe we are closer to the end point than the start point. As John Maynard Keynes supposedly noted, the market can remain irrational longer than we can remain solvent.

Now, a very quick history lesson on events that happened 45 or so years ago and why this has created numerous property bubbles in Australia and the world. In 1968 then US President Lyndon Johnson eliminated US dollar gold cover. That is, the US no longer had to have a percentage of gold in their reserves to cover each US dollar that was in existence. This was taken a step further in 1971 by the then US president Richard Nixon who suspended the US dollar’s convertibility into gold, which meant that a US dollar could no longer be exchanged for gold.

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Prior to this, under the Bretton Woods agreement in 1944, the US dollar was backed by gold and by proxy, so were the world’s currencies as they were valued against the US dollar on the exchange rates.

When the gold link was severed, the world changed from a gold backed to a credit backed and driven economy. This meant the economy would only grow if credit was increasing, so people were greatly encouraged to accumulate more debt by governments and central bankers. Many people were happy to oblige.

Anybody who bought property in the past 45 or so years has been the beneficiary of this huge loosening of credit brought about by the actions of both Presidents Johnson and Nixon.

When looking at Australian house prices from about 1880 until late 1960’s/early 1970’s, prices were relatively flat, when adjusted for inflation. Once credit was loosened however, from the late 1960’s onward house prices went parabolic over and above the inflation rate. The gains seen over the past 45 or so years are a product of this huge credit expansion.

House price stats Aus 1880-2010

Pretty much anybody who purchased property in that time, benefitted from increasing values. With few exceptions, property prices generally went up far in excess of the inflation rate.

The people who benefitted from this windfall weren’t geniuses, they were just in the right place at the right time. But many thought they were, because they made money each time they sold property and because they didn’t understand the underlying parameters that allowed this to occur.

So the myth of property prices doubling every seven to 10 years was born. The fact that this had only happened over the past 45 or so years wasn’t recognised. “45 years” somehow became “always”.

There were even pretty graphs with a starting year point and an ending year point to support this property doubling “fact”, but once again, the data was extrapolated and prices averaged out over the time frame, rather than show actual annual prices for the period in question. And more often than not, these were not adjusted for inflation. As previously mentioned, inflation adjusted property prices stayed fairly flat until the late 1960’s. They certainly didn’t double, for example, from 1910 to 1920 or 1930 to 1940, but the graphs made it appear as though it did.


However, in the current environment of low inflation and low interest rates, property prices are now starting to pull back and I believe they are reverting back to the more normal mean of only increasing in line with inflation.

Changing demographics as baby boomers retire and change from spenders into savers, will impact on property prices as well, particularly when they start to sell their assets to fund their retirement. Not just prices for property, but shares and businesses as well.

Overbuilding of flats around Australia’s capital cities will also have a dampening effect on housing prices, particularly in attached dwellings. Real sustained property price corrections could happen as soon as the 2017-2018 financial year, if not sooner.

The way global economies are at the moment, there are no guarantees that prices will remain stable, let alone increase any time soon. And with the oversupply of flats coming into the market, most likely just as the global markets enter a serious downturn, falling real estate prices are a very real possibility, particularly from investors exiting the market. When they are not seeing any real capital gain (after inflation), have very low or no yields and longer vacancy periods, but still have to put their hand in their pocket every month for expenses, there could be a rush for the exits.


Prices may rise but people seem oblivious to the fact they can also fall. What goes up can also come down. So capital gain only really exists if it is realised. Unless capital gain is locked in (ie. sold at the highest valuation price), it’s not real capital gain. You cannot rely on the greater fool theory forever. This is the theory that a greater fool will come along and pay you more for your “asset” than you paid for it initially. The banks have been complicit in this, allowing borrowing against any increase in equity so the debt load is constantly increasing. This strategy is also pushed by property spruikers as a means of increasing your property portfolio.

Yes, a property investor might have a two million dollar property portfolio. But if it’s secured against a debt of $2.5 million thanks to falling property prices, that’s hardly a sound financial position to be in. If and when that happens, the friendly bank won’t be quite so friendly any more.

The problem is that, as previously mentioned, housing is a non-productive consumption item whose purpose is to provide shelter, but is being sold as an investment item reliant on capital gain to create wealth rather than yield to provide cash flow.

So, as well as property not doubling every seven to 10 years over a long period of time, Australian property prices can also actually fall. And this is even more likely at this particular juncture.

We are entering a deflationary period, a period of asset price falls. The reason the massive money printing or quantitative easing programs we have seen over the past few years by many countries have not succeeded in increasing asset prices consistently, kick starting the economy or causing massive inflation or even hyperinflation, is that this money printing has just stopped the deflationary forces from having their full effect. It’s why the global economy is sluggish at best. With the amount of money printing carried out by various governments, global economies should be booming. They are not.


Just as record low, and in some cases negative, interest rates have similarly been unsuccessful in getting the global economy moving.

There is a train of thought, particularly amongst politicians and central bankers that inflation is good and deflation is bad. But I disagree. Before the turn of the last century, (and incidentally before the proliferation of central banks), deflation was as much a part of an economy as inflation. Before the 1900’s, periods of inflation were generally always matched with periods of deflation.

It was only when central banks decided that deflation was a bad thing that we have had persistent inflation. Inflation has only been a feature of modern economies from about the early 1900’s onwards (incidentally, the US Federal Reserve Bank came into being in 1913).

Why is deflation the enemy? Deflationary periods are useful to dampen and remove mal-investments from the markets and bring the economy back into equilibrium. This is now being prevented from happening.

Japan is well into its third decade of deflation. Asset prices (property, stocks and businesses) are about half the value they were during the 1980’s and have never recovered those highs. The various governments of the day have tried desperately to stimulate inflation and asset price growth through massive quantitative easing (far greater than the US) and zero and negative interest rate policies. It hasn’t worked. Inflation is still negligible and asset prices are still languishing. And yet Japan is still ticking along nicely and they’re in no immediate economic trouble. Why? Because inflation isn’t needed!

And why are our politicians and central banks so desperate to see inflation? Because it increases asset prices, which brings about the so called “wealth effect”. When asset prices are rising, people feel wealthier and more secure and this supposedly encourages people to spend more. And why is this a good thing? Because under a fiat (debt backed, not gold backed) monetary system (pretty much all developed nations and most developing nations) in order for the economy to grow, we need to borrow more and get further and further into debt. In other words consume today with tomorrow’s income.

The record amount of debt we currently have in Australia does not bode well either. Australia is currently one of the most indebted nations in the world. We have record amounts of private and corporate debt, and public debt is increasing faster than any other developed nation.

Rising public debt endangers our AAA credit rating, which in turn will increase borrowing costs for the major banks causing interest rate rises above the RBA “official” rate. Many of the private debt holders won’t be able to afford any interest rate rises. A massive amount of this private debt is secured against this non-productive consumption item, property, which will either be defaulted upon or sold at a loss.

What does this mean for the housing bubble? Who knows! It could continue for another 10 years, start to deflate next month or pop in a year.

The markets can only be gamed for so long before they revert back to the mean. We are probably now entering an extended deflationary period and sluggish global economic growth, after more than 100 years of constant inflation. Get used to it. This is most likely the new normal.


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The Australian Economy & it’s Effect on Housing

Transparent Background

Investing 7

A recent real estate article outlined why real estate in Australia was unlikely to crash. It then went on to list a number of reasons about Australia’s economy to support this argument. There were a couple of factors I agreed with, but a number of things were so wildly inaccurate I felt I had to respond. This is my responses to each point made. It doesn’t mean that Australian property prices will crash soon. But it doesn’t mean they won’t ever crash either, at some stage.

The bold text at the beginning of each point is a point in the article for a non crash. The text after the bold is my response.

  1. A depression or a severe recession unlikely. I and many other contrarian commentators disagree. I think a global depression or severe recession could be as likely as next year (2016). The world’s economies are slowing and the pace since the GFC has been lacklustre to say the least. There are too many variables to list here and include factors such as the Baltic Dry Index, which incidentally is at its lowest levels in decades, but any or all of these can impact on Australia’s and the global economies. Given the amount of money many countries have printed we should have absolutely booming economies, but we don’t. We instead have sluggish growth and many countries failing to get traction and slipping into and out of recession. The very thing that saved us during the GFC, China, is now the thing that will impact the most on us due to their slowing economy. Whatever happens outside Australia will impact on Australia internally. Even the IMF is continually adjusting growth figures down.
  2. Unemployment levels low. Now seriously! Does any thinking person still believe the data massaged, manipulated, “seasonally adjusted”, watered down, made politically more palatable figure the ABS releases as the unemployment rate is in any way accurate? The official figure is not measured the way it used to be, even as recently as the 1970’s. The Roy Morgan Research Study releases parallel unemployment level figures to the ABS. It’s figures paint a less rosy picture with unemployment at nearly 9% and the combined unemployed and underemployed figures as high as 17.4%.
  3. Interest rates rising. This one I agree with. Interest rates are unlikely to rise anytime soon. Actually, to quantify that, “official” interest rates are unlikely to rise soon. We should ask ourselves why interest rates are so low. Lowering interest rates are usually used by central bankers when a country’s economy is slowing or tanking, to try and stimulate it because confidence in the economy is low. Regardless of the fact that the last dozen interest rate cuts have not stimulated the economy and with each subsequent cut, the law of diminishing returns come into play (the effect is shorter and less effective), the RBA will likely cut interest rates again as our economy once again falters. There is a race to the bottom with low, zero or even negative interest rates thanks to currency wars and no country can actually afford to raise their official interest rates. The world’s economies are carrying so much debt, it is unlikely they can sustain an official interest rate rise, despite the US Federal Reserve Bank raising interest rates one whole quarter of one percent this month (December 2015). Also, it’s not the job of the RBA to “save” those who borrowed too much and then find themselves over their heads when real interest rates rise (see point 5 below).
  4. A huge oversupply of properties. This is most certainly the case in most major capital cities, as rent seekers try to find yield due to low interest rates, and look for it through other means, such as multiple dwelling development to maximise returns. This of course leads to a glut of attached stock, such as we are seeing in Sydney, Melbourne, Brisbane and possibly even Perth, which also has a glut of commercial property. Several commentators are on record as saying we are building too much of the wrong stock. The type of housing of which we need more is detached housing, small lot housing, aged care housing and housing that allow people to age in their own single level, no stair homes. These are not being built, as our Councils and state governments have become lazy and dependent on the easy money to be made from constructing block after block of flats.
  5. Credit market illiquidity or a credit squeeze. Australians currently hold record debt (which I will expand upon further in point 11). This has been possible due to foreigners being willing to lend more to Australian banks, partly due to our higher interest rates. When our interest rates drop too low, or global events make foreign investors nervous and are then no longer willing to lend money to Australia, real interest rates could rise above and beyond the level the RBA has set official interest rates. This has already happened in part due to the tightening lending criteria set by APRA. If public debt (government spending) becomes too high, it will make us unattractive to lend money to for the rest of the world. That coupled with high personal debt could threaten our AAA credit rating and real interest rates will rise regardless of what the official interest rate is. The ability of our banks to access foreign funds for lending is entirely outside of their control and as availability tightens, real interest rates rise.
  6. Robust population growth. Australia’s birth rate fell to 1.8 children per couple according to the most recent figures. It is heading to its lowest level in 20 years at 1.7 children per couple. We are not even replacing ourselves. Immigration is also slowing, and the type of immigrants are usually families. Families have lower housing requirements than singles, ie. one house can house a number of people just as easily as it can house a single person. This put downward pressure on housing requirements with less housing and rentals required.
  7. A healthy economy. Really? Based on what? Thanks to a slowing China, our mining boom is over, with record low commodity prices. We have a negligible manufacturing industry. Our service industries are struggling. Our governments and politicians would like to replace the mining boom with a construction boom, but all we build are more and more blocks of flats. How does property provide the long term productivity and ongoing employment that a real business provides? Once it’s built, it doesn’t employ many people consistently. We are not going to become wealthy selling properties to each other. This relies on the greater fool theory and eventually there is no greater fool. As the real unemployment and underemployed figures show, our economy is not really doing that great.
  8. A sound banking system. Once again, seriously! Our banks are overexposed to property, with some banks holding as much as 70% of its loans against property. Their investment in business, particularly small business, the real powerhouse employer, is negligible. They have belatedly begun to realise that if there are no businesses, there are no people to actually buy all these properties that are being built. How many people know that at least Westpac, Commonwealth, National Australia Bank, Bankwest and AMP among others, required bailout funds during the GFC under the US government’s TARP program? How many people realise that there was such a run on Australian banks during the GFC, that the Royal Australian Mint had to do emergency print runs to print more money because the banks were 24 hours away from running out of depositor’s money? Australian banks sound? Those in the know definitely know better, but it suits the banks, central banks and politicians to keep up that illusion.Bank 4
  9. Business confidence. This can change in an instant. All it will take is a black swan event, or something that is outside our control, such as acts of terrorism, acts of war (we have a threat right on our doorstep with China and its claim of sovereignty over parts of the China Sea) or something else that is unexpected and the confidence mood will swing the other way. Australia is a commodity producing country, just like Canada and Brazil. These two countries are currently in recession, and Japan just went into recession again.
  10. Consumer confidence. Ditto as for business confidence.
  11. A healthy level of household debt. And again, seriously, are you kidding! We currently hold record levels of household debt. We have half as much again as we had during the GFC, which was a debt crisis. A recent Barclays survey listed Australian households as amongst the most indebted in the world. The ABS reported Australian personal debt reached record levels at $1.8 trillion for the country, or nearly $80,000 for every person. Household debt as a percentage of disposable income is at all-time highs at over 175%. That is definitely NOT a healthy level of household debt. The number of mortgaged homes is increasing and the number of homes owned outright is decreasing. Based on these facts and figures, if some households have no debt, it means that others are extremely overleveraged and overexposed and extremely vulnerable to a downturn.Australian debt
  12. Property prices growth slowing. Property prices growth is slowing, and I believe we are reverting back to the mean of property prices increasing in line with inflation, which is what it does in a properly functioning economy. As we are now in what is most likely a low inflation and low interest rate environment, and which is unlikely to change in the near future, we are making our way back to the new normal. The parabolic capital gain asset price rises are only a product of the past 46 years since the decoupling of currencies from gold and the easy availability of credit. Before that, property prices, adjusted for inflation, were fairly flat.

The point is, nobody knows what is going to happen in the future. We are in uncharted territory, we do not have any precedent for what might happen next apart from the fact that no fiat currency has ever lasted beyond a couple of generations and creating money ex nihilo and ad infinitum has always ended badly throughout history. Maybe property prices will crash and maybe they won’t. We could continue on as we have been for another 20 years, or it could all collapse in a heap next week. We do have a very large investment stake in what is essentially a non-productive consumption item and we are not immune from corrections. However, as economist, John Maynard Keynes observed, the market has the ability to remain irrational longer than we can stay solvent.

Owl 1




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