To The Moon

7 JUNE MARKET NEWS FOR AUSTRALIA -> TIGERS

The sky-high Australian residential property prices.

A good insight into the expensive Australian property market – Where and Why?

As interest rates begin their gradual ascent in Australia, there are a lot of nerves in the domestic property market. Dr Philipp Hofflin from Lazard Asset Management believes these concerns are well-founded, singling out a couple of eyebrow-raising metrics.

• During the period preceding the GFC in the US, property prices over there rose by the equivalent of 60% of the national GDP. Australia has done a lazy 100%-plus over the past three years.
• During the Japanese property bubble (over 15 years from 1986 – 1991), Japan set the record for the ratio of the value of its residential land to GDP, which was more than 330%. Australia has just beaten that record.
• A 200 basis point rise in interest rates could translate into a 16% hit to property values - this is near that point where you risk a loss of faith in the market.

In 2019, Dr Hofflin wrote that forecasting the "timing of any (real estate) downturn would be difficult, if not impossible, to predict." Since then, interest rates have continued to bottom, boosting domestic property prices. Based on the metrics above, it looks like a residential property decline could be coming sooner rather than later.

In this episode of Expert Insights, Dr Hofflin discussed his research on global property busts and compares that to the domestic market. He also discusses the implications of declining residential property values for equity market investors. Cont…

EDITED TRANSCRIPT

Do you have a base case on the outlook for residential property prices?

Look, we don't try to forecast property prices. We really see that as a risk. It's a risk that was off the table for a little while because rates were very low and the environment was very favourable, but it's a risk that has returned. It's returned because of three factors if you will.

The first one is that we've had another very significant rise in prices. In fact, during the period preceding the GFC in the US, property prices rose by the equivalent there of 60% of US GDP. Well, we've just done a lazy 100% plus in three years.

Residential values rose by two and a half trillion dollars over the last three years, they hit over 10 trillion at the start of this year. And you can see this dwarfs really any other asset price in the country.

A slightly more positive angle is that during the last three years, debt levels didn't increase an awful lot compared to household incomes, but they did remain almost double US level. They didn't get any worse, but they didn't improve either.

Are there parallels between the Japanese property bubble and the current Australian market?

The Japanese residential bubble was of course probably the most famous residential bubble in the 20th century. It was of extraordinary size and it, of course, changed the Japanese economy very dramatically from pre-bubble in the '80s to post-bubble in the '90s.

The concern is that we have just either equalled or beaten probably, the record that Japan set for the ratio of all the value of residential land in Japan to a GDP, which was over 330%, and the price to income ratio in Japan in 1990. We've just beaten that record in Australia, which is not a great starting point.

They want to reduce debt. And debt really is the driver here. There have been, over many years, a lot of debates about why do we have such expensive property values? And there have been sort of three schools of thought if you will. And they're not exclusive necessarily.

One is obviously just rates and availability of debt.

The other one is demand and supply of housing.

And the third one was, is it just foreigners, foreign capital coming in, driving the market up?

And to a significant degree, we conducted what an economist calls a natural experiment. We kept people out, so no more population growth, but we kept on building. There was no more capital coming in and we cut rates to zero. And I think the results speak for themselves.

It's pretty clear that yes, interest rates and availability of debt, your borrowing ability is what drives Australian property prices.

And I've included here a chart, which come from Gerard Minack, a wonderful chart because it covers 110 years of history, and shows how tightly linked have been the ratio of property price to GDP and credit to GDP.

As again, Gerard likes to say, the price of Australian housing is not determined by the demand and supply of housing. It's driven by the demand and supply of debt.

Graph below…