In my last post I outlined the reasons why I thought 2014 was going to be a big year, and house prices were on track for some impressive growth.
Now every time I say something like this, people look at me sceptically. Houses are already so expensive. How can they go higher??
How can they go higher, unless there’s a bubble??
First of all, there’s a lot of people who claim Aussie property has gone bubble. But just because something’s expensive doesn’t mean there’s a bubble. BMWs are expensive, but that doesn’t mean there’s a bubble in BMWs.
And if you look around at what’s going on overseas, it doesn’t look like there’s a bubble here – even in super-charged Sydney.
Take a look at this chart here, from ANZ. This looks at house prices in a number of major cities around the world.
What it shows is that price increases in Sydney have been relatively tame. We’re certainly no Shanghai! We’re not even a London or Toronto.
So if someone tells you that Sydney property (let alone the other capitals) is in a bubble and it’s about to burst, tell them you might believe them once the bubbles in Shanghai, Hong Kong, Toronto, Singapore and London have burst first. Until then, it’s not something to worry about.
But price is a really simplistic guide to spotting a bubble. And not that helpful. As I said, just because something is expensive, doesn’t mean there’s a bubble. We’ve got to dig down past simple price movements, and look at what’s going on at the most fundamental levels – supply and demand.
So the first question we need to ask ourselves is, is there enough demand to support prices at the current level?
Another way to get at this is to ask the question, can people afford the houses that are on the market now.
This is getting at the idea of ‘affordability’ and it’s fundamentally important.
There’s a few ways I’ve seen to cut this up, but none of them are telling us that house prices are out of reach and that there might be a bubble.
The first one I like comes from RP Data and HSBC. It looks at average house prices as a multiple of household incomes over the past 20 or so years.
What HSBC argue is that around the turn of the millennium there was a level shift in the house price multiple. Through the 90s is held around a consistent 2½ times income.
But after the turn of the millennium it took a step up. They argue that there were some fundamental changes to the market that caused that to happen. Interest rates fell and were held low, inflation expectations became contained, and there was easier access to credit.
This meant that people could afford to spend more on their houses, and they did. The multiple jumped up to 4.2 times. But people weren’t worse off. Because interest rates had fallen and incomes were rising, it effectively cost them about the same.
So the millennial jump had everything to do with a structural change in the market, and nothing to do with a bubble. That’s why it’s held steady at 4.2x since it made the jump.
ANZ also have a chart looking at affordability I find very evocative.
They calculate their own measure of household purchasing power. Basically they’re adjusting household income to account for prevailing interest rates. Then they compare that purchasing power to actual house prices:
What they show is that, right now, following five years of go-nowhere growth in house prices, and at the same time as incomes have been rising, actual purchasing power is now running far ahead of actual prices!
The implication is that prices are actually cheap right now. And since the 80s purchasing power and house prices have always come back into alignment, but it’s always prices that did the adjusting. Purchasing power tends to grow steadily.
To make it clear what that means, I’ve highlighted it here on this chart:
The last time we had a gap like this was back in 1998. The gap then was around $80,000. What we saw was that, over the next four years or so, prices made that gap up very quickly, and then some, until they finally caught up with purchasing power.
By the time they did, prices had risen over 50% in four years!
That’s the kind of gap we’re looking at now. There’s almost $100,000K difference at the moment. That gives you a feel for the kind of catch up we can expect… at a minimum.
But if incomes keep growing – and as I said in my last post, there’s every reason to think that they will – then the reunion point could be at a much higher price. Just eyeballing it, it looks like it could be around the $700,000 mark.
From current levels, that means about a 30% increase in just a few years!
So much for that bubble.
But is that really what we can expect? Sure demand is bumping along with rising incomes and foreign interest. But what’s happening to supply?
Well, as I’ve argued before, Australia is actually pretty crap at building houses. We’re just not building enough of them.
This chart here tells the story:
That’s a 50% decline!
So supply is lagging way, way behind. And so if demand is forging ahead, but supply is lagging behind, that’s got to be driving us towards a shortage.
And that’s exactly what we’re seeing.
This measure from CBA looks at the demand and supply balance. On their measure, we swung from surplus to shortage around the time of the GFC, and we’ve had a serious shortage since.
And shortages mean rising prices. But we haven’t seen that have we? No. Confidence has kept a tight lid on things.
But that just means we’ve got a lot of catching up to do! Prices are a tightly sprung coil.
So the take home message is this. No, there is no bubble. Aussie house prices don’t appear over inflated. In fact, looking at purchasing power, we should expect to see some big price increases in the years ahead. And looking at the supply / demand balance, huge shortages also imply that big price increases are on the cards.
Prices are being jacked up by both demand and supply. To my mind, 30% over the next couple of years would have to be the minimum.