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You are here: Home / Blog / Pick a bubble, back a shortage…

Pick a bubble, back a shortage…

September 25, 2013 by Jon

So the media has pretty much entirely come around to my point of view. Property has made a come back. The next bull run has begun.

But not happy to leave us with a good news story, the media has gone and run ahead of the game again. Suddenly we’re back into bubble territory.

“Housing Bubble Trouble” – The Age, 22/9/2013

That’s effectively got to make it the shortest bull run in history. Just a matter of months after the doom-merchants had realised their positions had become untenably ridiculous, the boom cycle had run its course, and we had a bubble on our hands.

Turn it up.

What do they take us for?

Even the RBA was out hosing down the media during the week. RBA Assistant Governor Malcolm Eddey said all this talk of a bubble was “unrealistically alarmist.”

That’s polite central bank speech for bulls#*t.

But that’s just the way it is. The media is always fishing for the next disaster story. The next little girl locked in a basement. It’s what sells.

We don’t buy papers to be told everything’s fine. We buy papers to be informed (=scared).

But even though it’s all alarmist rubbish, I still wanted to take a look at this bubble story. I’d bet my last two cents this isn’t the last we’ve heard of it.

Because remember we’ve had people making a song and dance about the bubble since the before the millennium clocked over.

But I want to make the case that there was no bubble. There never was, and there never will be. (ok, I don’t know about never, but not in the next few years anyway.) And the price rises we’ve seen all make sense in the context of the fundamentals – especially those most basic of fundamentals, supply and demand.

And this isn’t just an academic exercise. The stakes are high. Why? Well it’s not just about whether you and I make money out of property over the next ten years. This is about whether Australia remains the lucky country, or falls into an Irish bog hole.

Remember what happened in Ireland? A property market crash there wiped out the banks. The banks held the government to ransom, said if you don’t bail us out we’re taking the economy down with us. The government caved in, and the bail-out package wiped out the government.

I don’t think that will happen here, but it’ not because we’ve got better government or less greedy banks. Oh no.

Because it is true that our banks have a huge exposure to property. Take a look at this graph from the IMF. What it shows is that over 60 percent of the Australian bank loan book is made up of real-estate loans.

Screen Shot 2013-09-25 at 9.31.23 AM

That makes our banks the most property dependent banks in the world. And this list includes countries where there arguably are bubbles emerging, like Canada and Norway.

Now our banks are also some of the best capitalised banks in the world, and our regulators have, so far and relative to some other countries, been on top of their game. So I don’t think there’s any real risk here. But it does highlight what’s at stake.

If there was actually a bubble, and that bubble burst… if a whole lot of mortgages went sour and people started defaulting on their loans… then the banks would be in real trouble.

And if one of them went down, even one of the minor or regional banks, because they’ve all got their hands in each other’s pockets, the whole system would get the wobbles.

And then it would be up to government’s to bail ‘em out of that mess. The government’s got deep pockets and a good credit rating now, but saving a banking sector isn’t cheap. Just ask Ireland.

And this is why we’ve had so many people worried about whether the housing market’s gone bubble or not. The stakes couldn’t be higher.

And of course it’s not hard to see bubbles if you’re looking for them.

This chart here neatly sums up some of the bubble-blowers main arguments. It comes from one of my favourite bubble-blowers, Leith Van Onselen at Macro Business.

Screen Shot 2013-09-25 at 9.31.39 AM

What it shows is house price growth, relative to other ‘housing fundamentals.’ We all know the story. Since the mid 80s house prices have grown quickly, much faster than the economy itself (GDP).

And house prices have grown faster than the cost of the physical house itself (construction costs), faster than the return on investment (rents), and faster than our ability to pay for them (disposable income).

The argument then runs that the fundamentals don’t justify the price. On all these measures, house prices seem over-valued.

Why would house prices grow faster than GDP, if not for a bubble? Why would people invest more in an asset than the returns justify, if not for a bubble? Why would prices run way ahead of the physical cost of the house itself, if not for a bubble?

It’s all very neat.

But it’s all very wrong.

Because there’s an answer to all of those whys: supply and demand.

The dynamics of supply and demand dominate all of these factors. And so if demand is running way ahead of supply, it is possible to have sustained increases in price, even if the “fundamentals” are not keeping pace.

And I’d argue that the last 30 years have been characterised by mismatched supply and demand.

Demand has been increasing strongly, thanks to population growth, demographic dynamics, and financial revolutions that have made property much more attainable to the average citizen.

But at the same time, supply hasn’t kept up. New construction levels fall further and further behind the population growth rate every year, and zoning restrictions tie up and limit the supply of buildable land.

And the more the gap wides, the higher prices go. There’s no bubble here. Just simple, text-book supply and demand. And it only shows prices going higher still….

Don’t believe me? Over the next week, I’ll take a closer look at supply, and a closer look at demand, and you can decide for yourself.

Filed Under: Blog, General, Property Investing, Real Estate Topics

Comments

  1. Anth says

    September 25, 2013 at 11:55 am

    Two words – Negative gearing.
    I agree with your position on supply and demand, and that there is no eminent bubble, because of this.
    However, the question still remains — Where does the money come from?
    Change the rules on negative gearing and then perhaps, we may just have that bubble you explained doesn’t otherwise exists.

    Food for thought for your next article…

    Like always, I enjoyed your work on this one.

    Thx

  2. joe petranov says

    September 25, 2013 at 1:39 pm

    I agree with supply and demand controls price !
    but the latest boom or bubble … whatever u like to call it…. is driven by low interest rates ….. ROI
    Some food for thought from a property investor (me) ….. when the interest rates start going back up……the house price index will get to a point where average wage earners will not be able to afford a owner occupied home / loan in say Sydney ….and will rent for a vast majority of their life …..so after this boom passes who will buy our investment properties when we choose to cash in ??….rich chinese ??
    So should we diversify in the type of investments we have ….not just RE huh ?
    Joe

  3. De-leon Coleman says

    September 25, 2013 at 4:33 pm

    If changing the rules on negative gearing created a bubble, why would you change them…..

    • Anth says

      September 27, 2013 at 4:50 am

      I wouldn’t, but the government might.

  4. William says

    September 25, 2013 at 7:06 pm

    I agree with your article but it doesn’t say if the construction index includes land costs or not. This may also help explain the disparity. As a land developer I can tell you the land cost of housing has increased way beyond most cost indices for 2 reasons: (1) local authority’s standards of development, including limitations on development areas, keep increasing, and (2) local and state governments have changed their policies about development charges and infrastructure contributions so that developers pay higher contributions compared to previous where a greater amount of infrastructure costs were covered by the tax take.

  5. Matt says

    September 26, 2013 at 12:49 am

    If a lack of supply is to blame shouldnt rental growth track house price growth?

  6. Anthony says

    September 26, 2013 at 2:08 am

    Complete nonsense to wave away (as if by magic) “fundamentals” because of “supply and demand”.

    This is a similar argument to what was promoted widely in the USA before the real estate crash.

    Rephrasing this message makes the anomaly clearer: “Don’t worry about prices being higher than fundamentals because of XYZ”.

    XYZ being almost anything you like.

    As things play out over the next couple of years, I suggest we will hear this same message more often and more loudly – and with XYZ taking on various forms.

    Btw, I am not anti-real-estate, I own many investment properties.

  7. dean says

    September 27, 2013 at 3:45 am

    i cant seem to think, somehow, that people are but the pawns in these fiscal shifts.

    Yes..those good people whom have saved their schekels like mama drummed into them..who are fiscally responsible and have thought the banks vis a vis thru the governments controls would recognise and reward fiscal austerity..saving for the rainy day, now seemingly are being forced..manipulated…pushed into extending their credit and jumping onto the property bandwagon as their meagre savings increasingly fail to show fair and reasonable return, and those returns are eaten up by burgeoning inflation, and the tax man.

    The new wave of property investors perhaps are hesitant and scared…fearful of becoming the property pawns in these shifting times, ..scared to jump into see sawing stocks..but unable to exist as they should and could on their savings because of federal bank intervention…manipulating and tweaking interest rates to artificially pump the “supply and demand” you seem so happy about Jon. Sadly it seems that property ..old bricks and mortar…is coming back in vogue…as the lesser of evils…hardly something to be happy about really.

    Personally, i feel sorry for these people whom may feel forced to act, but may end up trapped due to the huge potent for the failure of these manipulations …5 yrs after U.S Quantitive easing has shown itself to be a failure..but which cannot be withdrawn because as all addicts know, the easy paths the only path…when we have a whole series of global systems tweaked to what i think is a potential series of crisis points, the govt seemingly is prepared to sacrifice a whole generation of austere, good, fiscally responsible people to fuel the ill based fire of confidence needed to kick start an ailing economy.

  8. Tom says

    September 28, 2013 at 3:03 pm

    Love your logic Jon. A couple of the demand factors worth looking into will be the SMSF rule changes and Asian money being plonked down here for safekeeping.

  9. NOEL says

    September 28, 2013 at 9:57 pm

    Hi guys, i enjoy reading the many varied views that you all have on realestate investment and as a novice i try to gain little bits of knowledge from your comments. I think at times some people complicate the process of investing in property. I follow a very simple rule and that is, if the numbers dont work dont do it if they do work go for it but if an exit stategy, you can get to bogged down in the what if,s and i dont have time for that,All the best

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