The US crash shows us what we should, and should not, be scared of.
I've been thinking a lot lately about the next step for the Australian real estate market. There are many opinions out there on what happens if our real estate market crashes.
I have found that you can predict the future by being a keen student of past trends and cycles. A great example is what happened in the US 7 years ago and where that market is at now.
I remember when the US market ‘crashed’.
People went nuts talking about a ‘lost generation’ and how it would take America 30 years to dig itself out of a hole.
Steve Keen was patting himself on the back for being the only ‘economist’ to pick it, and then said that it was coming here.
He’s still saying it’s coming here. Any day now. This time for sure…
But fast forward 7 years – just 7 years – and where are we at? US house prices are rising, have past peaks in most states, and people are now talking about a rental crisis.
Yep. A rental crisis.
That housing glut that was meant to leave America in a puddle for 30 years dried up surprisingly quickly.
Too bad if you didn’t follow Warren Buffett’s lead and buy in at the bottom. The bottom’s now long gone.
Anyway, the Enterprise Foundation estimates that over 20m Americans are in “housing stress” – where 30% or more of their income goes on rents. Over half of those, or 11 million, spend more than half their incomes on rent.
On their figures, about half of all renters spend 30% of their income on rent, while 25% of renters spend more than half.
This, in their eyes, is a “rental crisis”.
I’d have to agree that this looks like a problem. The question though is where it comes from.
In part it’s been driven by the unequal recovery of the US – where QE has juiced up the top end of town, and hasn’t done a whole lot to help poorer Americans – who typically are the ones who rent.
So if you’re not earning very much, it’s easy to spend a lot of your income on rent.
But it’s also true that housing costs are increasing. Rents are rising, and so are house prices and mortgage payments.
And since rents are rising faster than lower-level incomes, more and more Americans are finding themselves in “housing stress”.
And why are rents rising? Well you remember that glut that was going to take 30 years to unwind. Turns out it didn’t take that long. Actually, it was more like 3.
Take a look at US vacancy data. Vacancy rates have come way off, from a peak of over 11% in 2010, to a current rate just under 7%.
To Australians who are used to vacancy rates typically in the 2-3% range, 7% might sound like a lot. But 7% in America is actually the lowest level since the mid 80s!
As I said, so much for that glut.
And the absence of available rentals isn’t because everyone took advantage of the market bottom and bought into their own place.
Home-ownership rates have actually fallen to lowest levels since the mid 90s.
So there’s a shortage of homes, there’s a shortage of rentals, and rents are getting too expensive for many people.
Suddenly America has a housing crisis on its hands.
Just 7 years after an apocalyptic housing market ‘crash’, America has a housing crisis again.
And this is why I roll my eyes when I hear characters like Steve Keen banging on about 30-50% declines in house prices.
Seriously bloke, it’s been 7 years already. Give that milking cow a rest.
And look, we’re looking at some testing times for the market right now. It’s going to be interesting to see how it all plays out. We’ve got a few headwinds coming at us – government regulations, rate hikes, foreign buyer breathers…
But the biggest swing factor in all of this is sentiment.
I think it’s not entirely impossible that we could see a fall of 7% in the next year or two. That’s not my prediction. But I can see that it is possible.
And that could happen if the market gets spooked. The GFC is still fresh in people’s minds. A lot of people thought it was coming here. If the sentiment of the herd goes sour, then a fall of 7% could be possible.
But the question is, for the investors with staying power, at what point do the market fundamentals kick in and give the market a floor.
As the US showed us, those fundamentals can kick in surprisingly quickly. Almost no one saw it coming.
… except Warren Buffett and friends, perhaps.
And the fundamentals that have taken us here are still in effect. I’m talking about the lowest interest rates in a generation (even if they’re inching higher). I’m talking enduring shortages. I’m talking population growth and our major cities bursting at the seams.
And a lot of people point to the construction boom we’re currently enjoying. There’s a lot of supply coming on-line. That will give us a glutty market, and prices will go into free-fall.
But America had a construction boom too. And for a few brief years, America had a glut too.
But for a ‘glut’ to have a real impact on prices, the housing supply needs to be matched to housing demand.
And if you look at where supply is being added, it’s mostly in inner-city shoe-boxes.
If you’re a family of 5, a glut in inner-city shoe-boxes is totally irrelevant. You need a house, or at least a large town-house. And if there’s a shortage of them, you’ll just pay what you have to pay.
So this is my thinking. There is a chance we’ll go down the same path as America.
That’s sounds scary to the people who don’t know, but as I’ve told you, the American path involves some great buying opportunities at the bottom, and a quick return to profit.
If you see Warren Buffet making a play here in a year or two, don’t say I didn’t warn you.
Are you expecting a property crash?
What markets will be the big performers in 2016?
…and will Steven Keen EVER be right?
Robby Meyer says
I always love reading your articles Jon, they tend to make me feel better about the situation I am in with WA based investment properties. However, the media is doing a good job of spinning that good feeling on its head. You mentioned staying power in your article, I think that’s the key isn’t it? hanging around until the market turns. Putting that into action is however a very different story, with salaries dropping and redundancies are starting to sneak in, it makes negatively geared properties an additional challenge.
If only the money I was playing with was “spare” 🙂
Ken says
As I’ve said before, many times, I was taught that if you don’t know the past, you’ll never know the future. The market has been down too long now, to be down for too much longer. Based on a doubling of housing every 7 to 10 years, which has been the norm in the past. A lot of want to be economists on Jon’s blogs have been predicting a lot of bubbles bursting now for the past 5 years. A good sign of negativity. What I’ve seen is a lot of cheaper homes rise about 60% over 4 years, but the price of new homes have remained almost stationary. Vacant home sites are rising more than new homes. If anyone can explain that I’d be interested in reading about it?
Stuart says
I’m in Sydney and while the phenomenal growth that we’ve had over the last 3 years is not sustainable [we just sold our house for a 73% increase in a little less than 3 years – sounds great but we’re buying a new more expensive house in the same market and it has probably done something similar …] however the point that get missed is the increased Supply. The last few weeks have had record numbers of properties going to auction; buyers suddenly have more options, and thus fewer interested buyers per property. So while the media and the odd ‘expert’ carry on like the sky is falling in, the reality is that prices are increasing at a slower rate because there are more sellers – perhaps trying to ‘catch the wave’ of price increases before they end. But prices are not crashing as you would be led to believe.
Sanders Payne says
I have relatives in the US to whom of which were heavily invested in the market before the crash and have been renting ever since after loosing faith in the government and banking system.
No doubt foreign investment has taken hold of property there and also nervous to rent these properties creating the rental demand you speak of..Sorry but I’m with Steve Keen and if you realize that America has had China and Russia dump US bonds and a so called mystery buyer in Brazil (the fed?) buy them back to save its economy.
So America now has its debit back and nobody is buying it’s printed money followed by a 600 billion dollar injection into is foreclosures id say there is nothing here in history to go on. ?? Speculation is too dangerous at the moment.
Forclosures are the new trend?
Great article Jon
ron says
hi jon….good article..gets one thinking..about human nature…its amazing the surges and the abatement that create the waves of housing activity, shares volitility and general economic activity. if there is one thing that is obvious is the misinformation coming through the media. people react or respond to anything they read or hear from the media. the ‘fed’ chairperson (omg!) janet yellen’s every word is devoured, ingested and responded to as though she was reading the ten commandments! but…she and her cohorts at the ‘fed’ have lost control of the match..the headwinds will make her pronunciations worthless. really. the investors of the world have lost patience with them hence the bond market fiasco being played out as you read. and make no mistake this is very serious business. you may or may not know that at the time of the g.f.c (2008 style) the ‘off balance sheet’ borrowings of the four ‘big banks’ (australian) was one trillion dollars..from overseas investors. this amount has since grown to 1.5 trillion dollars. off sheet balances because this money is borrowed offshore and goes almost directly to residential housing (80%) and commercial purchases (20%). through our wonderful banking channels. say borrowing at 3% and reselling to borrowers at 5 or more %..so their margin for handling is still around 2%. nice work…with the aforesaid shenanigans going on on the bond markets and the almost certain rise in interest rates very soon..the ‘fed’ will be powerless to contain any rises. one other scenario might be that the central banks throughout the world will band together and abolish cash as a means of transactions and make credit cards compulsory as the one form of currency thereby giving complete control to the banks and their mates the politicians….as there is no cash they intend to introduce debit interest and charges on all accounts which will be deducted so your deposits shrink before your eyes. nice. of course if you borrow money from these people(banks) they will actually pay you interest!! goodbye to savers..its gonna be all debits from now onwards. and the bell still tolls my friends. this scenario was espoused by none other than the governor of the bank of england in a speech to the eu community of bankers recently. so you can see where we are headed.. this state of affairs is already in operation in several euro countries. its like the people are on dope..yes and its to get off..cold turkey..maybe! but who is willing? you cannot fight a world of idiots..and thats what they are..the people who run this circus are out of control..and we are the clowns who obey the rules lol.. values, business acumen..forget it. it is roman circus in the world at the moment. and what’s worse is we have this terrorism stuff. this is an engineered process to undermine western style democracy by none other than mr barak obama,.he is on track to islamacise the usa..he has some opposition though..two top congressmen are wanting to impeach this fellow. he has the backing of the top c.i.a. intelligence and several top ranking generals who are fed up with his incursions into other countries (syria) thats pretty solid backing as the said c.i.a. boys were in the kremiln 3-4 weeks ago yacking with their russain counterparts. subject of course..obama. they will need a two thirds majority in the us senate and the backing of the american people to completely get rid of him. so you can readily see why i am staying here in perth. i hope they don’t find us ..we are so far from anything ..but i am worried about you eastern staters lol
Kathy says
What a lot of people don’t know is that the “glut” of US houses were bought up by institutions, not individuals, that’s why the supply dried up so quickly. These large corporations were able to buy hundreds of houses at a time because the banks were desperate to sell them and were willing to offload their entire foreclosure books to these large institutions, who were happy to sit on them, and can afford to sit on them for a long time, waiting for the possibility that the prices might rise at some time in the future.
Another thing to realise is that US wages have not increased in real terms since the 1980’s. In other words, they are earning as much today in real adjusted terms, as they were in the mid 1980’s. If real wages are not rising, but real costs are, then of course they cannot afford rent, let alone to buy a house.
And one last thing to remember is that Australia’s house prices are largely fuelled by massive amounts of debt thanks to record low interest rates, which are even lower now than during the so called “emergency levels” of the GFC. Australia is one of the most indebted nations in the world. Personal debt stands at a record $1.8 trillion. We can only borrow what other countries are willing to lend to us. If public debt gets too high (and our governments have abolished the debt ceiling), and our official interest rates drop too low (because this time the lower interest rates WILL stimulate the economy, never mind that the fact the last dozen rate cuts didn’t. Oh, and don’t forget the law of diminishing returns) as we engage in the currency wars that the rest of the world is engaging in, then we stand the risk of losing our AAA credit rating and other countries will not be so willing to lend to us any more. When (not if) that happens, the prices of credit will increase, regardless of what the “official” interest rates are.
Oh, and property prices have never, ever consistently doubled every supposed seven to 10 years. Just because they did for the past 40 years, does not extrapolate to “always”. They did so because the US severed the ties of the US dollar to gold, which allowed unfettered currency (NOT money) creation which hugely expanded credit. By default, because most global currencies were linked to the US dollar, these also decoupled from gold and suddenly the global credit boom began. Thanks to fiat currencies, economies cannot “grow” unless debt is increasing.
It always amuses me to see these property “experts” who made their money during the past 40 to 50 years thanks to growing capital gains far above and beyond the inflation rate, which is what property should increase by, simply because they were in the right place at the right time, and think themselves geniuses. And now people have been brainwashed to speculate in the property market on capital gains, (which probably won’t happen consistently in a low inflation environment), rather than yield.
This current increase in asset prices (property, shares and other assets) is simply because our artificially low interest rates practically forces savers to try and find yields from anywhere they can, as they can’t get any from cash.
When this debt fuelled, fiat currency experiment fails, which it ultimately will (the market tried to get rid of all this excess debt in 2008 through a little thing called the GFC, but was thwarted by politicians and central banks), a lot of people will be caught holding overpriced and overvalued assets where their debt far outweighs the value of the asset. All the money printing and quantitative easing around the world is the desperate attempt by central banks and politicians to stop deflation, but this has only been temporarily delayed.
Unfortunately, nobody really knows when this will happen. As Keynes correctly noted, markets can remain irrational longer than you can remain solvent.