Australian Residential Property, Is The Bubble Ready to Burst?

By Jason Fittler

I have been researching the Australian housing market for the past month; it is my belief that the Australian housing market has formed a bubble, which is set to burst at any time.

During my research I came across an article written by Gerard Minack of Morgan Stanley, his research echoed my thought on the property market, so instead of re-inventing the wheel I have attached a full copy of his article below. (You can download here.)

It is quite long so I have prepared a brief summary below on the Australian Property market. If however you do have the time, I recommend that you read the full article.

Warning - you may find this offensive if you are a residential property investor.

The Australian residential property market is currently 40% overvalued; this in technical terms is a bubble. As we know, all bubbles burst.

When looking to see if housing prices are high there are two simple comparisons to use.

1. House prices compared to household income. At present, house prices are on average 500% above the household income. Although this trend has been increasing since 1960, it should be around 360% of household income.

2. House prices compared to rent income. Yields on residential property have been falling since 1985. Investors are accepting less and less return and therefore relying on capital growth for profit. This is not a sustainable situation.

When compared to the rest of the world, Australian property is the most expensive as a percentage of household income. When compared to other Anglo economies Australia is sitting around 40% more expensive then UK, US, Canada, NZ and Ireland.

So, what caused this bubble?

1. Interest rates. When the mortgage rates are adjusted for inflation, you will note that the effective interest rate paid is below the standard rate and below the mean. Low interest rates push up prices as people can borrow more and as such, they will pay more.

2. Supply shortage. With more demand for housing the prices should rise, this has played out in part but not to the extent, the media would like you to believe.

3. Loss making landlords. You cannot under estimate the extent to which Australians will go to avoid paying tax. The negative geared property is a favourite way to reduce your taxable income in Australia. 9.5% of Australian taxpayers report a loss from rental properties.

If you look back over the past decade you will see that property has been an excellent investment. Which is why right now, it is extremely unwise to expect such gains to continue.

The investment fundamentals of housing have sharply deteriorated.

1. Gross rental yields are below mortgage rates. Which makes property cash flow negative. The percentage of landlords making a loss from their investment properties has risen from 50% in 1993 to 65% by the end of 2009.

2. Loss making landlords are mainly middle class income earners. In fact, 80% of landlords earn $80,000 or less. The risk here is that as the investment fundamentals deteriorate it is more likely that these investors will start to sell these properties causing the bubble to burst.

3. High levels of debt. When we look at the value of the asset against the debt held against the asset all seems to be ok. As asset prices increase, banks will lend more against that asset. The catch comes once the price of the asset falls. Due to the inflated prices on property any fall in value of the underlying asset will cause financial stress to the property owner. This in turn will burst the bubble.

Against all of the media hype, I am advising against property investing.

In fact, I expect to see the residential property sector suffer a similar fate to the stock market.

The situation is unstainable, and with the banks tightening up on their lending practises, property prices at best will not be moving up for at least 10 years. At worst we will see the sector collapse.

Final Fact!

In 1891, a house in Melbourne cost the equivalent of $300,000 in today's dollars. It was not until 2001 that this price was reached again. This is a period of 110 years of no real growth.

Want to know more? Please call me on (07) 4771 4577.

Please click here to read the full article by Gerard Minack of Morgan Stanley.