Chicken Little has lots of company in the media. The Australian newspaper carried two articles recently that warn of dire things to come. The first, by journalist Katherine Jimenez, ran on May 3 and was headlined ‘Housing tipped for price implosion.’
The essence of the story is based on comments made by Edward Chancellor from US investment management firm GMO, who estimates Australian house prices are more than 50% above their fair value.
The second article, also by Katherine Jimenez, appeared on June 16 with an even more fearsome headline: ‘Australian housing market 'a time bomb.'
This time quoting the thoughts of ‘legendary’ US investor and co-founder of global investment management firm GMO, Jeremy Grantham, the article says that the Australian and British housing markets are the last two bubbles left in the wake of the financial crisis, and it is only a matter of time before they crash.
The Housing Bubble and its Dangers
The basis of the calamitous predictions by Messrs. Chancellor and Grantham is primarily the disparity between the typical ratio of house prices to family income and the present situation.
"The price of housing typically trades about 3.5 times of family income and in bubble it goes to 6 or . . . 7.5 (times),” says Mr Grantham. "You are at near 7.5 times family income . . . which suggests you are twice the size that you should be." (The Australian, 16 June 2010)
Mr Grantham tells us that if the Australian housing market does not return to the ‘normal’ multiple of family income it will be the first time in history this has happened.
"Sooner or later, the rates will go up and the game is over," he concludes. And he’s not alone.
The Sydney Sun-Herald joined the Chicken Little brigade on June 7 with a story by Penny Pryor captioned: ‘Property: ready for a fall.'
The article referred to a drop in auction clearance rates and a rapid decline in the rate of increase in the RP Data Rismark Hedonic Home Value Index. Ms. Pryor also noted the increase in interest rates from the historic lows of a few months ago, and a substantial drop in the number of loans for home purchases.
Even Jeremy Grantham’s forecast of a drop of around 40% in housing prices got a mention. (‘Ready for a fall,’ Sun-Herald, 7 June 2010)
Compare Today's Propety Market with 2008
There’s a significant gap between prices that are ‘softening’ and those that plummet by 40%. For a bit of guidance as to what’s going to happen, consider the market conditions that prevailed two years ago, in June 2008.
At that time the Reserve Bank had slowed the market with 12 consecutive interest rate rises and house prices were beginning to show the effects. Across Australia the price of houses had risen around 14% in the 12 months to March, but then growth began to slow dramatically.
The Australian Bureau of Statistics house price index that bases its calculations on prices in the eight capital cities rose a meager 1.1% in the March 2008 quarter.
Sydney property had posted a 7% rise in the 12 months to March, but went backwards by 1.5% in the March 2008 quarter. So in May the RBA left its rates untouched as the twelve previous increases seemed to have had the desired result of keeping inflation under control.
That was two years ago, and now once again the RBA has put its interest rates on hold as economic conditions – just like auction clearance rates – demonstrate a bit of softening. The cash rate at the end of June was at 4.5%.
Since two years ago Sydney property has enjoyed a boom that has seen prices rise to a median figure of $558,000. (Domain, 7 June 2010)
It’s interesting to note that in May 2008, when the foundations of today’s housing prices were being laid, the official cash rate was at 7.25%. Today’s interest rates are still cheap in comparison.
Every Real Estate Boom has its Limits
It would be naive to suggest that the high volumes of real estate transactions and the accompanying high levels of auction clearance rates would continue unabated from their record levels of just a few months ago.
Two years ago Sydney property values took a brief statistical step backwards, then quickly recovered and returned to follow their upwards pathway on the historic graph of housing prices.
Auction clearance rates and numbers of home loans are important indicators of what’s happening, but interest rates and housing supply are more important factors in determining what’s going to happen.
The legend of Chicken Little tells us that indeed, the sky was not falling and life went on just as before. Affordable interest rates and a scarcity of housing stock relative to demand will ensure that price falls of 50%, or 40% or anything like that will remain the stuff of fiction.
Far more realistic is the forecast by economic forecaster BIS Shrapnel that house prices will rise between 11% and 22% across the major cities over the next three years, with Sydney’s growth figure estimated at 20%. (‘Economists predict 22pc house price rise,’ ABC News Online, 15 June 2010)
Philip Keeffe - Phil Keeffe is an Australian journalist originally from California who has lived in Sydney since 1968. His communications background ...
Join the Conversation