Housing: The Cold Hard Truth

The Age has run a story about the housing affordability crisis, pointing to anecdotal experiences and flimsy evidence to support its argument. I have no doubt that housing has boomed over the last 5 years. The main reason I can see, is traditionally low interest rates, and more liberal bank lending practices. Since deregulation, anyone and everyone can now obtain a home loan, pending a basic income and credit check. This fueled a rise in prices, particularly in sought after suburbs (e.g. Bondi), and in true suburban areas (e.g. Lane Cove). This pressured people to take out large mortgages, in fear of being left in the cold, as they watch their neighbours and co-workers take Monday’s off to visit their local loans officer. This is usually how bubble start; the fear of missing the boat drives people to make irrational decisions. I disagree that this is a true bubble, but I’ll go into that later. Now we begin to see rising prices in a depressed stock market, still reeling after the tech bubble burst and 9/11 terrorist attacks, and lacking confidence in a bizzare world where even the sanity of simple accounting could no longer be relied upon thanks to several large scale blow ups (Enron, WorldCom, HIH, One.tel, etc). Speculators, looking for somewhere to produce above average gains, not seen since 1999, decide to move in on the high prices. “Flipping”, which has been around as long as property ownership itself, became a vogue idea for those looking to strike it rich. People would buy run down houses using no money down interest-only loans, using their own property as collateral, investing 30-50 grand in renovations, enticing the same scared buyers who feared on missing out on owning a home to bid and make a huge paper sacrifice to move into the market.

There’s more to it, though. The ones who were ‘flipped’ to originally, whom are now knee-deep in debt, surviving on paycheck to paycheck, are now able to use leverage to re-enter the market. How? Its simple, they bought in a bull market. Property values appreciated further. This gave them the leverage they needed to take out another loan. The bank didn’t object; in such a market, if they were to default, selling the house back to the piranhas was the worst that could happen. Upper management, desperate not to lose market share, gave middle management the green light to construct flexible re-draw accounts, hand out additional lines of credit, and make valuations based on future estimates rather then current estimates. One can still see these products being advertised this very day. Mr and Mrs Smith, pooling their dual incomes to buy the first property, and not obviously not content to leave their current house, are given the option by banking to capitalise immediately off the gains in property value. Seeing how easily everyone else is making money, and how great it would be to secure their kids future (which translates: we’d like to buy more luxury items like BMW’s and renovations on credit), they seek out broken down properties. Armed with extensive expertise, ranging from a book with the words “Secret” and “Millionare” in the title, and a taped season of “The Block”, they set to work, buying something that looks grotesque but fits the books simple to follow criteria, and set to work with budgeting the renovations. After completing without a hitch (except of course, being 20 grand over budget and some minor plumbing problems), and with the overworked councils approval, they take advantage of the secret ancient art of the “auction” to drum up interest and make a quick sale.

Mr and Mrs Smith are ecstatic to learn they just made a gross profit of $120 000 off the sale, with only 6 months work and $40 000 worth of expenses, giving them a net profit of $80 000; not bad for 6 months work done by relative rookies! They gloat to their friends about how they skillfully managed their finances (except for the $20 000 over budget, but who’s counting?), and now the little tots in the house can look forward to an inherited BMW as part of the loot when their parents hit 76.9 years. No doubt, these people would be patting themselves on the back. But there was no skill involved. All they did was hold a highly appreciating asset for 6 months. Its highly unlikely that with all the renovation and flip business plans going around 4 years ago, that many of them added real value to the house. Why? Because inexperienced project managers are terrible at keeping costs low. A renovated house doesn’t fool anyone either. Almost everyone is capable of getting free estimates, thinking of a plan, and articulating those ideas into a property their interested in. Mr and Mrs Smith did not add value, they merely traded the property like a stock, and made some cosmetic changes to make the “For Sale” ad in the classifieds slightly more appealing. All they did for their $80 000 is banked off the next wave of people just like them, either buying a property for the first time, looking to flip, or looking to secure a ‘cash flow’.

That brings me to the next type of person in the property bull market mix; those looking to secure a cash flow with an asset those also appreciates over time. This group of people tend to be older, wealthier, have either paid off their mortgage or close to, and are thinking about the long term. A housing bull market has given them a strong financial position, with their house appreciating upward of 40%. They aren’t looking for nicer things; they just want to insure what they already have. Since property seems safe, rent is always going to be a solid earner, they lean away towards a full stock portfolio, and use property as a way to diversify. They too draw on their loan, but this time its to find good solid rental properties. New apartment complexes built in highly sought after locations are the usual targets, because of the perceived safety in rental incomes, with no need to under take messy operations like renovations and permits. Apartments are also cheaper, and provide a stronger rental return vs asset worth. They take a draw on their existing house, and use tax conscious strategies like negative gearing, and keeping the asset portfolio in someone else’s name. They’re prepared to sit on this property for 10-15 years, renting it out, until there’s a need for additional cash. Meriton and other property investment companies would kill their own family for a list of these people, as they buy off the plan and give them a strong cash flow stability.

Unfortuntely for all of the above, there comes a time when buyers dry up. People are no longer willing, or even unable, to pay more. As people with cash flow problems begin to sell, it slowly depresses the market. But why isn’t this a bubble? Its simple, people will just sit on their house. Flippers will either bite the bullet, hold on, and start renting the house, or will liquidate for a small loss. The longer term property investor will also hold, still happy as long as prices remain constant. So long as people are comfortable with holding an asset after the mass appreciation phase has swept over, its not a bubble. Remember, there’s still buyer pressure. People are still (grudgingly) entering the market, because of either cultural pressures or thanks to appreciation of other assets like stocks, giving them the extra capital they need to enter. Wages are also on the rise thanks to an expanding economy. Rising wages gives existing housing owners encouragement to ‘upgrade’ to a better home. There’s a million reasons why people would buy property in this current climate. This balancing act has occurred in the Sydney market for the last 2 years. Property prices are flat, and will probably remain flat for the next couple of years at least. For historical context, the Japanese housing market also went through a mass explosion in the late 80s. What followed was flat prices for the next 16 years. Luckily, the Japanese real estate market was a far bigger explosion then our own.

Hope this explains why the housing market went hot, and is now lukewarm in Sydney, Perth, and still with some steam in Brisbane, Adelaide, and Melbourne (whom are further behind in their cycles). “A generation’s home dream vanishes” seems to suggest that this phenomenon is limited to Australia. Although its true that Australia’s culture, city/state planning, and infrastructure development give people less options when it comes to location, this is mostly the creation of a country which is low on arable land. This forced centralisation, which breeds most housing problems. Housing markets in California, New York, and major European cities like Madrid, Amsterdam, and Paris all face similar problems. Using English-speaking only countries as a bench mark is ridiculous, because its an economically irrelevant way to divide up nations.

Numbers the newspapers will spin to make Australia #1. With an election looming, and the public demanding politicians wave a magic wand to fix the problem, no doubt economists will be busy debunking silly ideas. No politician in their right mind would stand up, and tell the Australian public the truth; housing prices are high because demand outweighs supply, and there’s nothing a Federal Government can do short of city planning and investment tax breaks that will change that. The Sydney Morning Herald presents the speculator as the core problem with affordability. Money coming into the housing market encourages investment, which gives an incentive for large developers to undertake large housing projects in high demand areas. No, the problem with housing is that all the speculators have left, the market is stagnant, and there’s little incentive for big developers to offer aggressive housing projects. Once again, supply and demand shows its ugly face. The characteristics of housing mean people are prepared to wait and see, holding supply back. Demand stagnates, giving little incentive for investment into more housing. The media has deemed the current level ‘unaffordable’. Thats probably true, but to blame the government, speculators, and even the Reserve Bank for the problem is insane. The real problem is we think everyone is entitled to a house in the best location possible, and so long as our culture stays stagnant, so will our housing problems. If we truly want everyone to own the home of their dreams, then we need to look at fundamental supply issues; town planning, and centric thinking. This hard truth won’t stop the politicians from promising a quick fix, or the voters for buying the idea, sadly.