Thursday, December 23, 2010

RP Data: Don't worry, be happy

"It is difficult to get a man to understand something when his salary depends upon his not understanding it." So said Upton Sinclair in 1935, but the words could equally be applied to the Australian property lobby today. As the housing market starts to slowly deflate (and in some areas like the Gold Coast shows signs of serious distress), we are being reassured it's now "a buyer's market", that any price declines will be very modest, and that fundamentals such as population growth and tight supply will continue to provide support.

RP Data's "Property Outlook" for 2011 is a classic example of this "move right along, nothing to worry about, she'll be right, don't worry be happy" attitude:
A variety of indicators are now suggesting that market conditions will continue to transition in favour of buyers... Despite the fact that the Australian housing market has moved out of the growth phase, this down turn is not likely to result in any material declines in home values. 

The good news is that Australia continues to record strong population growth.  Overseas migration to Australia appears to have peaked, however total population growth remains well above average...  Such a high rate of population growth will continue to create a high level of demand for Australian housing.  Coupled with the fact that, as a nation, Australia is building too few dwellings, the undersupply of housing is not likely to be corrected any time soon...
Now, I have argued before (see this post, for example) that population growth, supply constraints, etc are -- while worthy of examination -- largely a distraction from the broader issue, which is actually very simple: Australian house prices have grown much faster than household incomes for far too long, which means that the amount of mortgage debt required by the average household to buy an average Australian house today has simply reached unsupportable levels. The logical conclusion from this is that prices have to fall -- perhaps by quite a lot -- to restore affordability.

This is the same conclusion that a lot of overseas analysts come to after a quick glance at the relationship between Australian house prices and incomes. See p. 16 of this piece, from the well respected fund manager Jeremy Grantham, for example:
The key question to ask is: Can a new cohort of young buyers afford to buy starter houses in your city at normal mortgage rates and normal down payment conditions? If not, the game is over and we are just waiting for the ref to blow the whistle. In Australia’s case, the timing and speed of the decline is very uncertain, but the outcome is inevitable. For example, the average buyer in Sydney has to pay at least 7.5 times income for the average house... With current mortgage rates at 7.5%, this means that the average buyer would have to chew up 56% of total income (7.5 x 7.5), and the new buyer even more. Good luck to them!
Grantham notes that the sheer vitriol he faces when making such arguments, is, in itself, a sign that something is probably deeply wrong:
Australia ... does pass one bubble test spectacularly: we have always found that pointing out a bubble – particularly a housing bubble – is very upsetting. After all, almost everyone has a house and, not surprisingly, likes the idea that its recent doubling in value accurately reflects its doubling in service provided, e.g., it keeps the rain out better than it used to, etc. Just kidding... In any case, Australians violently object to the idea that their houses, which have doubled in value in 8 years and quadrupled in 21, are in a bubble.
Indeed, in response to such "simplistic" arguments, the RP Datas of the world invitably become indignant and roll out the "supply shortage" cannon. This is probably the single largest enduring myth surrounding the Australian property market, and it is repeated so often that many Australians have simply accepted it as fact. For this reason, it is important to examine the merits of the argument. I am not going to go into great detail on this, because The Unconventional Economist has already done an excellent job in debunking the "housing shortage" argument here.

But a couple of quick points are in order about RP Data's claims above. Firstly, Australia's rate of population growth has slowed considerably. The political appetite for the high levels of immigration seen in recent years seems to be waning, while the number of international students entering Australia is declining sharply, partly due to the strong Australian dollar.  In fact, the number of permanent and long-term migrants coming to Australia over the year to July was down by a record 32.5 per cent (see display below).

Source: RP Data

If you believe in the argument that strong population growth supports house prices (see the chart below from the IMF) then this development should trouble you.

Secondly, while it is true that we have an undersupply of affordable housing, the argument that we are not building enough to keep up with population growth is highly suspect. The display below, from the RBA's Ric Battelino, shows that overall, the number of dwellings in Australia has easily outpaced the growth in the number of households since the mid 1980s.

Here's what Battelino had to say in a November 2009 speech accompanying this chart:
Census data show that the number of dwellings built has exceeded the increase in the number of households by a large margin. As a result, the ratio of the number of dwellings to the number of households has been rising over time; as at 2006, there were 8 per cent more dwellings in Australia than there were households. Presumably, most of this surplus reflects holiday houses and second houses.
Presumably, many of these holiday houses and second homes are also held by the baby boomer generation, which is currently entering retirement. The question is, if prices fall sharply, how many baby boomers will decide to cash in on these investments, accelerating the downturn?

When you are in the midst of a speculative boom, it always looks like there is a lack of supply. The same argument was made in many parts of the United States, Spain, Ireland, etc.  What subsequently became obvious in many of these markets was that it wasn't so much a lack of supply that was the problem; it was an oversupply of demand from speculators, or "investors".

When the good times eventually end, holiday houses and second homes will be sold, children in their 20s will move back in with their parents, foreign investors will sell their property investments as the Australian dollar falls, and the apparent "supply shortage" will suddenly turn into a glut of properties that cannot be sold.

Just don't expect RP Data to tell you this first.

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