by Steve Keen on 21 May, I'm starting this thread to record thoughts regarding a (potential) housing bubble in Australia.
For what it's worth here are my thoughts:
Australian housing prices are high and in bubble territory. However we know from previous bubbles (eg. Nasdaq late 1990s) that the mere existence of a bubble is not sufficient for prices to (1) stop rising and (2) start falling.
Keen recently lost a very public bet with a Macquarie Bank economist regarding the movement of Aussie house prices. My view is that Keen is right, just very early.
While I agree that Aussie house prices are high by a variety of measures, one thing that may provide *some* kind of floor under the housing market is the tax treatment of investment properties in Australia.
Specifically, it is possible to make a tax-deductible loss on the operating costs of housing investment (eg. rent received less interest paid on loans less maintenance expenses), in the hope of making a capital gain.
Furthermore, long-term capital gains (holding period 1 year or more) are taxed at 50% of the normal marginal tax rate. For a taxpayer on the highest bracket, long-term capital gains will be taxed at 22.50% and not the usual 45%.
So let's assume that the RBA cuts interest rates to 0.25%. In this situation there will still be demand for housing (and those who won't sell) given this generous tax treatment.
Since 2000, the Aussie government has had a history of providing grants to first home buyers. Given that the Aussie govt debt / GBP ratio is lower than that of many countries, especially PIIGS nations, it is possible that if Aussie house prices experienced a significant decline (10% ? 20% ?) then these grants could be increased. This is particularly true given that a Federal election is expected before the end of 2010, and that many swinging voters look to move up the socio-economic ladder by "investing" in property.
Summary:
* House prices in bubble, but waiting for confirmation of bubble popping before considering trades to capitalise on the bubble deflating. Such trades include buying Aussie govt bonds, shorting AUD/USD, shorting Aussie banks (CBA, WBC, NAB, ANZ, BEN, BOQ)
* Some government policies (negative gearing; capital gains discount) will provide a floor under house prices, so that declines may not be as big as some house price bears expect.
* Low government debt to GDP ratio provides room for the Federal Government to increase existing home buyer grants without the bond market vigilantes punishing such a move
* Wildcards include the deflationary clouds hovering in Europe, negative wealth effect of a declining stockmarket and an economic contraction in China. If one or more of these factors hit the Aussie economy, then a housing decline could be deeper than if these factors were not present.
While I agree that Aussie house prices are high by a variety of measures, one thing that may provide *some* kind of floor under the housing market is the tax treatment of investment properties in Australia.
Specifically, it is possible to make a tax-deductible loss on the operating costs of housing investment (eg. rent received less interest paid on loans less maintenance expenses), in the hope of making a capital gain.
Furthermore, long-term capital gains (holding period 1 year or more) are taxed at 50% of the normal marginal tax rate. For a taxpayer on the highest bracket, long-term capital gains will be taxed at 22.50% and not the usual 45%.
So let's assume that the RBA cuts interest rates to 0.25%. In this situation there will still be demand for housing (and those who won't sell) given this generous tax treatment.
Sounds plausible, but it's wrong, at least it has been wrong in every single bubble and crash I have traded and studied. In fact, distortions like these are often what *inflates* the bubble even further before it finally crashes i.e. they make the crash more likely and more severe, not less. Things like this are always trotted out as rationalisations of bubbles, and are always cited as reasons why a crash can't happen, or why it will be small if it does happen. Remember how California and Florida real estate couldn't go down because of migration to those states? Remember how Hong Kong property couldn't go down because of the crowding and low taxes there?
Capital gains in the UK were cut a couple of years ago, from 40% to 18%. The housing market crashed shortly afterwards. So tax rates do not in any way stop a housing crash. The UK also used to have tax write-offs on investment property, yet still had housing crashes. In fact, in the late 80s the government eventually abolished this write-off, helping to precipitate another crash. With tax revenues in danger, and the left-wing Australian government announcing capricious new taxes (e.g. on the mining sector), I would say that both capital gains tax AND the favourable tax treatment of investment properties are in danger. Neither make any sense - income should not be taxed at double the capital gains rate, it's grossly unfair to wage earners, and subsidizing property speculators is also politically untenable in the long-run. These two tax breaks are thus arguably *strong bear points*, not bull points. At best, they are neutral, just as similar things were neutral in the past great post-bubble crashes.
As for cutting rates to 0.25%, in the UK the BoE cut rates from over 5% to 0.5% in under 2 years. The housing market still fell 25% on average, and the more speculative areas such as provincial new builds and 3rd tier locations fell up to 50%. The Fed slashed rates similarly, down to 0.25% - Miami still fell 50%+, Vegas still got annihilated. So cutting rates won't stop a crash either.
There will always be people who won't sell. But they don't set prices, any more than people who never buy would set prices. Prices are set by the marginal buyer and seller. If the marginal seller goes from patient seller (relocations, divorces, deaths etc) to bank foreclosure, and the marginal buyer goes from wealth confident property investor or desperate family buyer in a tight market, to beady-eyed bargain-hunting distress investor and scared witless first-time buyers who can't get mortgages with less than 30% deposits, have a guess what that will do to prices at the margin.
Typical turnover in the property market is 2-4% per annum. So a mere 1% of homeowners needing to sell in a hurry means that 25-50% of the market each year is now being liquidated by desperate price-slashing sellers. At the same time, a mere 3-4% of the population getting scared about investing in houses means that almost 100% of the annual demand will shift to significantly lower prices. Look at the ratio of foreclosure sales as a % of total houses for sale in prior bubble areas of the USA, it is gigantic, and totally swamps the average buyer or seller. On a street of 100 houses, if only 3 are for sale, and 2 are defaulting sellers/bank foreclosures, then the entire street is worth maybe 15-25% less than if there's just one patient seller who is in a comfortable situation, and multiple desperate/confident buyers.
I recommend you look back at the posts on the US/UK housing market on ET in 2005-2007. There was vigorous debate between bulls and bears as to whether there was a bubble, how big it was, would it crash, would "demographics" and other factors stop a crash. Many experienced real estate investors there, not just clueless noob johnny come lately property pikers, were totally blindsided because they focused on things like relative valuation/comps, ignoring outright valuation measures like rental yields and price to income ratios. Even quite a few bears lacked conviction because of these factors. Yet the crash came and it was gigantic. Focusing on patterns and lessons from prior bubbles was what let the bears spot the bubble and the inevitability of the subsequent crash.
I agree 100% that the timing and execution of bubble trades is very important. Choice of trading vehicles is also critical - as John Paulson showed, it can make a giant difference to returns. Last but not least, having a strategy for hanging on, and how to handle the numerous large bear market rallies, is also critical. Many US housing bears got out too early, or got stopped out by the huge bear market rallies in 2008, before things hit bottom.
I would like to add, that the current China RE bubble is and will be playing a significant role in defining the correct timing of the bursts at either side.
* Nicolas Perpitch
* From: The Australian
* May 20, 2010 12:00AM
WESTERN Australia's first-home buyers market has collapsed because of continued interest rate hikes and the end of the first-home owners grant, the state's real estate institute says.
Figures from the Office of State Revenue show there were 988 first-home buyers last month, compared with 2322 in April last year. This is the lowest level in 10 years, along with a point in mid-2007 just before the state government announced it was raising the stamp duty threshold to $500,000.
The figures reflect yesterday's Westpac Melbourne Institute consumer sentiment index survey showing a fall in consumer confidence from 116.1 points to 108 points, largely attributed to rising mortgage rates.
In the northern Perth suburb of Ellenbrook, which last year had one of the highest rates of home purchases in the state, estate agents said sales had been "running riot" but were now a trickle.
Christian Smith, principal at Century 21, said sales had fallen by 60 per cent on last year, with virtually no first-home buyers.
"We've got houses on the market for $320,000 to $360,000 with minimal inquiries, whereas you go back 12 months and you couldn't get enough stock."
Real Estate Institute of Western Australia research director Stewart Darby pointed to the six interest rate rises in eight months and the end of the first-home owners grant of up to $7000 on December 31.
"The FHOG boost was great," he said. "It soaked up a lot of excess housing. But the major point is it operated in both established and new home markets, and it really pulled a lot buyers forward.
"You wonder if there are still any first-home buyers around."
Institute figures show a 15 per cent drop in Perth home sales last month, and a rise in unsold properties from 12,700 at the end of March to 13,400 now.
Sydney's property market has suddenly caught a cold.
Auction clearance rates in the past two weeks have been down and agents report fewer visitors to open houses.
Properties were being passed in because buyers were reluctant to commit, said Paul Lowe, of Ray White Double Bay.
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''The last interest rate rise has put some uncertainty in the minds of most buyers,'' he said.
Most inner-west agents detect a cool wind blowing through their recently booming market.
''None of the vendors are happy,'' a Newtown agent, Ee Poh Ling, said. ''I've seen it before, in October 2003. It was hot as crazy. the following week I stood at an open and I said, 'Did I forget to put an ad in, where are my buyers?' ''
Sharlene Purser, an agent in Marrickville, is blunt: ''It's died in the arse.''
Faced with fewer buyers, many agents are encouraging vendors to sell before auction. Colin Hills, from Forsyth Willoughby, recently sold 3 Milton Street, Frenchs Forest, for $830,000 before auction.
Mr Hills said he had 40 groups through the home and they had given a price indication of just under $800,000. The successful buyer pushed the boundaries, he said, and the vendor accepted.
Despite the sudden chill in the property market, no one is predicting that prices are about to plummet. After a year in which median prices jumped 20 per cent, the senior economist at BIS Shrapnel, Jason Anderson, is instead forecasting a quarter of no growth, either in the June or September quarters.
''For some people, I suppose that will be a cold shower,'' Mr Anderson said. The slowing of the market could then encourage more first-time buyers.
