Tuesday, 18 December 2012

Home on the Sheep’s Back - Home on Ponzi Finance - or Home & Away?

IAustralia is experiencing an unsustainable housing bubble?

Is the growth in house values based upon sound fundamentals or are Australian house prices severely overvalued and due for a correction?

The property industry and industry experts and real estate “spruikers” would have you believe that Australia is different to the rest of the world and that our housing market is underpinned by a strong economy, high population growth and housing shortages as well as a strong banking system.
So who is correct?

Australia’s housing market is being underpinned by, what could be called, “Ponzi finance”, whereby the rental income from a property does not cover the debt expense incurred to purchase the asset, therefore, requiring perpetual capital growth, a supply of “greater fools” or subsequent investors to eventually purchase and ever-increasing levels of debt to perpetuate it?

According to the Australian Bureau of Statistics, real rents have increased by around 15 per cent since 1987 whilst real house prices have risen by around 165 per cent over the same period. It is no surprise, then, that yields on rental houses have plummeted from around 8 per cent in 1987 to 3.5 per cent currently.

Could our housing market then be a debt-fuelled time bomb or a bubble in search of a prick?

Prices of productive rural properties such as cattle and grain farms have, historically,   always enjoyed capital gain regardless of the return to capital being generated and over decades, prices rose and then levelled out but never dropped – until now where we have seen reductions in market value of around 20% common.

Rural valuers HTW report that “Throughout the year (2010) we have seen varying stages of value corrections, with most areas back a minimum of 10%, and up to 30% or more in some cases. Values may continue to decrease until they are at a level where purchasers can acquire these assets and achieve a reasonable rate of return….”

So back to the housing market and the “Ponzi finance” theory, where investors and owner occupiers have been leveraging up, and “negative gearing”  to buy property in the hope of achieving continued rapid capital growth  or ‘getting in’ before prices increase further.

With the significant low or negative income returns from holding residential property, the only way that house prices can continue to increase faster than incomes is if buyers believe that prices will continue rising and that large capital gains can be made by selling the same asset to other buyers (the ‘greater fool’ theory). Such a scenario requiring ever-increasing debt levels, could well be unsustainable.

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