If you’re in your twenties or thirties and either recently bought or want to buy property in the near future, do yourself a favour and speak to a baby boomer about interest rates. There were stages in the last fifty years when interest rates were four times higher than today. Interest rates right now are incredibly low, as low as they can go. This might seem like the best time to jump into the real estate market but the view on the horizon needs to be considered.
Counter Collective interviewed a senior executive at one of the Big 4 banks who agreed to speak on terms of anonymity. This executive states that a housing market crash in Australia is no longer avoidable. First, we need to look at what caused the bubble.
The booming Chinese economy caused many in China to look for investments outside their country. In recent times the Australian government has introduced weak tools to curb this but if you have been to an auction lately you will know that the number of Chinese bidders (or their proxies) has increased and they seem to have an endless supply of money. This added competition has driven up demand and prices have followed.
Low interest rates and metro population flooding
As mentioned before, there has never been a better time to borrow money. Depending on your bank and the terms of your loan you can get 3-4%. Combine this with the increasing number of people moving into metro areas and demand increases even further.
Investment and negative gearing
Negative gearing skews market advantage to those who have access to big loans and tax benefits. Often these investors leverage existing property as security to take out multiple ‘interest-only’ loans, rent out the property and rake in a 10% per year return on their risk.
If every Australian could afford a house at today’s prices I don’t think anyone would complain about prices going through the roof, but unfortunately this is not the case. Young Aussies entering the market are crippled with massive loans that hinge on multiple incomes and thinly stretched budgets.
At the current rate of growth, the median metro house price in Melbourne will be $1,800,000 ten years from now, while the average dual income only climbs to $160,000 p.a. Even if you manage to save $180,000 for a 10% deposit, your monthly mortgage will be over $8,000 or 90% of income. This is obviously unsustainable.
Going back to the causes of the bubble you will notice three drivers: foreign buyers, low interest rates and gluttonous investing. Like a tripod, if one leg fails the others will give way.
As an example of how fragile the system is, we will use Mike as an example. Mike (32) is an office professional working in Melbourne CBD who inherited his family home fully paid for. The Burwood house was bought by his father in 1980 for $90,000. Mike, who wants to use this house to catapult his family into wealth and riches, consults banks and real-estate agents who convinces him to sign over the family home as security to purchase three other houses on an interest-only loan. The renters cover the “mortgage”. At no extra cost and with a 10% annual home value increase, Mike will have earned an extra $2 million in 10 years without selling his family home, which by then would be worth $1.2 million. Sustainable, right?
Now let’s look at three likely scenarios
In scenario one, with uncertainty in the Chinese market and the big economies finding balance in fairer bilateral free trade deals, China goes into a minor depression. The banks in China increase the requirements for loans and hike the interest rate. Would-be Chinese investors now have diminished access to credit, and so stop buying up houses in Sydney and Melbourne. The Chinese economy woes filter down to Australia and the drop in foreign house buyers spooks the gluttonous, heavily leveraged domestic investors. They start offloading, creating a dip in house prices, which in turn spooks less leveraged investors to do the same. We now have low demand.
In scenario two, the average Joe who can’t afford a house votes in a government who will cut “unfair” negative gearing. This causes concern amongst heavily leveraged investors, who in turn scare away foreign investors followed by low-leverage domestic investors. They all rush to sell. We now have low demand.
In scenario three, world markets start demanding higher interest rates. Mike goes from paying nothing (his interest-only loan repayments are covered by rental income) to an additional $3000 a month for new interest payments. Due to financial pressure, Mike rushes to get out of trouble but is only able to sell his three investment properties at 90% of the cost, leaving him with a shortfall of $200,000 against his family home. Ten thousand other Mikes do the same, followed by foreign and low leveraged investors. We now have low demand.
As my banking connection tells me, often the first retort you get from real-estate agents, bankers, investor buyers and those who think this trend will go on forever is that there is too much demand for metro housing to show negative growth. The reality is, demand is driven by those who have the means to leverage 30% over actual value. The larger portion of buyers sit on a much lower pay scale. The “one family one home” people are not drivers of the current market. They are simply not paid enough to afford it. Those who know the truth say the market needs to correct 20-30% bringing in line with a more a natural growth rate for the last 20 years, thus my banking connection has sold off four properties in six months.
Another indicator he says is that the banks are using tactics to limit the amount of small development projects (for example splitting one house into two units). A few years ago if you wanted to develop property for under $30 million, you did not require a contract with your builders. As of a few weeks ago, new rules state that for development loans over a million dollars you now need all sorts of contracts with builders. This tightening is not for security but to turn away small scale developers through red tape and legal fees.
Over the next few weeks I will share more information that will show this magic carpet ride is coming to an end despite a low interest rate being used as a risky tool to keep the bubble artificially inflated. The prediction is that from early 2019 the crash will start, so keep an eye on politicians and banking execs selling property. A balance will be found come 2021 with prices leveling out at around 70-80% of today’s prices.
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