PORTFOLIO POINT: While property prices may not spike as significantly as they did in 2009, low interest rates plus cashed-up investors would appear to equal a solid rebound.
There’s been a lot of talk about bubbles of late – the latest bout occurring in the wake of the Reserve Bank of Australia’s interest rate decision last week.
Specifically, Moody’s warned that low interest rates could spark a new housing bubble domestically – and it is not alone in these sentiments. They have been mirrored by former Future Fund chairman David Murray, the Australian CEO at ANZ Phil Chronican, and the head of property at the Future Fund Barry Brakey.
At a casual glance I can appreciate why some would argue that it is absurd to be warning of a new housing bubble– credit growth is at its lowest in about 30 years, after all. Yet I don’t think these fears are without foundation.
The key piece of evidence is simple – the Australian experience during 2009. Recall during that time that the Reserve Bank had just cut rates to 3%, and within the space of a year house prices surged, rising 18.8% year-to-year to the March quarter of 2010.
What was so striking was the rapidity of the price spike, catching many of guard. The market went from recording price falls, averaging 3% per quarter in the preceding three quarters, to recording strong price gains – in the space of one quarter. That’s a very rapid turnaround when you consider the global and domestic backdrop.
As we know, the global economy was in a recession – an actual recession, not the pretend ones we’ve had every year since then. Australia was flirting with recession, the unemployment rate had shot up to 5.6% (0.5% points more than it is now) and it was a very real possibility. Yet amidst all of that, house prices surged. Indeed I had recommended to investors in late 2008 (following aggressive central bank action) to gear up and pile into property. Bubble or not, it was a good call then and I believe it to be a good call now.
The way I see it, we sit in a much better position than were we were in 2009. The global economy is nowhere near recession, and although the Australian recession call is ongoing no data supports this. It’s not even close, whereas in 2009 it was. We also need to consider three key misnomers doing the rounds in the market:
- That consumers are cautious and risk averse;
- That consumers are heavily indebted, and;
- That a rising unemployment rate will subdue the market.
Property bears would argue that these three key factors are weighing, and will continue to weigh, preventing any marked upturn. I would disagree.
The consumer caution thesis has been around for a while, but in all honesty I’ve never found the arguments to be all that compelling. Not only does the house price experience of 2009 illustrate the flaw of this hypothesis but, even more simply, the broadest measure of consumer spending, the national accounts, shows that consumers have been out and about spending for some time. Spending is strong. They certainly haven’t put their wallets away, although that may be the experience of some individual retailers. But for those retailers, their troubles appear to reflect company-specific issues – poor service, poor product offering and the like. That’s not to forget a change in consumer spending preferences – rather than a broader malaise.
We know that consumers are not risk averse, because they are going overseas in record numbers, buying cars in record numbers and spending quite heavily on discretionary items more generally, such as electronic gadgetry including iPhones and iPads. We not only see it in the national accounts, but also company accounts as well. So to believe that consumers are being cautious, you have to dismiss a lot of multi-source complementary data – and I just don’t think it is reasonable to do that.
As for the idea that consumers are heavily indebted. This is usually backed by charts, such as the one below from the RBA.
It shows debt, as a percentage of disposable income, has surged to 150% of disposable income. Of course, pictures can be misleading. What the chart doesn’t tell us is that interest rates (or the price of money) have plummeted over that period. As we know, if you lower the price of something, in this case money, people will buy more of it. And that’s what they did – people could afford much larger loans. That doesn’t mean they have too much debt.
Indeed the idea that consumers have too much debt, while popular, is inconsistent with three key facts:
- Only about one-third of consumers have a mortgage. For interest, another one-third have paid off their debt and one-third rent;
- The average mortgage outstanding is about $200,000, which is 2.2 times the average household income of about $90,000 ;
- Of that one-third who have mortgages, 50% are estimated by the RBA to be ahead on repayments. Of those, 40% have a buffer of one year or more (see chart 2).
Note that I only refer to mortgage debt because this is what constitutes the vast majority of consumer debt. The remainder is nominal and doesn’t affect the above analysis.
Now this result is largely independent of one’s view of house prices already – that is, whether they are already expensive or not. People will argue they are, others will argue they’re not. That’s not the issue, the way I see it. The issue is whether property prices can push higher, regardless of whether that’s from a high or low base.
And that’s because the question is answered, not by referring to an absolute debt level or some debt-to-income ratio relative to some other point in history when the world was so different. Rather, it’s answered by reference to the amount of debt consumers can service. At its recent peak, debt servicing was about 13% of disposable income and now it sits at closer to 10%. So we know it can push comfortably higher. Similarly we know it can push higher because 60% of Australians don’t have a mortgage. That is, Australian’s are not heavily indebted and the price of money is extremely cheap and getting cheaper. Add to that the fact that disposable incomes are rising at a decent clip, that savings rates are around 10% and the unemployment rate is low, and yes house prices can certainly push markedly higher.
The elephant in the room is of course the fact that we’ve been talking about only one side of the balance sheet. Debt, liabilities – debt servicing. No discussion is complete without acknowledging the strong asset position of Australian households.
Chart 4, from the RBA shows that while debt might be 150% of disposable income, net worth is around 600% of disposable income. Financial assets alone are 300% of disposable income (twice the size of our debt). More to the point, and with saving rates around the 10% mark, a good portion of this is held in highly liquid cash.
Chart 5 shows that investable funds held in term deposits are at $228 billion. This is around 15% of total funds under management – more than double the rate that prevailed in the 20 years prior to the GFC. If the proportion of funds held in deposit were to normalise, that would free up $150 billion for investment into other asset classes – including property. And that’s unleveraged. Including the leverage there is, theoretically, $1.5 trillion available to be reinvested into the property market just from a portfolio allocation out of cash. I appreciate that it is highly unlikely all of this money would find its way into the property sector. But the point is, it is there. It is available if investors choose. And with interest rates on deposits being cut, investors just may choose property.
The final headwind cited is the high probability that the unemployment rate will rise. What if, as many expect, the unemployment rate rises? Could this stymie house price growth. Yes, it certainly could is this answer, but history suggests the impact need not be significant. For instance, back in 2002-2003 when house prices were surging around 15-20%, the unemployment rate was 6% or over – and yet house prices still surged. Indeed employment growth, especially in 2003, wasn’t at all strong, rising by an average 4,000 per month in the first half of 2003. Employment growth has averaged 10,000 per month in 2012.
Overall then, I do think another property bubble is entirely plausible at some point. But that’s not a signal for investors to avoid the market. On the contrary, with credit growth currently at recessionary levels and given the strength of household balance sheets, I suspect a dangerous bubble is some way off.
In the meantime, the analysis above suggests investors should remember the experience of 2009 and consider turning their gaze back to the market.