Is Australia in a property price bubble?
The inexorable rise of prices during the past two decades has caused many to argue that Australian housing is overvalued.
Surveys by The Economist and Demographia claim that Australian homes are among the most expensive in the English-speaking world.
On the other hand, the Reserve Bank of Australia acknowledges that Australian homes are far more expensive than they used to be, but considers them unexceptional by global standards. So who's right?
Cross-country comparisons of house prices against incomes and rents are inherently problematic, but comparing the total value of a nation's housing stock against the size of its economy makes for a more useful comparison.
Australia's ratio of housing stock to gross domestic product increased by more than 50 per cent from the mid-1990s, peaking at 3.3 times GDP in 2007 and 2010. It has since fallen back to about 2.9 times GDP, similar to that of New Zealand and Britain but much higher than the ratios of the US and Canada. By international standards, this simple measure confirms the view that Australian housing is relatively expensive but by no means head and shoulders above every other country's.
There's another consideration, though. Declining house prices, near-record low mortgage rates and rising incomes have improved housing affordability, although repayments on a median-priced house remain above their 40-year average.
The argument that housing supply hasn't kept pace with population growth also has some merit. Since the mid-2000s, population growth has been well above average, while dwelling construction has hovered around it. But that doesn't mean tight housing supply will insulate home owners against significant price falls.
With excess bedrooms in the pre-existing housing stock, if economic conditions deteriorated then share accommodation would probably increase, turning a perceived housing shortage into a surplus.
It's not an outlandish proposition. Household formation rates in the US fell to 65-year lows in the three years following the global financial crisis, leading to a large oversupply of homes and exacerbating the downturn in prices and rents.
In the US from 2000 to 2010 the key "bubble" states of California, Nevada, Arizona and Florida experienced lower rates of housing construction than Australia.
Rising housing debt was the key driver of Australian home prices until 2004 but strongly rising incomes from the commodity boom have played a greater role since.
A reversal of this trend could prompt a severe correction of house prices. A slowing Chinese economy or an increase in global commodity supplies could cause a sharp reduction in incomes and employment.
How should you protect your portfolio against this potential risk? Under a prolonged commodity price correction, Australia's banks would be in the firing line. They're heavily exposed to the housing market, with the proportion of total loans comprised of mortgages growing from 24 per cent in 1990 to 59 per cent now.
Much of this lending has been financed from abroad, so the key risk is in the banks' ability to refinance their borrowings. This is where it gets tricky. Under the disaster scenario, with banks trying to repay foreign creditors and new domestic lending restricted, Australia's banks and housing sectors would be very hard hit.
If you own your home and have a significant chunk of your portfolio in banks or mortgage insurers such as QBE Insurance, you're particularly at risk.
Buying a home is an emotional decision, making the rational assessment of an asset difficult. This also explains why articles such as this are so often quickly dismissed.
But if you own your own home or an investment property or two and have more than 10 per cent of your portfolio in banks and another 5 per cent in QBE Insurance, for example, you're very exposed to falling home prices. If you work in financial markets or the resources sector, you're even more vulnerable.
None of this is meant to indicate an impending crash. But a slowdown in demand for our raw materials could have devastating implications across the country. Now is the time to make preparations.
You can guard against the chances of a crash in house prices by reducing your exposure to those businesses most exposed to the housing sector, and by allocating a higher percentage of your portfolio to international stocks.
The yield you may forgo could come back to you gift-wrapped in a falling currency. There's always an opportunity in every challenge.
This article contains general investment advice only (under AFSL 282288). Leith van Onselen is an analyst for MacroBusiness. This article was written in conjunction with Intelligent Investor share advisor, shares.intelligentinvestor.com.au.
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