Foundations in place for a housing-led recovery

Can the Australian housing market recover as it has in the past or is it different this time? Ask any foreign money manager what scares them about the Australian sharemarket and they will invariably say the risk of a housing collapse because of gross overvaluations.

Can the Australian housing market recover as it has in the past or is it different this time? Ask any foreign money manager what scares them about the Australian sharemarket and they will invariably say the risk of a housing collapse because of gross overvaluations.

It makes a lot of sense. Virtually all the western world has seen house prices crumble since 2007 while Australia's residential market has defied gravity, recording only gentle declines. The median house price in Australia is about six times the median household income, some 30 per cent greater than the US and the long-term average.

Does this predicament mean that a housing recovery in Australia is a pipe dream? Is housing going to be a handbrake in the coming years rather than the path to economic prosperity? No one has a clear answer but it is the seminal question for sharemarket investors as we enter 2013.

The bulls like myself believe that history will repeat and lower interest rates will eventually trigger a building cycle that in turn will drive domestic growth. The bears counter this argument by saying it is different this time because household debt still sits at a lofty 172 per cent of gross income. They believe any spare income from lower rates will be used to pay down debts and not ploughed into the property market. In the early 1990s household debt was only about 50 per cent of gross income, providing a sturdier platform for a housing boom.

If the housing bears are on the money the Australian economy has a real chance of falling into a recession in the coming years as the peak of the mining and energy boom passes. We may talk about developing new areas of growth such as education, technology, tourism and high-level manufacturing, but the reality is these are niche industries that will take many years to develop into major engines of growth. Housing is our only realistic hope of avoiding a protracted period of substandard economic growth.

Last week the building materials group CSR said it was optimistic that a recovery in housing activity was in its nascent stages and pointed to a spike in housing finance as a strong lead indicator for future building activity.

Housing starts in Australia have sunk to a multi-year low of about 125,000 and are predicted to rise to 140,000 next year, with the moribund Sydney market surprisingly leading the charge. The long-term average for Australia is about 150,000 starts, but underlying demand is closer to 170,000 given population growth.

Goldman Sachs wrote earlier this year if the Reserve Bank managed to reduce official interest rates to 2.75 per cent by 2014 then housing starts could jump over 180,000 by 2015. That would be a full-blown recovery and a boon for the economy as the tailwinds from the mining and energy booms drop off. A jump in housing starts drives growth for banks, construction companies and retailers. It is also a major employer.

In previous economic downturns - in the early 1990s and after the global financial crisis - building activity led the recovery. In simple terms: lower interest rates unearth the first home buyer who is always in the market if they can afford a house. It also entices investors looking to achieve a return on their money rather than be stuck with cash in a low interest rate environment. As the Reserve Bank governor, Glenn Stevens, suggested recently it is time to look at riskier assets.

This time it may be different though. Just like in the US, lower interest rates are taking a long time to have an impact. The RBA has cut rates by 125 basis points over the past year and we are still waiting for a tangible increase in housing starts. The lead indicators such as approvals, finance and auction clearances are heading in the right direction but 2013 will be a key year in working out whether the old rule that lower interest rates automatically fires housing activity still applies.

It would seem a gradual housing recovery is at last taking place in the US, more than five years after the peak. Zero interest rates and a dramatic decline in prices have taken several years to have any meaningful impact. The US market was in a different position to Australia with supply of housing outstripping demand by several million. This has been slowly whittled down and seems to have realigned at last. Fortunately for Australia this supply and demand imbalance never really existed and saved the country from a 40 per cent collapse in prices.

I am a bull on housing. I believe lower rates will eventually increase starts even if the rise is more gradual this time. The threat of high prices is a genuine one and investors should not expect major capital growth for three or possibly five years. It may well be enough if house prices simply remain steady during this period. My view depends heavily on the Reserve continuing to lower rates next year, allowing first home buyers to enter the fray. With a surge of people entering the first-home buying age of 30 to 34 years in the next five years, construction could well reach record levels.

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