While surfing the net during a particularly asphyxiating Melbourne train trip, I came across an Sunday Telegraph article on the housing market which cited comments from the Sydney economist, Dr Steve Keen.
As usual, Dr Keen's comments were laden with predictions of economic doom, tanking house prices and warnings that first home buyers would be turfed out of their homes as they struggled under a pile of crippling debt. To reinforce his point of view, the paper sought a quote from the legendary market bear Gerard Minack, who obliged by forecasting halving of values on the Gold Coast and value drops of 20% in some cities.
To anyone who knows anything about real estate markets (and I happen to know quite a lot having worked in this area for almost 20 years), in the context of Australia's current circumstances these predictions are simply asinine, not to mention irresponsible. As with any downturn there will be individual horror stories but falls of this magnitude just aren't going to happen across the board. However, in an environment where newspapers are actively looking to run bad news stories, they will eagerly publish all manner of rubbish from all manner of idiots as long as it supports their editorial direction.
To illustrate my point, try typing "Dr Steve Keen" into Google. I did, and I gave up navigating after about 10 screens as the media references were unending. The man is so addicted to publicity you have to wonder whether he ever gets time to lecture at his university. He hoovers column space like Shane Macgowan of the Pogues hoovers whisky. The plethora of media references evoke a recent quote made by an eminent Melbourne investment banker about the American business analyst, Jim Chanos: "He's full of sh!t, but he gets an audience."
Of course it's inevitable you will get in the paper when you go and pull publicity stunts like the bet Keen entered into late last year with the Macquarie Group economist, Rory Robertson. Under the terms of the bet, if house prices drop less than 20% from their 2008 peak level, Dr Keen is required to walk from Canberra to the top of Mt Kosciusko. As Dr Keen has openly predicted a 40% drop, he presumably felt he was fairly safe in agreeing to 20%.
However, by the looks of things, he should be investing in some decent hiking boots fairly soon. The peak-to-trough looks like being closer to 8% than 20% and early signs in some capital cities are that median prices are heading up again - even BEFORE we hit the bottom of the interest rate cycle. No wonder Dr Keen is so motivated to talk things down. He can obviously see some nasty blisters in his immediate future.
Why are Keen's predictions set to fall so wide of the mark? After all, everyone has seen the horror stories in the press about US and UK house values, which seem hopelessly caught in a dangerous downward spiral. When housing in the big economies is floundering so badly, what hope does a small country like Australia have?
The answers can be found first in the fundamentals of the Australian market, which are completely different to those in the US and UK and secondly, through a basic understanding of how those fundamentals correlate and determine price movements.
House prices are predominantly driven by 4 things: supply, demand, credit availability and the big one -affordability. In fact if you were to create any chart depicting movements in house prices and overlay affordability, apart from a slight lag the correlation between the two is as close as you can get. This helps explain the dramatic collapse in prices at the start of the 1990s. In Sydney, it took approximately 80% of the average wage to pay the average Sydney mortgage - a crippling figure if there ever was one and it's hardly surprising prices plummeted when the economic bubble burst.
In most cities, prices tend to fall where 40% or more of the average salary is required to service the average mortgage, while they tend to rise when the figure drops below 30%. Despite the economic boom, with the exception of Perth prices in the capital cities didn't rise enough to reduce affordability to dangerous levels. Now thanks to a succession of huge interest rate cuts, this key figure is hovering in the mid 30% range and continuing to head down. If, and this is a big "if", unemployment doesn't rise too much then more rate cuts will give a further kick to affordability and set the scene for a return to growth in values. Contrast this to the US and UK, where even after substantial price drops, affordability is still relatively low by historic standards and further price drops will need to take place before these markets hit bottom.
In addition to being relatively affordable, the Australian market is also in the happy position of being undersupplied rather than oversupplied. A lot of the US housing market's problems can be traced to the huge amount of overbuilding that took place earlier in the decade, fuelled by a seemingly endless supply of cheap credit and price rises that ultimately proved unsustainable. Before the US can recover, it needs to work through the large volume of unsold housing stock generated by the construction boom. This will take some time but given affordability has risen substantially in the last year, the bottom now is clearly in sight. In Australia however we have been underbuilding now for a few years and vacancy rates for rental properties are around 1% in most capital cities. Given banks are reluctant to lend money to property developers at the moment to build housing, this situation is unlikely to change, even though strong migration levels into Australia would suggest a fairly urgent need for more housing.
Finally, while credit markets for commercial property markets are in the toilet, in Australia housing loans are still readily available at reasonable rates due to the strong position of our banking system relative to the UK and US. Unlike their offshore counterparts, Australian banks maintained reasonably sound credit practices through the economic boom and as a result, aren't suffering from crippled balance sheets and the consequent flow on effect to liquidity. The fact that US and UK banks just don't have money to lend to homebuyers is a cruel kick in the teeth that those markets just didn't need.
What all this means is that median prices should start to stabilise about now and start trending up towards the end of 2009. The one thing that might save Dr Keen from a rather lengthy walk is if there is a dramatic spike in unemployment, as nothing affects affordability more than not having an income. However, when unemployment rises the Reserve Bank generally counters with even lower official interest rates, which should help offset some of the negative effects of unemployment. Further, the Government are spending money like drunken sailors in order to ward off a recession and a lot of their largesse is directed towards propping up housing. Therefore in these circumstances further major price drops are unlikely.
A quick read of Dr Keen's soundbites reveal a lot of scary sounding statistics like high historic debt levels and high house prices relative to salaries. However any economist worth their salt knows that in order to be meaningful, the statistics or trends you are spruiking MUST correlate with the trend you are trying to establish. Otherwise the contentions made based on those statistics are not economics, they're histrionics. Unfortunately for Dr Keen, all of the dreadful numbers he cites have little to no correlation to the way house prices behave and this is why in a few months he will start looking like a rather large goose. Not to mention a fairly exhausted one after he makes his trek to the top of Kosciusko.
So, to all homeowners out there, I would just disregard the rubbish in the press from these so-called experts and just hang in there. Even if you don't want to delve deeply into the statistics to make yourself feel better, just take some schadenfreude from this - in anticipation of his predictions coming true, Dr Keen sold his Sydney property last year at a point which is now shaping as close to the bottom of the market.
Doh ! A lung-busting walk, a substantial capital loss and sizeable embarassment in few months time when he is exposed as yet another economic "Chicken Little". I wouldn't be too keen to be in Dr Keen's shoes right now.
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