Gentle Poke On The Australian Housing Bubble

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Includes: CROC, FXA, GDAY
by: FX Analyst

Summary

Both the BIS and IMF have noted the Australian Residential Market bubble.

Result of record low cash rate and negative real cash rate after inflation.

Housing Price rise as wages moderate resulting in unsustainable housing price to income and housing price to rent levels.

The Australian Council of Financial Regulators are taking a proactive stance to poke the bubble before it caused a major recession.

The Bank of International Settlements (BIS) has concluded its recent survey of residential property in 55 countries around the globe in September 2014. Australia has the dubious distinction of being the second most expensive country in the world after Norway with its housing index at 200.

Source: Bank of International Settlements

A closer look at the Australian housing price index over the past 5 years shows that housing prices have rebounded sharply in 2012 after the sharp drop in 2010. This is largely the result of the record low cash rates from the Reserve Bank of Australia at 2.5% for 14 consecutive months and with inflationary pressure fluctuating between 2% -3%. The obvious response to this issue would be for the Reserve Bank of Australia to rise rates but however this is unlikely to happen in the near future. For more details, you can refer to my previous article, RBA's Hands are tied.

This has resulted in a situation of negative real cash rate as seen on the chart above as provided by both the Australian Bureau of Statistics and Reserve Bank of Australia. So for investors with the excess cash, it makes sense for them to invest in properties and securities to stay on top of inflation.

However for the average Australians, they are in a difficult spot where they have to contend with declining wages as seen in the chart below.

Their wage growth has moderated this year between 2-3% in both the private and public sectors and this brings forth the question of sustainability. The commonly used metrics to measure sustainability is the housing price to income and housing price to rent ratios.

So according to IMF, Australia has the 2nd highest price to income and 4th highest price to rent ratio worldwide. Of course both price to income and price to rent are just general indicators of housing markets. There is a need to gather supplementary information like growth of credit, indebtedness of the household, characteristics of the lender and method of financing.

This is a significant macroeconomic issue for Australia as banks are heavily involved with the purchase of property. The market is mindful that it is the property crash that sunk Japan into a crisis and the US and the world into the Great Recession of 2007. Competition over the Australian mortgage market has resulted in declining net interest margin.

So far for Australia, the regulators are doing a commendable job in terms of ensuring the quality of the underwriting standards of the mortgage. There are no significant non-performing housing assets and it has been on a slight downtrend since 2011.

Still, vigilance and caution are still called for when dealing with such a sensitive asset where it has a direct impact on Australian livelihood-unlike stock or bonds.

In Australia, there is the Council of Financial Regulators which provides a comprehensive oversight of financial affairs to prevent any gaps. It consists of the Reserve Bank of Australia as Chair, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission and the Treasury.

The Council is working to restrain the housing bubble especially in Sydney and Melbourne as part of their macroprudential policy framework. "We're keeping a close eye on the build up of credit to investors in the housing market, not to owner-occupiers per se and certainly not to first home buyers. They're not the issue," said RBA governor Glenn Stevens. They are targeting foreign investors searching for yield which makes up half of the housing investments without making it difficult for first time owners to own their house.

It is good that senior financial regulatory figures are keeping a lookout for this housing issue as the market can't take another shock after the fragile recovery from the Great Recession of 2007. It remains to be seen if they are able to moderate the housing price to a more sustainable range before it bursts. That will start a unnecessary new recession in Australia. In order to rein in the housing bank, the Council would have to implement of unpopular cooling measures which would be met with heavy resistance from vested interests from the banking and construction industries.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.