Australia's Real Estate Bubble Is On The Verge Of Popping With A Surge Of Inventory

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Includes: AUSE, DBAU, EWA, FAUS, HAUD, IAF, QAUS
by: D. H. Taylor

Summary

Increasing prices are being met with increasing inventory. A lot of this inventory is coming on line right now.

Real estate prices have not kept up with wage growth.

RBA decides to leave interest rates alone at last meeting and even hinted at lower rates.

Australia is in a property bubble. Prices in Sydney have increased 18% year-over-year alone. Unlike the rest of the world when the financial crisis hit in 2008 Australia was largely insulated. China's economy was booming and Australia's economy was largely tied to that. Now, however, with China's economy slowing and wage growth in Australia not keeping up with prices, the bubble looks set to collapse as more and more inventory comes on line.

Already in Australia, new home sales are declining. While the levels are not as high as they had been there is an obvious slowing to the pace of new homes sales. This is disconcerting simply because there is more and more inventory coming online throughout the major cities. For now, however, the House Price Index has been increasing on a quarterly basis with the most recent showing a 4.1% increase:

The next two charts help illustrate that there is more and more inventory about to come online and that the country of Australia has not had the downturn in their real estate market that the rest of the world has.

There is a lot of inventory making its way into the markets as the first chart suggests. That new inventory will likely drive price downward for rents in apartments. Less individuals will be interested in buying real estate because of costs. Fewer people buying real estate will mean lower prices for homes. It is already projected that Sydney's property market is set to decline significantly and may even wreak havoc in the economy with the bubble bursting.

As mentioned, Australia never really saw the same decline that the rest of the major industrialized world saw. Instead, since that time, the real estate prices have continued to increase more and more. One of the factors behind this is that Chinese investors have been buying real estate abroad. The Chinese government, dealing with their own property bubble have instilled several methods to limit new home purchases in China. Individuals wanting to buy a home have been restricted so these investors have been sending their money overseas. This has significantly impacted real estate prices throughout various markets including Australia and the United States.

The Reserve Bank of Australia (RBA) has taken notice of the property market and is one of their biggest concerns. However, and this caught markets off guard, the RBA did not raise short term interest rates at their last meeting. Instead, the bank hinted that interest rates will need to go lower. The RBA fears that the property market is already on the way downward based on the inventory levels as well as the government regulation that was a instilled to bring the property market back in line with wage growth rates. Translation: The decline is already starting.

Bursting a real estate bubble is never a pretty thing. But, it is necessary. When the signs start strengthening that the property bubble is bursting more and more then I am predicting that the shifts outward of money are going to be significant. For instance, the United States is in the beginning stages of raising interest rates upward to remove the extraordinary policy accommodation that was put into place during the financial crisis. The RBA is talking about lowering interest rates. The differential in interest rates is going to send money out of Australia in search of higher yield. The AUD will fall precipitously. Already, the interest rate on the Australia 10-year government bond is falling. Here is a comparison of Australia's government bond yield versus the United States. While the two rates moved lower over the same period of time, the U.S. rate did not move as much. The interest rate differential now favors the United States over Australia.

The currency is moving lower as well, and this is where I see the greatest market move about to take place:

My expectation is that the AUD will fall significantly over the next several weeks and months as more and more data solidify that the property market is slowing. In fact, I am expecting that the currency could fall to lows not seen in some time; I can expect AUD to be trading sub .7000.

The property market is a significant risk to Australia's economy. Whereas the Federal Reserve has been raising interest rates the RBA is speaking in terms of lowering interest rates. While the rest of the world propels forward with economic growth Australia will be doing the exact opposite. I expect a lot of money will be flowing out of Australia because of this and I expect government bond yields to move lower as well as the equity market and currency. This will likely exacerbate the situation because capital is the rule of any economy. Yet, Australia is about to see their fuel tanks dry up.

However, although a lot of these moves are just starting the moves I am looking for are going to be far more significant than what has happened so far. If you have not made any kind of protective moves yet you would be advised to do so now before Australia's real estate bubble really begins to collapse.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.