Why a property crash is not likely

The good news…

A recent survey in The Economist Magazine suggested that Australia has the most over valued residential property in the world. Once again they predict a property crash in Australia, as do a number of commentators

This makes for scary reading and I understand why many home owners and investors are nervous, but a property crash is not on the cards for Australia.

Sure our property boom is over – but that doesn’t mean we’re going to have a property crash.

There is no doubt that property markets have a lot to contend with this year. Apart from rising interest rates, our property markets had to deal with a global credit crunch, the US sub prime crisis, a US economy heading into recession, the stock market down turn, plummeting housing affordability, unprecedented rental supply shortages and lenders tightening their belts.

So it is not surprising that one questions whether Australia’s property market can survive all of these blows or will it suffer the same fate that is happening overseas?

The recent USA National Association of Realtors house price survey recorded an average 7.7% drop in property values for the year of March. This is the biggest on record since 1982. In some states, including California and Florida, property values have plummeted by up to 30%. There are even reports that some financiers are repossessing homes and then asking the owners to stay on rent free just to protect the property from vandals.

Property values have also crashed in Britain, but not to the same extent as the USA. Britain is also suffering from the fallout of the American sub prime crisis with lenders severely restricting funding for investment properties.

So…… why do I think The Economist and other property commentators have got it wrong?

Firstly, I could say The Economist was wrong when it made similar predictions 2 years ago. At that time they forecast a property collapse in Australia, yet property values in most of our capital cities have increased by ten, fifteen and in many cases over twenty percent in the last year alone. Of course a counter argument could be: ” Well all this means is that we are now in for a bigger crash!”

I believe the doom-sayers have got it wrong because they don’t understand the difference between the fundamentals of the Australian property market and those overseas and the difference between this property cycle and previous property downturns.

In America many residential housing loans are “non-recourse loans.” In other words lenders don’t have to personally guarantee their loans. They can walk away from their loan commitments, leave their house to the lender and the bank can’t make them pay for any shortfall when (and if) they sell the property.

This is why you will often see different investment strategies used by property investors in America where the mortgage stays with the house and not with the borrower.

Obviously, here in Australia you can’t just walk away from your loan. If you can’t make the re-payments, the banks may take over your property and the day of reckoning will eventually come when you will have to pay the bank for any shortfall they have after repossessing your property.

Our local housing market is underpinned by the fact that 70% of Australians own their own homes or are paying them off. Considering the strength of our property markets over the last few years, unless they bought recently or over committed, many Australians have a large amount of equity in their homes and a significant proportion have no debt against their homes.

We are investing in a market dominated by non investors. As opposed to shares investors, home owners don’t just sell their house when the news is bad or property market is flat.

If you think about it, at any one time only about 5% of property owners are going to need to buy or sell their homes. This means the majority of property owners are not really affected by what is happening to property values as they are in it for the long term. They won’t need to sell their properties if conditions in the property market get worse. This is obviously very different to the stock market, where as the share prices plummet, more investors have to sell to cover their margin calls accelerating the drop in share prices.

There are many other strong fundamentals that should prevent our property markets from crashing. Our market conditions are very different to previous property downturns.

Currently we have a robust economy, strong population growth, changing demographics, a huge deficiency of properties for both owners-occupiers and tenants and rising building costs. All of this points to a short downturn, with strong fundamentals underpinning the next stage of the property cycle.

In previous property market downturns we had an economy in recession, while today our economy is strong and buoyant.

In previous property market downturns immigration fell, as people didn’t want to come to a country with an ailing economy. This time ’round Australia is experiencing a population boom, with the current rate of population growth the highest in almost 20 years.

Recently released Australian Bureau of Statistics figures reveal that the Australian population increased by 331,872 new residents or 1.6% over the 2007 calendar year. Our rate of population growth has not been this high since 1989. In general, highly skilled cashed up business migrants who are keen to buy houses are coming here. Many of these migrants are from Generation X or Y and are balancing our aging natural population. This is a good thing and something the ailing property markets in the USA and Britain would be desperately jealous of.

At the same time our changing demographics, with an increase in single and two people households, means that we need more dwellings for the same number of people.

In previous property market downturns we experienced an oversupply of properties. Over- enthusiastic builders constructed too many apartments and excited property investors put too many new properties onto the letting market. This increased supply of stock in the presence of decreasing demand meant that both property prices and rentals had to fall.

This time round we have a deficiency of stock in the presence of strong demand.

If we combine the low number of new constructions with the shortage of available property supply, accentuated by higher building costs and banks tightening finance for new development, we have a volatile mixture that can only lead to a much higher cost for the next round of new dwellings to be built.

What about all the news of rising interest rates and mortgage stress?

In previous property slumps we had low employment. Rising unemployment with no wages coming into the household meant families were forced to sell their homes. Today we have full employment, which means that even though there are higher loan repayments stretching family budgets, with household incomes rising it’s not likely that owners will walk away from their homes.

Another factor suggesting this property downturn will be short lived is the strongly rising rentals that property investors are receiving all around the country. Rental increases usually lead to rising property values as investors come back into the market chasing more robust yields.

Putting all this together, it is unlikely that a property crash is on the cards.

On the contrary, our property markets are behaving normally; working their way through the individual property cycles. Within each state the property markets are fragmented with some suburbs, in particular the more affluent inner city and bayside suburbs, still performing strongly, while other suburbs will languish.

Understanding these cycles means that there are great opportunities out there for property investors who are selective and have the ability to think long term.

By Michael Yardney