Is there a Bubble? Will it Burst?

Property Bubble

The property market is enduring a prolonged growth period that has seen records for transaction volumes, prices and clearance rates. On the back of this, speculation has increased that the Australian property market is in a bubble.

Depending on who you choose to listen to and the varying opinions and data that support their argument, getting a clear picture of the market and it’s likely future can be confusing.

If you’re in the property market and wanting to know what’s going to happen – here’s our take…

There is no bubble – but there is a lot of blowing

“A bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.”

– Investopedia

The 3 charts below show the growth in median house prices by capital city.

December 2011December 2016Growth
Source: RBA
Source: RBA
Source: RBA

Australian property folk-law suggests that property prices double every 10 years or grow in value at a rate of 7% annually. To be on track a property should have increased in value by 41% after 5 years.  If that benchmark is the “typical” market then only Sydney has outperformed the required 42% for the period between 2011-2016.

There’s nothing to burst – but there’s a likely slow down

So the tables above outline that we’re not in the middle of a broad property bubble but that doesn’t mean it will be smooth sailing for property prices.
Property values, as with any commodity, are dictated by supply and demand.  And a look at the graph below shows a big spike in the supply of apartments since 2010.

Number of Dwelling Units Under Construction Source: ABS

At the same time, housing supply has continued on within its normal range.  With supply of both houses and apartments mirroring each other up until 2010, the spike in apartment construction has created a split in the residential property market where we really need to categorize residential property into 2 markets, Low Density (Housing) and High Density (Apartments).

By viewing these as different markets we bring in the possibility that one of these markets could experience a bubble independent of the other or more likely that one market will have different value movement to the other.

Looking to the demand side of the equation, whilst clearance rates and sales volumes indicate that demand for existing housing is strong.  A more difficult scenario to get clarity on is the demand for apartments.  Sydney, Melbourne and Brisbane are all touted as having an oversupply, which could easily be supported by the spike in apartment construction.  The majority of this new supply was brought about by developers looking to profit from foreign investors, in particular the Chinese.

Recent Chinese regulation has further limited the amount of money a citizen can take out of the country and with the major local banks withdrawing lending to foreign investors, the demand that appeared so strong 2-3 years ago is in danger of evaporating.

A secondary concern on the demand side is the effect of interest rates.  Record low rates have helped fuel demand from investors, but recent banking requirements around capital reserves are seeing the majors either withdrawing from some lending markets or increasing rates so they become unattractive to borrowers.

Debt to Income Ratio

Ratio of Household Debt to Disposable Income  Source: RBA

Property prices and debt are fused together, because the majority of property purchases are made with leverage. Should interest rates rise, it is inevitable that property prices will slow in growth and in the apartment market possibly drop.  The current level of household debt to disposable income is at a record 189%. Every tick upward on interest rates for these owners is directly closing the gap between their ability to service the loan and their need to sell out.  If enough owners are forced to sell out, property prices will fall.

As such, we will be watching the speed and quantum of rates rises closely when that starts to happen.

Brett Dickinson

Brett Dickinson

Director - Property & Operations at United Global Capital
LREA, DipFinServ
Brett is a Licensed Real Estate Agent and manages United Global Capital's property projects and client acquisitions.
Brett Dickinson

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