Housing price rises: 'recovery' or bubble?

Issue 

On August 4, the Australian Bureau of Statistics (ABS) released figures that showed housing prices across Australia's capital cities rose by 4.2% over the three months ending in June. The rapid increase has worried the Reserve Bank of Australia (RBA) enough for it to warn of a threat of a housing bubble.

In a July 28 speech, RBA governor Glenn Stevens noted that higher housing demand could simply push up prices. It could mean "all we end up with is higher prices and not many more dwellings".

If so, "it would also pose elevated risks of problems of over-leverage and asset price deflation down the track". That is, the housing bubble could burst. This would make inflated housing prices crash, wipe out accumulated wealth and lead to a more serious downturn.

The solution, Stevens said, was to "add to the dwelling stock without a major run-up in prices". He said this should be possible given the low price of raw materials and because "labour shortages [are] lessening".

Stevens' solution to the problem of the housing bubble rests on two fundamental assumptions. First, there is a (genuine) shortage of houses. Second, the most important buyers of houses are homebuyers — people who buy the houses to live in them.

But neither assumption is necessarily true.

Steve Keene, associate professor of economics and finance at the University of Western Sydney, cited evidence that there is no real shortage of housing in Australia, but rather a massive oversupply.

In the April edition of his Debtwatch bulletin, Keene referred to ABS figures that showed there were 800,000 unoccupied dwellings on census night in 2006. Over the long term, more houses are being built than are being filled by a growing population.

Keene said: "Over the period 1985-2009, an average of 1 residential dwelling was built per 1.75 new Australians, and only in the last 3 months has the rate of new building fallen behind population growth."

He concluded that there are around 1 million unoccupied dwellings in Australia.

"Far from having an undersupply of housing, Australia may well have a substantial oversupply. It's just that no one is living in many of them."

So, if the housing stock is continuing to rise at a faster rate than population growth and there is already a surplus of houses, why are house prices continuing to increase?

The answer Keene gives undermines the RBA's second assumption.

"A very likely cause of this large stock of unoccupied homes is Australia's system of negative gearing", he said. "Most 'investors' build houses not for the rental income, but for capital gains "

Housing speculators, whose only goal is to make a profit from the buying and selling of houses, push up the price of housing while the market is strong. However: "If prices start to fall substantially, then many owners who have kept their properties off the market may be motivated to bring them out of mothballs.

"The 'undersupply' of both rental properties and houses for sale could thus evaporate, and rather than supply issues putting a floor beneath house prices, they could well pull the rug out from underneath them instead."

The actions of housing "investors" could therefore undermine the RBA's housing price expectations. It could seriously increase the risk of a bubble developing and magnify the fall in prices if the bubble should burst.

Keene also cited evidence that Australian housing prices are already highly inflated.

Despite small falls in housing values over the last year, house prices continue to be "3.5 times the long term average versus 'just' twice the average in the USA". The question is whether those historically high prices will remain stable, or crash spectacularly, as they did in the US in 2007.

The RBA's only plan to slow the development of a bubble is to increase interest rates. However, with unemployment expected to rise to at least 7.5% by the end of 2010, a rate hike could lead to a rash of foreclosures among homebuyers who took big loans on the expectation of low interest rates, flooding the market with houses.

In this case, speculators would quickly join the rush, driving hyper-inflated house prices lower still, wiping out personal wealth and causing a whole new stage of the economic downturn.

So don't believe the hype that an increase in housing prices means a "recovery" is on the way. The threat of a housing bubble to the Australian economy is a very real one. Moreover, don't assume Australia's financial regulators can solve the problem, rather than make it worse.