Affordable Housing Institute : US

As those who remember Y2K can attest, with the first global celebration in Sydney Harbor, every new day begins in Australia (or its feisty neighbor New Zealand). 

 

 

With the Aussies always living in the future, might their home ownership markets presage changes in US markets?  The New York Times, doing its best to provide a scare context, thinks so, offering a bleak headline picture (”Hole in the Housing Bubble“) of the Australian housing market:

 

SYDNEY, Australia - For several years, dinner party chatter here did not linger on favorite Australian subjects like rugby, cricket, sailing and surfing or politics. No, all the talk was of real estate: how much a house was worth, how much more this year than last, and how much more valuable it would be next year.

 

A mid-level office worker, for example, who bought a house in a middle-class Sydney suburb for 188,000 Australian dollars in 1996 was offered 720,000 Australian dollars ($504,000) in 2003. Sound familiar? As in many regions of the United States these days, house prices here seemed to defy gravity. They just kept going up and up and up - in Sydney, by 11% in 1997, according to the Real Estate Institute of Australia, followed by a leap of another 21% the next year. After more modest increases, prices rose by 16% in 2002, and another 23% in 2003. It was similar in other major cities.

 

“It overshot all models, all predictions,” said Rod Cornish, head of property research at Macquaire Bank.

 

Now that you’re duly worried, the Times then summons the invisible ‘many experts’ to scare you further:

 

Even the world’s foremost expert is concerned ….

 

 

 

In the last two years, though, the Australian housing boom has come to a halt, in a move that many experts see as the first signs of the end to a housing bubble, not just in Australia, but also in the United States as well as several other rich countries around the world.

 

It is impossible to say for sure how the situation will work out here - or in the United States, for that matter. But so far, despite predictions that housing prices in Australia would plummet by as much as 20 to 30%, there are no signs of a crash.

 

Indeed, far from crashing, the prices have merely leveled off:

 

 

Nationwide, for the year ending March 31, the rise in house prices was 0.4%, the lowest since 1996, according to the Australia Bureau of Statistics.

 

“It’s been an orderly correction,” said Mark Steglick, managing director of Gowings Properties, a Sydney property development company, who said that there had been few foreclosures or forced sales since the boom ended. “There’s not blood on the streets.”

 

Though ‘orderly corrections’ are not the stuff of a good thrill-ride, so the Times tries again:

 

But there are significant differences within the market that may provide some clues as to how housing booms elsewhere could run out of steam.

 

And here, finally, the article becomes interesting and relevant:

 

Prices for investor-owned apartments have fallen considerably more than for owner-occupied houses. Nationwide, prices are down about 10% from the peak.

 

This is relevant because, as Fed Chairman Greenspan pointed out, investor-ownership appears to have ticked up from 7% of the inventory to 11%, a 50% jump in market share.  Further rises would add volatility across the whole market.

 

The most expensive homes, particularly those along the coast, have held up better than the rest of the market

 

The US housing market is also cushioned against volatility in ways that other markets are not:

 

House financing here differs significantly from the United States, where the 30-year fixed rate mortgage has been the norm and most adjustable rate mortgages delay rate increases for several years and then limit them to set annual amounts. In Australia, fixed rate mortgages are very rare. The standard mortgage is a variable, with the rate rising automatically whenever the central bank raises interest rates.

 

So someone who borrowed at 12% in 1985 found that his monthly mortgage payments had gone up by nearly 50% five years later, when the rate was just over 17%.

 

There was “blood on the streets” then, with thousands of foreclosures and forced sales.

The market remained stagnant until around 1996 or 1997, when prices began to rise, first in Melbourne, then in Sydney.

 

Remember, however, that we are also seeing a rise in interest-only and adjustable-rate loans, both of which are less costly up front but more vulnerable to exogenous shocks like rising interest rates.

 

Underneath it all is the first real driver, interest rates:

 

As in the United States in the early 2000’s, the primary driving force behind the housing boom in Australia was the decline in interest rates, which dropped to about 7% here by the end of 1997.

 

And the second, even more powerful driver, the economy:

 

Simultaneously, unemployment fell, continuing to shrink to as low as 5.5% today.

 

As we have noted previously, home liquidity itself moves money through circulation and keeps the economy humming:

 

With interest rates falling and as the value of homes soared, homeowners began borrowing against their equity, whether to renovate or buy the latest flat screen television. It was a lending practice introduced here by Citigroup, and now followed by nearly every bank.

 

The economy has continued to expand - it is now in its 14th consecutive year of growth - and with money and confidence, people not only bought their own homes, but properties for investment as well. In this, they have been actively encouraged by Australia’s tax laws.

 

Government policy also has its effects, but not in the way one might think:

 

In contrast with the United States, interest payments on an Australian home mortgage are not tax deductible.

 

Ordinarily one would expect that interest deductibility would boost homeownership, but since markets always clear their way back to equilibrium, and land value is a residual, in practical terms the presence or absence of mortgage interest deductibility turns out to be simply a question of where one wants to strike the equilibrium price. 

That said, however, how government differentially incentivizes tenures has a powerful effect on tenure choices:

 

But for those who invest in property and rent it out, the payment is deductible as an expense against rental income.

 

If total expenses exceed income, the loss can be offset against ordinary income. In a country where the top marginal tax rate is 48.5%, that provides a strong incentive to search for ways to reduce taxable income.

 

For example, an investor who has $30,000 a year in rental income, and $40,000 in expenses, including the mortgage, can take a deduction of $10,000. But when the property is sold, the gain, quite substantial in recent years, is taxed as a capital gain at a rate of no more than 24%.

 

Rental housing, even at the individual-investor level, is thus advantaged during the hold (deductibility) and at disposition (conversion of ordinary income into lower-taxed capital gain).

 

All of that contributed to a peppy market.  When it became too peppy, the central bank decided to cool things gently:

 

In late 2004, the central bank started raising interest rates, by a quarter point in November followed by another quarter point in December. There was another quarter point increase in March.

 

“They hit the brakes, lightly,” said Shane Oliver, head of investments strategy and chief economist at AMP Capital Investors, who estimated that the value of his house on the water in Avalon, a small suburb north of Sydney, has gone to $3 million, from $700,000 in 1995.

 

But no one was sure of what was coming, and the fear was that rates would continue to go up. The psychological impact was just what the central bank wanted and was needed.

 

The median price for a three bedroom house in Sydney has gone up only 0.2% so far this year. It has dropped 5.2% in Melbourne, according to the Real Estate Institute.

 

Cooling the housing market has also cooled the economy:

 

The leveling out of housing prices is beginning to have a ripple effect on the rest of the economy. “Housing equity withdrawal has now ceased,” the governor of the Reserve Bank, Ian Macfarlane, said in a speech in mid-June. That has contributed to a sharp slowdown in consumer spending. Some of the major retail stores, like David Jones and Coles Myer, seem to have been offering almost perpetual sales since November.

 

Now the question on people’s minds: is the decline over, or is the worst yet to come?

 

Still trying to scare the readers ….

 

Mr. Oliver thinks Australian house prices are still at least 25% overvalued, as measured by their historical values, and as a ratio to wages. It now takes 500 weeks of average wages to buy the typical home in Australia, Mr. Oliver wrote recently in his newsletter, much more than the 350 weeks, on average, required in the United States.

Still, he is not predicting a crash.

 

“It’s easier to trigger a panic in the share market than in the housing market,” Mr. Oliver said. “People get attached to their homes.”

 

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