The Greatest Property Bubble or A New Beginning?

Melbourne’s population is booming, and it has not only become one of the wealthiest cities in the world, but has also developed an international reputation as one of the greatest cities in the world.

Melbourne is in the midst of a land and property boom. Rather than building high-density apartment blocks like the European cities, Melbourne expanded wide and far. Real estate is ‘The Land of Promise’, as proclaimed by this sales poster for Moreland Road, Brunswick.

Investors are buying up farms and subdivided them. They are luring buyers with free railway passes out to the new estates, feeding them and serving champagne before bidding gets underway. In fact, the value of land in parts of Melbourne is as high as London.

The Argus newspaper wrote, ‘[The hunger] that has seized hold of so many people is the result not of an hallucination, but of an awakening to the value of land as a safe, a sound, and a profitable investment.’

I’m talking about Melbourne in the 1880’s – it was dubbed ‘Marvellous Melbourne’. Here we are in 2019, and the tune hasn’t changed in 140 years.

In April of 1893 the bubble had popped, and the boom was over. Melbourne’s unemployment rate jumped to 20%. Property prices dropped almost 40% (Melbourne) within years, which compares to a drop of 20% during the 1930’s depression. It would take Melbourne 60 years to recover.

Every bubble is different. Their formation varies from duration, magnitude, and cause. It was higher interest rates that would eventually pop the bubble of the 1890’s, and the banks’ failure to take security for loans written during this frenzy would lead to the collapse of a number of them.

With bank lending having soared since 2012, prices having doubled during this time, and interest rates at an all time low, could we be facing another crisis like the one that has been buried in history books for decades? Or is it different this time?

According to the media, Australia’s property bubble is akin to that of the US.

When people refer to the US property bubble, I ask them which city they’re referring to. Sure, the US had a property meltdown, however not all cities we’re wiped out. New York fell 24.45%, Dallas down 7.53%, and Boston fell 16.38%. In fact, it wasn’t even the cities that had the largest growth pre-GFC that fell the most (refer LA and San Francisco). On average, prices in major cities fell around by one third of their value.

Similarly, when people talk to me about the Australian property bubble, I ask them which city/ies they’re referring to. In Australia, it’s largely been a story of Sydney and Melbourne.

I decided to run a few charts to analyse the current state of play:

Australian Real House Prices

Here’s a long-term view on real house prices:

Major City House Prices

Since the RBA started cutting rates in 2012, house prices doubled in major cities. Since peaking in 2017, Sydney is down 14% and Melbourne 11%. Hobart continues to climb, and prices rises in Sydney and Melbourne guide investors to cheaper cities.

Residential Building Approvals

The story of Australia’s construction boom has been one of apartment construction. Detached housing has been moving sideways for sometime now. Economics 101 tells us that when the supply increases, price decreases, and when supply decreases, price increases. This is the story of apartments and detached housing.

Price to Income Ratios

This ratio tells us how much of the median income (as a multiple) does it take to buy the median house. For example, in Melbourne, it takes 10 times the median income to buy the median house. In Sydney it’s 13 times. In Hong Kong it’s 20 times. It seems as though global ratios are converging following a massive divergence pre GFC.

Housing Finance Commitments & House Prices

There’s a strong correlation between the amount of debt the banks lend out and house prices. In fact, house prices lag lending by about 6 months. The data tell us that lending is still falling.

Auction Clearance Rates

This is one of my favourite charts because they are timely and have a good cyclical relationship with property prices in Sydney and Melbourne. Clearance rates have been declining for some time now, although you can see a little kick post election – something to keep an eye on.

House Prices & Household Debt

This chart shows us the strong relationship between debt and property prices. Overvaluation in prices really started in 1996 –  it’s popular to blame negative gearing, the capital gains tax discount and foreign buying for high home prices and debt. However, the basic drivers are a combination of the shift from high to low interest rates over the last 20-30 years boosting borrowing power, along with a surge in population growth.

Dwelling Construction & Population Growth

For many years we have had a supply issue in this country (thanks to tight development controls and lagging infrastructure). It’s expected that Victoria will be home to about 8 million people by 2050.

And these people will want somewhere to live, surely. Based on these numbers, it may come as a surprise to most people, but we’re just now starting to build enough property to help support our growing population.

Sure, we’re going to see periods of oversupply and periods of under-supply, which in turn will result in periods of price growth and periods of price declines. This is not unusual, the free market has been valuing assets this way for centuries.

Bank Non-Performing Housing Loans

Although non-performing loans are down from their GFC peak, they have kicked up since late 2017. A switch from Interest Only loans to Principle and Interest loans have been driving servicing costs.

They say investors have a three year time horizon.

As human beings we’re wired in such a way that makes it difficult for us to be able to see so far into the future. Take the city of Melbourne for example.

Here’s the evolution of Melbourne city over 130 years, in images, taken from the top end of town – Spring Street:

Here’s Melbourne today:

Between 1% and 3% of a city is demolished and rebuilt each year, such that over almost a lifetime, a city is completely transformed and almost recognizable. Incremental change is so difficult for us to recognize, however over long-periods of time, it’s clear as day.

If for one moment you think our city can no longer be built out, here’s the City of Melbourne’s Development Activity Model. Here’s the city as we know it today:

Let’s add the buildings under construction (yellow):

And those that have been approved (green):

And those that are in application phase (blue):

As investors we need to fight the minute by minute news headlines that try and grab our attention each and every day. Although we are not wired to, we know deep down that true, significant, and sustainable wealth is created over long periods of time – yet we want it all now.

We’re clearly in for another interesting year in property, one with moderate price growth in some locations and virtually no growth in others and falling prices in others.

Australia’s property markets are very fragmented, driven by local factors including jobs growth, population growth, consumer confidence and supply and demand.

Investors need to have a sound strategy and game plan. So when the opportunity presents you know exactly what you need to do, and how to do it. It also ensures you maximise returns and avoid unnecessary market and asset risk. Shooting off the hip is not a strategy.

Our property markets are behaving as they always do – boom, downturn, bust, boom, downturn, bust…

The biggest profits are made during the downturn and bust stage of the cycle – that’s because downturns are only temporary, while the long term increase in the value of good property is permanent.

Take the long-view.