Earlier this month, Channel Nine’s ‘60 Minutes’ program ran a segment suggesting that Australia is about to see the biggest property crash in our history.
There was talk of a 40 per cent drop in property value in our major cities and the end of the seemingly endless growth cycle. In my view, ‘60 Minutes’ have taken the extreme position, it makes a better story, but the problem is real.
The average Australian is far more bullish on property than any other asset. I’ve heard numerous people say that you can’t lose money on property; we also hear enormous growth expectations like property doubles every seven years. Most people don’t blink about gearing up to 90 per cent or more into an investment property, often using equity in their residential property to front up their 10 per cent contribution to the property. That mindset has all the hallmarks of a bubble, and, as we know, bubbles burst.
In order for a bubble to burst there is normally a catalyst. Unfortunately, we have a few looming issues, any of which can easily burst the bubble.
For me, there are four main dangers to the property market.
The relative high cost of property: What is too high is always subjective however, if we look at property as we would any other investment, the cost compared to the income it derives is ridiculous. Rents compared to property values are way out of sync. The value of any investment ultimately should be linked to the income it provides, on this measure, currently, property is well over-valued. The other measure is the comparison of property to wages, this will drive future demand. People are limited to what they are able to afford. Currently, we are spending a higher percentage of our income on our housing than ever.
Tightening of lending practices: It is hard to get a loan right now, and getting harder. During the boom it seemed to be a game of chicken, whichever party was prepared to borrow the most against existing properties won the auction day. In my view, banks lent some people way more than was sustainable long-term. The real issue here is that so many people opted for interest only, as that is all they could afford to repay. Those interest only loans will all come up for renewal in the near future and many will be required to move to principal and interest. Many won’t be able to afford it, and be forced into a sale.
Interest rate risk: We have record low interest rates. At some point, these are going to ease up. Each rate rise will see people go past the point they can afford and this is likely to see a lot of forced sales. In some cases, if they are forced into a sale at a loss, they may lose their principal property as well.
The wind back of negative gearing and capital gains discount: Negative gearing and the capital gains discount are on the agenda to be wound back. They are artificial accelerators to the property market and make no sense. Negative gearing is an incentive to pay more for a property than it is worth because it is subsidised by a tax break. The theory being that someone else will also pay too much for it in the future. It is also nonsensical that we pay more tax on our salary and wages that we work for, than we do for investment income that we don’t earn. At some point both will be reduced.
Unfortunately, it looks like we are going to experience a downturn in the housing markets, which will have a flow-on effect to the economy as a whole.