Sunday, November 28, 2010

Housing bubble? No but, yeah but …

Talk of a housing bubble and an imminent collapse of Australia house prices gathered steam recently with reports of a senior Treasury official sounding the alarm on house prices as ‘the elephant in the room.’ (Read the story here). So is there a bubble, and if there is, will it burst or slowly leak? And what’s likely to happen next year?

Our media tend to focus on extremes – so balanced reports of what’s happening in the housing market are hard to find. Better to give exposure to doomsayers like Steven Keen (the Professor who predicted a 40% fall in prices, remember him?), or boosters like the many real estate agents or investment advisors, trying to pry money from your hands. A Treasury official may sound like an impartial judge of economic events but don’t worry too much about what one official may have to say – they’re notoriously inefficient in predicting economic outcomes. When’s the last time you heard of a government getting its budget forecasts even close to right?

That said, there are widening views about house prices in Australia and the banking system’s high dependence on a stable housing market makes this a deadly serious subject. The question of a ‘bubble’ presumes a risk of imminent collapse, which would mean economic calamity for many recent buyers without the equity buffer to ride it out, along with much of the economy.

So are prices too high, and if they are, do we risk a rapid fall? Yes, and no – in that order (and in my opinion).

The question of house prices hinges on people’s capacity to pay. Even with latest data showing the average wage has reached $65,000 per annum, median prices around $450,000 are still high – being around seven times average incomes. New entrants to the market find it especially hard, given their incomes are typically lower than average. Two income families are now the norm out of necessity, but even then, the combined household income is under pressure to fund a home at the lower end of the market (say high $300s). New product isn’t generally available for much under $400k – so gone are the days of moving out to the urban fringe to buy cheap.

Pressure on peoples’ capacity to pay is also being exerted via other means – rising utility charges (especially electricity, and now water), motor vehicle registrations, day care costs (a reality for the two income family) and so on. That’s why small movements in interest rates, adding $50 a month to mortgages, are hurting many. With all that in mind, it’s hard to see how prices can rise any further without substantial wages growth, and if that happened, the RBA would cool the growth by raising rates further, cancelling out the increased capacity to pay. Turn it whichever way you like, further rises in prices in the next several years are hard to foresee.

A further point on the RBA is their concern that rising prices, in the absence of new supply, would be a worrying trend. And that’s exactly what happened in the past couple of years – prices rose, and new house starts fell. Glenn Stevens, Chief of the Reserve Bank, warned of this over a year ago:

“A very real challenge in the near term is the following: how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices. Given the circumstances – the economy moving to a position of less than full employment, with labour shortages lessening and reduced pressure on prices for raw material inputs – this ought to be the time when we can add to the dwelling stock without a major run‑up in prices. If we fail to do that – if all we end up with is higher prices and not many more dwellings – then it will be very disappointing, indeed quite disturbing. Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over‑leverage and asset price deflation down the track.”

(You can read my article last year dealing with why Glenn Stevens was right to be worried about the housing market by clicking here).

So if we assume prices are now at a peak, what’s the risk of a rapid fall? Still pretty minimal I suspect, for a number of reasons.

The cost of new supply is one factor supporting a floor in prices. Developers would be releasing more stock to the market now if they thought the market was there. But the prices needed for new stock are determined by a range of underlying inputs – the high cost of raw land approved for development; the time cost of development assessment; the cost of taxes levies and charges; and the actual build cost the structure. This means the cost of new supply can’t fall (unless developers start selling at a loss). That new supply is around the mid to high $300s for apartments in Brisbane, and probably closer to $400k for a house/land package in a new estate. (Victoria’s new housing market is noticeably cheaper and their politicians are debating moves to make it even more so through cuts to stamp duty. A shame we don’t see that in Queensland).

New supply is also slowing, so there isn’t a big surplus of new stock floating around. Developers won’t sell for a loss and buyers can’t afford (or don’t want to) pay the necessary price for new product, so it isn’t being created. Plus, population growth – once an engine room of growth for the Queensland economy – is slowing, fast. Net interstate migration is falling fast, so we’ve become reliant on breeders and overseas migration for our growth numbers. That’s growth with a different demand profile to what we’ve been used to. So the demand isn’t there as it used to be, and neither is the supply.

Investors have reportedly been keeping the market alive but they will realise that the concept of negative gearing relies on capital growth for the sums to stack up. If prices are at or near their peak, it could be a long wait for capital growth to compensate for the yield losses on mortgaged rental stock. But unless investors are quickly forced to sell, there’s little likelihood of a flood of investment stock hitting the market.

Slower sales rates are already making themselves felt however, and vendor expectations are confronting buyer sentiment, which means prices are being dropped to meet the market. This will have to show up in median price data soon enough, but the percentages won’t be the calamity predicted by bubble theorists because as soon as reported median prices fall, bargain hunters will create a new floor of support. There are always plenty of punters who can’t say no to a perceived bargain.

Further to that, employment promises to remain strong. I remember the media laughing at claims (not so long ago) that unemployment would fall to 5%. Well, in the midst of the GFC, it’s barely moved from there. Provided people have incomes, and provided the cost of living doesn’t get further out of control, and provided interest rates don’t hit double digits, there won’t be that many people in a ‘forced to sell’ situation which would create the imbalance of supply and demand needed for a ‘bubble’ to burst.

The more likely scenario is not a burst but a slow leak. If next year we start to see median prices falling, the media will latch onto that and headlines will scream ‘collapse’ but in reality, a fall of even 10% will only being prices back to their 2008/2009 levels. Not good news if you’ve recently lashed out on a big mortgage and bought the most expensive house you could possibly afford, but those people are a minority in the market. (Media reports will of course focus exclusively on that minority).

Confidence will not be high if the media turns gloomy on all things housing, but perhaps it’s the breather the market needs? We can’t really sustain further increases in prices unless we are willing to consign an entire generation to non home ownership. Higher income households will unlikely be affected, and investors who bought more than three or four years ago will still find the increased rental incomes over that period sufficient reason to hold. There’ll no doubt be some movement in the median price figures, but it’s also quite probable those figures will be based on much smaller volumes of activity.

None of which is especially exciting for 2011, and possibly also 2012. Maybe real estate will for a time stop being the BBQ stopper it’s become, and we’ll see fewer shows on TV about how to make fast money on housing, and fewer spruikers occupying column centres in the press, talking up the future prospects of housing as a ‘make money’ proposition, as opposed to being somewhere to live.

Market stability doesn’t generate headlines, and once you stop reading daily or weekly reports about the housing market, or when TV shows like ‘The Block’ have faded into a memory, it could then be the time to dive back in. But that time may be a while away yet.

Tuesday, November 9, 2010


At a time when construction starts are falling across the spectrum from commercial to retail, industrial and housing, and construction industry jobs are going with them, you’d think the very people holding a key to a resurrection of fortunes might be lauded. But no, developers continue to suffer a poor public image. Why, and can it ever be improved?

The Reserve Bank’s recent move to increase interest rates was not well received by the development and construction industry. Housing and non-residential approvals are in a general slide and when the industry represents such a cornerstone of the economy, this might logically be a time when policy levers are applied to turning around the problem. A widely reported lack of new supply in housing is compounded by private sector commercial development at a virtual standstill, development finance the most widely cited culprit. According to the UDIA, construction industry jobs are down by around 25,000 in Queensland. That’s a lot of incomes not being spent in the economy.

Developers as a group though aren’t exactly being courted by policy makers or regulators, looking for a way out of the problem. Quite the opposite – politicians still regularly throw the mud at the very industry which holds a key to improving housing supply and construction industry jobs. “I won’t stand by and let greedy developers get away with … blah blah blah.” You’ve all heard it before. Denial, pass the buck and shoot the messenger continue to be preferred defensive tactics of politicians responding to industry complaints of excessive regulation. Labeling all developers “greedy developers” has about as much validity as suggesting all politicians are corrupt simply because a handful break the law, but the latter (politicians) continue to target the former (developers) - and get away with it.

It’s not just the politicians of course. Many regulators and planners, if you believe the horror stories, have taken an adversarial stance to development assessment whereby the applicant (the developer) is regarded with suspicion from the outset. The regulators don’t see themselves as facilitators of new activity but as ‘growth managers’ exercising every precautionary principle known in a bid to slow, curtail, check and re-check the consequences (real or imagined) of a proposal.

Then there’s community opinion, which puts developers and real estate agents and used car dealers into the same category. Development proposals that align with local or state planning schemes, and which may have already jumped through several hoops before a public airing, are often widely rejected via the pages of the local press. This isn’t just NIMBYism, because the target of hostile public complaint isn’t the planning scheme or the local or state politician who endorsed it, but the developer applicant who is simply complying with the scheme’s intent. Irrespective of how green, how sustainable, how rational or how much needed the proposal may be in community or economic terms, it’s the developer who gets the bad press.

Why is it that developers just can’t win?

I’ll venture a theory that many readers of this won’t like. Developers are too meek, too obsequious, too prepared to be thrashed with a wet lettuce and succumb. With rare exceptions (Stockland’s Matthew Quinn is one) developers rarely comment publicly about the problems imposed on the industry by excessive and growing regulatory burdens. The allegations of land banking, of profiteering, greed, opportunism, social irresponsibility and environmental vandalism are, it seems to me, infrequently challenged in the public domain.

Some of the reason for that no doubt lies in the politicisation of development assessment: development is no longer an exercise in market and land economics, but a political game. Political intervention in planning schemes and the ability to kybosh proposals means that developers need to be acutely sensitive to their position. Throwing back the facts and arguing the case publicly may not win political friends, and developers certainly don’t need any more political enemies. But what that means is that as more mud is thrown, more mud sticks.

It’s true that industry groups have their role to play in advocating development industry positions and promoting the benefits the industry brings, and by and large do a good job with the resources available. But is it also true that developers themselves tend to hide behind their industry groups in a sort of ‘good guy, bad guy’ act where industry group executives are left to do the sledging while developers do the schmoozing?

I recall a meeting with a Government Minister some years ago, dealing with a mounting problem in the Minister’s Department which threatened to cost the industry dearly. The meeting was civil but the issues weren’t danced around – “a full and frank discussion” might be its best description. The Minister was getting the message, loud and clear. But then, at the close of the meeting, the developer representative left the Minister with the comment that “Minister, thanks for your time and we want you to know you’re doing a great job.” Bang, pop – the pressure was instantly deflated. That Minister no doubt reported to their colleagues that the industry was pretty put off but didn’t present a political problem.

So if asking individual developers to publicly challenge the mud being thrown at them and defend themselves more aggressively is akin to asking them to paint a target on their forehead saying ‘shoot me’, is any sort of group industry response to a poor public reputation possible?

A clue might lie with the farmers. Faced with a problem where farmers (thanks to aggressive environmental politics) were copping all the bad press for tree clearing and land erosion to fertiliser and herbicide runoff, while the community somehow was allowed to forget that without farmers we don’t eat, they responded. The ‘Every Family Needs a Farmer’ campaign was a defensive community education campaign, designed to build more empathy amongst urban consumers of the issues faced by farming communities. The campaign has run through several incarnations over several years, and was no knee-jerk, one-off exercise.

Now if Dick Smith can fund a TV documentary and anti-growth campaign single handed, you’d think the entire development industry could manage something in its own interests? Especially when those interests are closely aligned to the interests of the community. I don’t see this as a hard sell, but it is a story that needs selling. You wouldn’t call it ‘Every Family Needs a Developer’ but you could start with a few things that the community as a whole seems to have forgotten:

Almost every street and the houses in it, in every neighborhood, is the result of a developer at some stage taking a risk.

Every shop in every high street, and every shopping mall your family visits, is the result of some developer at some stage, taking a risk.

Almost every workplace, whether it’s a medical centre, a factory, or an office building, is the result at some stage of a developer taking a risk.

Increasingly, many of the schools, roads and community facilities that we enjoy are funded through the activity of developers.

The homes we will need so that people aren’t sleeping on the streets won’t be provided by governments, or politicians, but by developers. The economy that we need to feed our families and support our aged and infirm, relies heavily on developers and the construction jobs that flow from them.

Many developers go broke trying, and in doing so, they lose their own money, not public money. It’s a high risk venture where certainty is essential. It’s not an industry where the public sector has ever shown much of a track record – witness the billions squandered on public housing programs which produce very few roofs.

Developers have legitimate concerns about the cost of doing business. It means their costs to the consumer – in the form of houses young people can’t afford, or rents that businesses struggle to pay, are higher than they need to be. It’s not developers making this happen – it’s regulation.

At the end of the day, developers can sit back and wait for more mud to be thrown, or begin to defend their reputation, and to defend the need for growth.

Is there anything to be lost by trying?