Will the property market crash? How devastating could it be?

 

The dreaded B-word is yet to be utilised with mainstream, middle of the road economists but many are saying that people should think twice before buying property in the current market, especially in Sydney and Melbourne.

American ratings agency Standard & Poor, has become more focused and vocal on the Australian market in recent times. Although it is important to mention that they missed the US housing bubble all together.

Many mainstream economists are predicting a long stagnant period for the AUS housing market, with the worst case being a 10-15% price slide while on the other hand there is still a minority warning of a bigger crash (20%+)

Here’s some facts and you can make up your own mind as to which is more likely..

  • Australian household debt is at a record high of approx. 189% of incomes and more than 123% of GDP.
  • This is one of the highest levels of household debt in the world.
  • This makes households very vulnerable to any interest rate increase, tightening of lending from banks (which cuts off access to additional funding) and raises in the cost of living or further  increase in unemployment. All could have huge impact.

Such an increase in unemployment is entirely plausible in a country where over-indebted households are now  clearly cutting back on spending, sending several high profile retailers to the wall less than halfway through the year

 

Another area making it likely to see a major correction or a crash is the lack of liquidity in our housing market. Liquidity being how easy it is to buy and sell when you want.

Unlike stocks (where there is a high level of liquidity), the housing market has limited stock and the homes on the market represent a small amount of the total homes. Selling can take months of preparation and large financial investment to prepare for market to snag the best price. On the other hand, buying is also a slow process in obtaining finance, looking for property, settlement periods etc..

At a given point in time, there is necessarily a limited pool of purchasers – not least of which because the availability of loan financing is essential to almost all home buyers, while it is not for most stock traders.

While the property market is rising, no one is worried about a crash and finance is freely available – this tends to push up prices.

The easy availability of loans means the pool of buyers gets bigger, while expectations of continued price gains keep the number of sellers low.

We’ve seen this in the major east coast markets in the latest boom, with little stock on the market creating intense competition amongst buyers for the few properties out there and pushing prices ever higher.

But this can’t go on forever. There is a finite limit to how much debt Australian households can sustain, especially with wages growth at its lowest level since at least the last recession.

Latest ATO figures showing 60% of all investment properties are making a loss. For these investment property owners their strategy is to offset the losses through negative gearing, hoping to get a capital gain with a 50% tax discount…. The only problem with this is that it doesn’t work when the property market stagnates and/or stalls. This lack of capital gain leaves investors with nothing but losses.

When losses commence and last for long enough, many investors will want to sell out and that’s where risk comes in. This is especially the case if rising unemployment – perhaps due to a household consumption slump and/or the end of the apartment building boom – generates a large number of forced sellers.

Just as happened in the US, Spain and Ireland during the GFC, listings jump but potential buyers are nowhere to be found or unwilling to bear the brunt of a falling market which leads to slashing of prices. Banks’ bad debts rise as defaults increase and more of them are in negative equity – they owe the bank more than their home is now worth.

Yes the government can step in as the Rudd govt did in the GFC boosting the FHG but the Commonwealth is already at risk of losing its AAA credit rating which could potentially limit the government’s ability to react.

A downgrade would be followed by the banks, where drop in their credit ratings would put upward pressure in their funding costs which would result in an interest rate increase.

‘What goes up must come down’ especially in markets with low liquidity.

 

DR

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