DWELLING PRICES – BURSTING BUBBLE ONE DAY;  BOOMING BUBBLE THE NEXT

The press never ceases to amaze with its desire for sensational headlines. 

For well over a year, the press has largely been focussing on sensationalist claims about dwelling prices collapsing in Australia, as have dwelling prices in some overseas countries.

Today, without any change in economic fundamentals whatsoever, the press has now changed its focus from the bursting of a (non-existent) housing bubble, to the beginnings of a new housing bubble!

What has changed is that the Reserve Bank Governor has acknowledged what we (and some others) have been consistently saying for a very long time.  This is that there is a serious under-supply of dwellings in Australia which has, and will continue to, support and place upward pressure on dwelling prices in the medium and longer term. 

The rightful concern of the RBA is how this pressure impacts on increased dwellings (good), instead of excessive price increases (bad). 

It is important to realise that, despite the headlines, the Governor did not forecast a new dwelling price bubble – he just acknowledged that such a risk exists.  The relevant extract from his speech follows:

“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.”

We interpret this statement as follows:

• Some rise in dwelling prices is accepted:  “how to ensure that the ready availability and low cost of housing finance is translated into more dwellings, not just higher prices”
• A major rise in dwelling prices is a possibility:  “this ought to be the time when we can add to the dwelling stock without a major run up in prices”
• Supply side problems do exist:  “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 is possible that prices may rise so much that an unsustainable bubble does arise:  “it would also pose elevated risks of problems of over leverage and asset price deflation down the track”
• As explained in previous newsletters, these are medium/long-term issues that will continue to be relevant well after the ending of the temporary dwelling acquisition incentives provided to first home buyers and investors by commonwealth and state governments.

Unlike the popular press, our view on these medium/long-term issues has not changed.  We have consistently made the point that the underlying dwelling shortage means that prices will have to rise to draw forth the required dwelling supply.  How much they will rise is uncertain.  But fewer and fewer people are continuing with the curious argument that dwelling prices can collapse in the face of long term excess demand. 
The long-term economic fundamentals for Australia are sound. 

• There are billions of people in Asia that are determined to lift their standards of living over the coming decades, and this will require resources from Australia
• They are also keen to educate themselves, and education services is Australia’s third biggest export
• Australia has sound financial regulators that have a good record of keeping things on track – deleveraging will run its course, and funding will return to normal (as it always has done in the past); indeed, Australia’s major banks have the best credit ratings in the world, have accounted for 10 per cent of global issuance of government guaranteed bank debt over the past nine months, and are very well placed to provide funding as required
• Australia’s government debt is (despite the press headlines) low by international western standards and can be wound back (as it has been wound back in the past).  Even by Australian standards, the forecast expenditures, revenues, and deficits (and the time projected to return to surplus) are not particularly out of line with recent history - see chart from JPMorgan below.  In fact, if the emerging forecasts of a softer-than-forecast downturn prove correct, the deficits will be lower than indicated by this chart

All this augers well for continued long-term growth in residential property prices.  As has been explained in previous newsletters:

• Population is rising and will continue to rise – at the moment it is expanding much faster than the supply of dwellings, and the dwellings under-supply is forecast to get worse for many years before it gets better 
• Immigration (as well as our domestic demographic projections) will ensure that the rising population is of working age (and not just people living longer)
• Wealth will continue to increase with continuing demand for our exports, the continuing contribution from the growing working age population, and hopefully continuing productivity improvements 
• In the past, countries with increasing wealth have chosen to allocate a disproportionate amount of their increased wealth this into dwellings, which is why over time inflation-adjusted dwelling prices have increased by more than GDP

We think that these long-term trends will continue, and that dwellings will continue their very long-term history of proving to be a sound investment offering superior long-term returns, with much less volatility than other asset classes.