One Last Giant Property Bubble

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Famed investor Jeremy Grantham called it a "time bomb," saying "you cannot possibly miss it."

Local economist Steve Keen says "it is only a matter of time before the bubble bursts."

Local Morgan Stanley economist Gerard Minack said, "There's a word for a financial asset that's over-valued by 40%, so let's use it: housing is a bubble." 

I'm talking about the Australian housing market.

But rather than take my word for it, The Motley Fool is sending its crack Global Gains investing team on a 20-hour flight to check things out for themselves, firsthand. I'll be here to greet them.

One big loser
Of particular interest will be the dinner with the aforementioned Steve Keen, the country's most prominent housing bear. Unperturbed by losing a 2009 bet that Australian house prices would fall by 40% (and having to trek 125 miles and up the country's highest mountain), Keen continues to preach doom and gloom for the property market.

He's definitely got a point. And as we saw above, he's not alone. Australia, for all its virtues, including vast reserves of natural resources, just might be sitting on the last giant bubble.

To put housing prices into some perspective, the average Sydney house sells for around A$600,000. The average Australian wage is around A$65,000. As far as affordability goes, it's about as bad as it gets. According to research from Demographia, only Hong Kong is more unaffordable.

Low interest rates? Think again
One might be excused in thinking low interest rates have fueled the bubble. You'd be wrong.

The cheapest variable mortgage rates today are close to 8%. You can do the math, but for people with large mortgages, let me assure you there's not much cash left over each month for beer and prawns for the barbie.

And it could get worse. Just last week, Access Economics predicted the standard variable mortgage rate could reach close to 9% by the end of this year or early 2012.

A soft landing?
Yet for all the evidence of a housing bubble, most commentators are expecting prices to cool, rather than crash. And while Australia continues to ride the China-fueled commodity boom, it's hard to see a catalyst for the bubble to burst. After all, unemployment stands at just 5%, close enough to a level economists consider to be full employment.

But there are plenty of warning signs. The strong Australian dollar, currently trading around parity with the once-mighty greenback, is hurting inbound tourism.

Retailers are feeling the pinch from both sides, with high interest rates curtailing consumer spending, and the high dollar encouraging online shoppers to flock to sites like eBay, Amazon, and even Wal-Mart in search of a bargain.

So what gives?

China wants it, we've got it
It's all to do about China. That country's insatiable appetite for Australian commodities, whether that be iron ore from Rio Tinto (NYSE: RIO  ) , coal from BHP Billiton (NYSE: BHP  ) , or LNG from the giant Gorgon field off the coast of western Australia, a joint venture between ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and Royal Dutch Shell (NYSE: RDS-A  ) , they need it and Australia's got it, in spades.

The great Chinese mining boom is virtually single-handedly driving Australia's economy. Take it away, and pop goes the housing bubble.

Lest you think an Australian property crash won't affect you, think again. The big four Australian banks -- Commonwealth Bank, Westpac (NYSE: WBK  ) , ANZ, and National Australia Bank -- dominate the market. But they have a heavy reliance on foreign money markets to fund their growth, and are already one of the world's biggest borrowers in global markets. A property crash in Australia will reverberate across global markets.

The lucky country
Australia is known as the lucky country. It has vast commodity resources, great weather, wonderful long sandy beaches, and an enviable outdoor lifestyle. The average life expectancy is 81.2 years, placing it fifth-highest in the world, significantly above the 36th-placed USA.

Lucky as Australia might be, the mining boom has its downsides. There is a two-speed economy: those relatively few people directly affected by the mining industry, and those not. Your average Sydney worker hates the boom, because it has the effect of adding to his or her mortgage stress.

Or not so lucky?
Whereas once Australia had relatively cheap, high-quality housing, according to Demographia, it now has the most unaffordable housing market in the English-speaking world.

And it's not only housing that's expensive. Some foreign tourists, with their weak currency compared to the surging Aussie dollar, have told me Australia is 20% more expensive than even London. Now for anyone who's lived in or visited London, that's saying something.

One exciting opportunity
Still, there's nothing better than experiencing things firsthand. The Motley Fool's U.S.-based Global Gains team is heading Down Under to check things out for themselves. Undeterred by massive cyclones, housing bubbles, floods, bushfires, snakes, spiders, sharks, cane toads, and temperatures above 100 degrees Fahrenheit, Global Gains advisor Tim Hanson has called Australia one exciting opportunity.

As well as meeting Steve Keen, Tim and the Global Gains team are meeting mining companies, mining services firms, agricultural names, and many other businesses that stand to benefit from the ongoing Asian boom.

As always, they'll be releasing a special report with their top stock picks from the trip upon their return home. If you'd like to follow along with them in real-time, simply enter your email in the box below. That way, they'll be sure to send you all of their notes from the field as they take them.

Bruce Jackson is the Managing Director of The Motley Fool's recently launched Australian site, Of the companies mentioned, he has an interest in BHP Billiton and Royal Dutch Shell. He lives in and owns a severely unaffordable house in Queensland, Australia. Chevron is a Motley Fool Income Investor selection. The Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 09, 2011, at 8:49 AM, Manlobbi wrote:

    Well done guys. This is a fantastic, extremely interesting and worthwhile subject to explore. Good on you for going all the way Down Under and trying to uncover some truths.

  • Report this Comment On February 11, 2011, at 7:46 PM, AussieBob wrote:

    When the majority of people talk about the Australian housing market they are taking it to extremes and are not comparing apples with apples. Yes housing affordability is a problem in Australia but the average price of $600k in Sydney is supplemented by higher income in those areas. If you go out west the average house drops dramatically to $350k in Blacktown, just like the average income levels. However looking at Melbourne you find that there has been significant price growth over the last 18 months, with very little income growth and the housing affordability level is actually worse in Melbourne.

    Sydney has many markets within markets and it is hard to be so general when talking about the Sydney real estate market. One underlying issue that has not been discussed and is often forgot about in the Australian Market is that of economics 101 and supply and demand. The fact that there is a housing shortage in Australia and in particular in Sydney means that the prospect of a crash is almost unrealistic to talk about. New housing starts in Australia are not meeting the demands of population growth even after the federal government announced plans to reduce the level of net migration to Australia.

    There is a lack of knowledge about the housing market and basic economics, and in Australia it appears that anyone with an opinion is an expert. Sending out a team to investigate the nature of our economy and housing market will be a good thing and I hope that Steve Keen will be eating his words again.

    Now I’m not saying we will not see a decline in price growth over the next 18 months, as with any market, there are always highs and lows. That is just the economic cycle taking control. The Fed Gov. stimulated the real estate market by the first home owners grant and withdrew this in Oct 2009, since then the market has been fueled by up graders who were able to purchase their second home, and now over the second half of 2010 we saw the investors return to the market. We will probable experience a consolidation period with the number of real estate transaction down on previous years with little and in some case negative price growth. However this is not a crash.

    It is simply the Aussie dream to own your own home and the baby boomers laid this foundation which has, through housing affordability, made it harder for young Australians to own their own home today. However, this is only at the dramatic levels in metro areas around Australia. Now, what we are seeing in some circumstances to combat this housing affordability issue in desirable living areas is people buying their first home in cheaper areas that are yielding high rental returns and renting in the city. There are tax benefits of such a scheme, which the interest is tax deductible and the investor is now building up equity, which they will be able to use to upgrade or buy further investment properties in the future. The process is longer, however it is achievable.

    The Australian Banking system is one of the most regulated banking systems and has proven even through the GFC that it is one of the soundest. The lending policies set by the RBA have only strengthened the banking system, making it harder for consumers to get credit, while this can tighten the market in the short term, it will be a safety net in the long term against mortgage failures.

    China is fueling the mining boom, which is how Australia pulled it self out of the GFC. Take it away and there could be some serious consequences on economic growth in Australia. However The Peoples Republic of China’s Government is continuing to intervene with the economy to ensure that the growth is sustainable, that is, they are tightening the growth so there wont be a bubble. Even after China has finished with Australia and our resources, there will most probably be shift to India as they strive to become a developed country.

    Sentiment in any market is a driver which forces prices higher then they should be, causing these massive booms and at the same time can cause prices to crash below their true value. This is evident with the sub prime crises turning into a global financial crisis. Fear pushed equity prices will below their actual value, making them cheap by historical standards. However saying that sentiment is going to cause the Australian real estate market to pop is a joke. If there is a crash, sentiment will push the prices lower and cause the “crash” to be come worse then it actually is, however it wont cause the crash. An underlying fundamental issue, which saw the extreme amount of mortgage foreclosures, caused sub prime the sentiment then kicked in as every one ran to sell pushing prices well below their actual value. People didn’t just wake up one day and say real estate is overpriced I got to get out before I lose my money. The economics, including the housing shortage, supply and demand and other key drivers, need to fail before sentiment can push prices well below par causing a crash. People need to believe there is a problem and there actually needs to be housing foreclosures in extreme quantities in Australia before there is to be negative sentiment.

    The only way there is going to be a housing crash in Australia is if there is a fundamental issue with the Australian economy and interest rates go back to their historical levels in the 90’s of over 15%, combined with unemployment of over 10% over a period of 2-3 years of negative economic growth. Can this happen in the short term? Not with China fueling the economy through the resource boom and India set to follow suit. Not with the big four banks tightening their lending policies, making it harder for everyday Australians to be so highly geared, like we saw with the American housing market and the Sub-prime mortgage crises.

  • Report this Comment On February 12, 2011, at 2:47 AM, OzHousing wrote:

    Nice spruik by AussieBob, it's possible to easily dismember his arguments one by one, but here's just one example from occasional property spuiker and analyst Terry Ryder, arguing, along with other analysts like Kris Sayce of Money Morning and Michael Matusik of Matusik Property Insights that there is no shortage of housing in Australia, only a convenient phantom dreamt up by developers and similar real estate interests lobbying Canberra:

  • Report this Comment On February 28, 2012, at 2:56 AM, kaistrother wrote:

    Aussie Bob makes some great points.

    Even with the average prices of houses in less affluent areas like Blacktown at 350K, thats still represents around the 5-7 times income.. Historically income to mortgage ratio's have been around 3-4 times income. If this ratio does not correct back down to the later figure it will be the first time in history..

    Im not sure why Australians feel like that it is a right of theirs to own a property. Have we adopted this sentiment from the US.. I think it has resulted in many Australians over reaching with mortgages, outlaying less deposit, to have it now rather than later and then riding what many are calling the equity train.. drawing down on speculation and over valued assets.. this is a recipe for disaster and it is my belief that the negative affects of such poor fiscal understanding will play out in the next few years. binge debt fuelled spending has become a way of life for many australians and it is simply unsustainable.

    Im not sure its safe to assume that interest rates could not return to the 16% we saw in the 80's. the Australian apetite for credit has meant our big banks have sourced funding from overseas including europe. These economies are suffering and so will either be looking to reduce exposure or simply charge more for these funds. Acting as any sound oligopoly would, these big banks will pass on those cost - as they did in 2008.

    This will have a devastating affect on consumer sentiment, couple that with (real) unemployment at around 10% (and rising) - according to Morgan Stanley and a hugely unaffordable housing market, people will opt to save and sit on their savings. More properties will come onto the markets due to higher interest rates flogging already over leveraged home owners who are fearful of uncertainty and global instability.

    Then we will see property prices return to true values (what people are prepared and able to pay for them)

    Government intervention and poor policy has led to the global economic woes we now face. The Chinese Government's intervention will be about as useful as the US Government intervention and as sustainable as the Greek politicians fiscal savvy. The idea that the Chinese government is prepared to bail out the europeans and buy-up putrid US bonds leaves me less than confident of their ability to essentially delay the bursting of their own property bubble.

    We live in very interesting times. Im sure 2012 will be a very telling year.

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