• As investors, we can’t drive the car with our eyes on the rear-view mirror, even in the current murky conditions. So where should you look at investing in 2023? watch here

We could be wrong about the property bubble (but we don’t think we are)

We could be wrong about the property bubble (but we don’t think we are)

There’s an unfortunate trait amongst the broader population of investors that a rising price reaffirms their investment thesis. Take, for example, ever-rising house prices.

We continue to amass a body of statistical and anecdotal evidence that the combination, of absurdly low yields (that cannot justify an investment in property on any grounds other than blatant speculation for capital gain dependent on the greater fool theory) and equally absurdly high debt levels (at an arguably structural low point in interest rates), is unsustainable.  (We remind negative gearers again that an unattractive gross yield of 3% is not made more attractive by borrowing).

And yet prices and debt keep rising!  So WE must be wrong.

Work conducted by Bordo and Jeanne (2002) and the Bank of International Settlements (2005) confirmed that when housing booms are accompanied by sharp rises in debt, the risk of a crisis is significantly elevated.

Over two decades, Australia’s household debt has increased more rapidly than household income. In 1990 household debt to income was 56%; by 2002 it had reached 125%. By April of 2014, it reached 177%. And according to the OECD it now sits at 206%.

The inexorable rise in credit card and mortgage debt means that Australians have simply taken on more debt, typically to chase more expensive houses, and have less money to pay for it all.

Yet prices keep rising!  So WE must be wrong.

Rising prices reassure the bulls they are right, reinforcing their irrational behaviour, extending the bubble and ensuring any subsequent bust is more toxic.

Look at every bubble and you will always see sharply rising prices. Look at the prices again, after a bust, and those sharply rising prices of the past are still there.  Those who believed that rising prices reinforced their thesis were wrong. As an aside when the RBA says the issue with housing affordability is ‘supply’ they ignore the data produced by Prosper.Org and others that show, for example, there are 80,000 vacant apartments already in Victoria alone.  Negative rental growth also suggests supply is not an issue.  According to CoreLogic’s asking rental price series, Australian rental annual growth turned negative in 2016 while the ABS’ established rent series shows rents have slowed to the lowest pace since the early 1990s recession, which itself was the worst economic downturn since WW11. What is an issue is speculative fervour and speculative fervour only

Who else is warning investors against borrowing to buy a property?

Back in 2015 my friend and AFR Columnist and Fund Manager Chris Joye commented on the latest RBA rate cut noting; “The RBA is blowing the mother of all housing bubbles to deflate an overvalued exchange rate” and “it is replacing one asset pricing conundrum with another, arguably more dangerous, one.”

In 2015 Treasury Secretary, John Fraser, had no compunction describing Sydney and Melbourne property as “unequivocally” in a bubble.

In February this year, the International Monetary Fund has urged Australia’s regulators to double down on their efforts to ensure the nation’s banks are resilient enough to “withstand a significant housing market correction” while raising concerns that negative gearing is pushing property prices to extremes.

Also in February chair of the Australian Prudential Regulation Authority Wayne Byres said the banks should also be “under no illusions” that any breach of the 10% “speed limit” on investor loan growth would result in further regulatory intervention that may hit profits adding, “If that is encouraging them to direct their competitive instincts elsewhere, then that’s probably a good thing for the system as a whole.

In March this year, the OECD has warned of a “rout” in Australian house prices, leading to a new economic downturn, saying both prices and household debt have reached “unprecedented highs” adding: “a continued rise of the market, fuelled by both investor and owner-occupier demand, may end in a significant downward correction that spreads to the rest of the economy.”

Later in the same month the RBA highlighted threats in the property market and an acceleration of domestic household debt even as it lent credence to the global reflation story. “Data continued to suggest that there had been a build-up of risks associated with the housing market,” it said in its minutes, adding “Growth in household debt had been faster than that in household income.”

And, most recently, ASIC Chairman Greg Medcraft referred to his 2015 property “bubble” warnings: “I’ve been saying for a while I thought it was a bubble, other people are catching up now.” Mr Medcraft also said ASIC was working with the Australian Prudential Regulation Authority to mitigate the risks a hot property market throws up. “We had a meeting and we focused on the housing market … And there we have worked together on the responsible lending,” he said.

The Team at LF Economics wrote on APril 6 this year: “Unfortunately, as one can analyse the housing market using ten different models, twenty different variables and thirty different parameter specifications, the results will be various and contradictory. Recent journal papers examining whether our housing market represents a bubble demonstrates this: “the national market is a bubble”, “not a bubble”, “Sydney is, but not the rest”, “some cities for some periods were a bubble but are currently not” and on it goes. For as long as prices and debt continues growing, housing is undervalued from a mainstream neoclassical perspective. From a heterodox Minskyian or Post-Keynesian view which treats private debt and banking seriously, however, the housing market is in the midst of a gargantuan asset bubble.

Read on for the latest warning…

What are the experts referring to in their warnings?

According to Carmen Reinhart and Kenneth Rogoff, who studied eight centuries of financial crises in their New York Times bestseller, ‘This time is different’, there are four leading indicators of a crisis. The first is a rapid inflation of asset prices, particularly residential housing. The second is excessive debt accumulation, either by the government, banks, businesses or consumers. The accumulation of debt almost always poses greater systemic risks than it seems during the boom, and the injection of cash makes the growth that results look more sustainable than it really is.

The third is outsized borrowing from abroad and reflected in a sequence of gaping current account and trade balance deficits.

And the fourth is the occurrence of slowing economic output.

So, according to Reinhardt and Rogoff, studied eight centuries of financial crises, and the above four factors are a strong signal of an impending financial and or banking problem. Of course, nobody is talking about the possibility of a crisis in Australia right now, but three of the above four factors are in place. And if you believe the oversupply of apartments will be followed by a decline in residential construction activity, then deteriorating levels of economic activity are almost certain.

That would make four from four.

Perhaps that’s why this week we heard from David Murray, former CBA Chief Executive, former Future Fund chairman and the chairman of the government’s Financial System Inquiry.  Murray sounded another alarm on the housing boom, warning that a crisis on the scale of the 1890s property collapse could not be ignored. Murray observed: “What people should do is look at the 1890s, which was caused by a housing land boom”, adding: “to say it won’t happen and simply ignore it is wrong.”

With the IMF, the RBA, ASIC, APRA and David Murray all suggesting property is in a bubble and at risk of crash, ignore them at your own risk.


Roger is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Had an unsolicited text sent to me yesterday saying ‘Prudential services are currently financing loans with low interest rates and no credit checks.To apply, please contact us at…..blah, blah…

    You have to have hit the top when these guys are grubbing about at the bottom!

  2. For those interested check out Australian Professor, Phillip J Anderson’s take on the property market and property cycles worldwide since the dawn of time……..if he is right there is some way to go before we see a slowdown or the sell-off that everyone fears…….his research and analysis is backed by hundreds of years of data from property cycles worldwide…..his views, as such, are contrarian but present a much wider explanation/thesis as to why economies have always been inextricably linked to rising land prices and will always be …… he has not just popped up in the last few years but has been detailing his views for the past 20 years or so……definitely worth a read

  3. Great article Roger. As you say, most of the ingredients for a housing crash in Sydney or Melbourne already exist. As an investor, it’s a no-brainer for me; avoid and buy an out of favour asset with a margin of safety instead. But as a new Dad looking to buy a home for my young family so we no longer have to wrestle with crooked landlords and real estate agents, the decision becomes a lot more difficult. What would you recommend if you had a son or daughter looking to buy somewhere to live in Sydney or Melbourne today?

  4. Hi Roger, great article. I totally agree with you that this recent growth rate in property prices in Melbourne and Sydney in particular is irrational and unsustainable with such high debt levels and rising interest rates.
    However the only thing that I can see continuing to perpetuate price growth (other than just a general over obsession with property and reaching for the ‘Australian dream’) is population growth.
    According to the ABS the annual population growth rate in Australia in 2016 was¬300k people, and ¬100k from natural growth (births-deaths) and ¬200k from overseas migration. The ABS forecast in their ‘medium case’ Melbourne the population will be around 5.5mill and 6.4mill by 2036, and Sydney 5.8mill by 2026 and 6.6mill.

    My question is do you think this population growth, as well as foreign investment will continue to increase property prices? Are these 200,000 overseas migrants cashed up and able to afford ever high property prices?
    I doubt that Australians been such highly indebted, lack of wage growth, increasing interest rates, and generally high cost of living (e.g. energy prices) could continue to perpetuate the price increases!

    • Household formation, which takes into account immigration, amounts to a total of 155,000 dwellings demanded per annum growing at 1.6%pa. Apartment completions alone exceeds 220,000 for the last three years. So forget migration. It’s just a ‘weight of money’ argument that has never prevented a correction in any asset market. Here at the blog you can type ‘household formation’ into the search bar and see what we’ve written about this in the past.

  5. Hi Roger, interested in your views on comparing an inner city dwelling priced at 30x earnings (rent) vs a similarly priced equity. Do the principles applied to equities change somewhat for real estate? I find it interesting that most of the commentary surrounding this topic ignores the simple fact that rental yields are 30x. I understand that P/E ratios are poor indicators of value but I think it helps put things in perspective from an investment point of view. Sure negative gearing artificially supports yields, but that more or less is offset by maintenance costs in owning an investment property. Interest-only borrowers are probably even facing zero to negative yields given recent interest rate rises.

    • Hi Victor, Yes earnings yields of 3.3% are low, but by themselves they mean little. For example, the earnings yield for M2 Telecoms in 2005 was much lower than telstra’s and yet it provided a 30 fold gain in the ensuing decade as well as annual dividends that by 2015 were as much as your initial investment in 2005. The important thing if you are buying on a low earnings yield is that a significant proportion of the earnings can be reinvested at a high rate of return. In property however this is not the case and so, you are right, its very expensive.

      • It seems the less than and greater than symbols cut out some of my comment, I see you’ve interpreted the rental yield / P/E argument correctly anyhow. Thanks for the response.

  6. You are certainly not wrong, but luckily yourself and Lindsay David have stuck to the mantra rather than bemoan making the call early. Bubbles always run further than you think, however once there is some selling pressure, it will be like sucking an ocean through a straw or a bulldog eating porridge. If the CBA was on a PE of 22x you could argue that it is 50% overvalued as banking will never enter a new paradigm despite what the pro banking crowd will say. Lindsay David suggests that Sydney and Melbourne are greater than 50% overvalued and this on a number of metrics.

    This is like Dotcom all over again, minus the deadcat bounces on the way down and T+5 settlement. 2.5% on a $1.8m house is only $45,000 commission. Perhaps the new entrant Purple Bricks should be renamed Brown Bricks?

  7. Great article Roger!

    What kind of impact do you think a housing correction will have on the wider australian stocks? I imagine stocks related to the housing sector like banks and retails would be affected but what about other sectors like resources and medicals?

  8. damian hicks

    Hi Roger,
    How is REA positioned if the housing market moderately or aggressively revalues and depreciates? You have mentioned before that you are comfortable with a correction for REA as advertising listing may sit online longer given the slower turnover averages and this is beneficial to them. Cheers

    • Sentiment could impact the share price but we believe that REA should maintain revenue and earnings growth. The only caveat is if inventory dries up but even that would return eventually, and presumably in spades.

  9. richard dobosz

    good morning and great comments by all,its great to have property going up or is up ,but who benefits… because property is not liquid ,unless you sell or draw a reverse mortgage,, the only beneficiaries are the beneficiaries of your wealth when you drop off the perch, children /grandchild etc ..who have not contributed to this wealth ..but will enjoy it .. remember we spend money differently when given than earned , to me we need to seriously look at options to access this wealth while still on the perch ..this is a MASSIVE industry that is waiting to be tapped …I can not understand how banks /and finance industries have not tapped this massive earnings hole ,,that could be a industry in it self ,,any comments….

  10. Record low interest rate, who know how long this mania will run. One thing that does puzzle me is that in a bubble (black swan event) there is supposedly only a few individual that is against the crowd and gets ostracised however, this time around most people know that property is expensive. I am interested to see how it all plays out.

  11. andrew ronan

    Armageddon is an extreme outlier, but then again can you point to a single time it the 5000 year history of money when interest rates were lower or negative? Or a time when debt levels per capita were higher?or a time when asset yields were lower? and that includes almost all asset class with yields.well I don’t think so, and the reason is money creation is out of control and has been for a long time ,cheap money= inflated assets and low yields this is the obvious problem and it’s really just a way of stealing money from savers and handing it to irresponsible gamblers to keep things going and people employed and governments in power it’s a Ponzi scheme and quite a grand one to, that is obviously unsustainable. Is Armageddon coming? I don’t know, maybe ask the Romans they tried a similar scheme.

  12. peter latham

    Roger, as a property investor in country NSW, I too share your observation that the prices of property in Sydney, Melbourne and perhaps Canberra appears to be in “silly” territory. With debt sky high and interest rates at historical lows, I believe the current property situation in those major cities may (and probably will) end in tears. Is it your belief that long term property investors with conservative debt outside those “hot” areas will also suffer when a correction comes ? or will reasonable prices, low debt, and a balanced portfolio together with prudent decision making, “insulate” us from the pending crash?

  13. Roger, the reason that you are not right (yet) is that it’s possible that for people looking at property as a ROI play cannot fully understand the market because they cannot quantify emotions. A large percentage of those in the property market are buying with a large dose of emotion (e.g. Being Closer to good schools etc might be worth $100k to one family and nothing to another) and those examining the market will continue to believe that it defies economic sense. It is like people who buy classic cars, I have never meet someone who has brought a classic car in the sole hope that it goes up in price. They buy them because they can afford it and it’s an emotional purchase. The property market will continue like a rocket until something really shakes the economy. My forecast is we have at least 18 months still to run.

  14. Among other things, cashed-up foreign buyers are propping up our property prices. We Australians have chased up prices to record “mortgage to income” ratios, whereas our foreign friends are barely borrowing to buy. When interest rates start to rise, guess who will feel the pain the most!

  15. Roger what you’ve been saying about the property market for some time makes complete sense.
    What’s got me dumfounded is the official treasury statements I see in the media from time to time. Talk of a pickup in the economy – GDP currently 2.5% outlook 3% by 2018 -2020 and lowering of the unemployment rate, down to 5.5% by 2018 -2020…… SERIOUSLEY? Surly they must do some ‘war rooming’ what would happen if the bubble bursts.

  16. Hi Roger, I hope property prices fall. It does Australia no good to have inequality entrenched between a landed class and ordinarily Australians who can’t afford to buy a house. Forget tinkering with negative gearing or CGT – all you need to do is to have two rules: 1.) houses are for living in, not speculating with, so no single person or couple can own more than 2 properties; and 2.) non-citizens cannot own residential property.
    This is not a supply problem, as evidenced by the low level of rental growth.
    Alas the landed class in Parliament in Canberra with multiple investment properties will never consider these rules – I despair for this country.

  17. Andrew Rowan

    I heard a property “expert” the other day tell the reporter (discussing low rent yields) that people don’t buy for income but rather the fantastic capital growth opportunities of property investment. Rear view mirror bias if ever I heard. I think that when we hit the wall it’s not going to be pretty.

    • If you buy a property with a 2% gross yield, and expect to double your capital, you need someone else to come along and accept a 1% gross yield. That’s relying on a Greater Fool theory – that a bigger fool than you will come along and take the property off your hands at even less attractive returns for themselves.

  18. Robert Warren

    I really think that the reserve bank are the ones at fault here now lowe has the chance to correct what the previous governor allowed to get out of hand by reducing rates so much and you still have economists saying rates will come down even lower how irresponsible can these idiots be and there are just as many financial people out there saying there is no bubble RBA you have been irresponsible now it’s time to take responsibility and cut rates

  19. Hi Roger, I agree with your view to hold more cash rather than investing in a overheated property market. But where can you put your cash. Is a bank account safe ? Forgetting the Australian Government bank guarantee, which the government may or may not honour, considering the federal government is ½ a Trillion in debt. Do you think that the 4 major banks in Australia are a safe place to keep your cash, considering that they will be heavily impacted in a financial crisis. Would you expect any of the 4 major banks in Australia to loose depositors savings in a major financial crisis ? If so, where is the safest place to keep your cash ?

    • Under the scenario you suggest – ‘armageddon’ – history says hard assets (commodities) is where to go. But remember your Armageddon scenario is an extreme outlier.

    • Cash in a brokerage account? Maybe a US one? Even in a housing market crash I don’t see depositor haircuts. The political fallout would be too great and we are a sovereign nation that can print its own currency. I’d be more worried about the value of the AUD itself not whether a haircut will occur.

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