Hockey: Rising Australian House Prices Are More Affordable

The government has changed. The nincompoopery continues unabated. And nobody can beat Treasurer Joe Hockey's truly surreal claim that higher Australian house prices make property more affordable:

'Rising house prices in Australia help to make some of the more marginal new housing developments affordable, realistic and deliverable.'

We're speechless. But there is some sort of absurd logic in there somewhere.

What he's referring to is that the supply of Australian housing should rise as prices do. He's worried about affordability for developers, not buyers. That's fair enough...if you want to ignore the other half of the supply and demand equation.

Perhaps that's why Hockey also said, 'A lot of commentators, particularly [in the US], don't understand the Australian housing market. Australia is a long way from a housing bubble.'You see, in Australia, when it comes to a housing bubble, we only worry about supply. Without a housing construction boom, there can't be a bubble, can there?

Actually, it's restrictions on supply that are important to triggering the creation of a Australian housing bubble. And it's government that's restricting supply. More on that below, including some reader mail.

But what about the buyers? Do higher prices make things more affordable for them too? Conventional wisdom from the property sector is clear; yes, it does. Maybe Hockey isn't completely delusional (don't worry we'll show you that he is). If you're confused as to how higher prices can make things more affordable, you haven't been reading enough property blogs. We'll let you in on the secret of the Australian real estate sector:

If the price of your house goes up, you can borrow more against it and buy another house. Then, when that house price goes up, you can borrow more against it and buy another house. And that is why rising house prices make houses more affordable.

It's also the reason why housing booms are so epic. Or should we call them bubbles? They are self-sustaining speculative frenzies.

There are two problems with this. One is the debt the buyers are accumulating and the second is first home buyers. Remember, the US house price bubble was a sub-prime mortgage crisis first. Debt triggered the housing bubble to pop.

As for the first home buyers (FHBs), well, there aren't many new ones. After all, you can only afford to buy property if you've been owing property that's been going up in price, and are willing to borrow against that equity.

So the younger generation is being called 'generation rent'. Your editor is a proud member. In fact, we're also a temporary boomerang child as well. Our flat in Melbourne is overrun by pollen this time of year, so we decided to sit hayfever season out for a few months and visit family in Queensland. Yay, living with family...think of it as market research on what our generation has to put up with in a property bubble world.

Enough anecdotal evidence, here are some figures from the MacroBusiness blog. First home buyers are making up less and less of the demand curve for Australian housing:

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It's largely down to a surge in investors rather than a drop in FHBs (see next chart below). Incidentally, that gigantic blip in FHBs around 2008 was Kevin Rudd's FHB grant. Many of the poor suckers will have lost a lot of money on the value of their house over the last few years. They're learning the hard way what you get for being in league with the government. Unfortunately, buying a house is a high stakes game.

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But let us ask you, what are houses for? Living in or speculating on? Who should be buying houses in a healthy market, speculators or people who want to live in them? And what happens to the property ladder if nobody is getting on the bottom rung? It's looking top heavy if you ask us.

So when will this bubble finally pop? Well, we're always sceptical of short term data. Having collected some on climate change for the CSIRO in our uni days, we know it's mostly rubbish. Also it tends to make us look like a fool many times before proving or disproving anything. But for what it's worth, home loan approvals dropped for the first time this year.

And house prices in much of Australia are struggling. The summarised data hides some real issues. A recent RP Data report shows that one in eight houses sells at a loss before transaction costs and taxes are thrown in. Queensland made up the bulk of the losses.

But here's the punch line. 22% of homes bought since 2008 were sold for less than they were bought. Those poor FHB grant takers...

Another sure sign of the bubble is that banks are pulling back their lending while non-bank lenders are stepping up. We've written to you about the collapses of Banksia and its fellow debenture companies before. It's the old periphery/core argument. Crises start at the periphery and move inwards.

Here in Australia, the latest news is that mezzanine financing is filling the gap left by the banks. For example, banks are cutting back on lending to developers until their projects are de-risked. Companies like Alceon lend to them instead at 19% rates until zoning laws and government approval is in place, at which point the bank makes its move. In finance, return and risk are closely correlated. A 19% rate of return on lending is telling you something about the risk. And the banks aren't willing to take it...

So how does restricting supply cause a property bubble? Well, if you restrict the supply of anything it becomes more valuable. Diamonds are everyone's favourite example. Some say the entire diamond industry is based on a fake scarcity managed by a few big families.

When you restrict supply by creating zoning laws and other regulatory rules, you create an environment where an increase in demand translates to an increase in price instead of simply more supply. Once that process begins, the housing bubble takes charge. Rising house prices become a consequence of rising house prices, as investors and speculators pile in and borrow against increasing equity. At this point, debt and interest rates become the key.

Because of the risks of debt, you don't need a supply shock to pop the bubble. In other words, house prices can tumble without the government giving in and releasing more land. Instead, all it takes is for house prices to stop rising once debt is maxed out. People cannot unlock more equity in their homes if it doesn't exist in the first place.

At this point, the momentum is pulled out from under the market and the debt becomes unaffordable. That's what Australia is bearing down on. Debt and prices are incredibly high and interest rates low. Something is going to give.

One interesting side effect of this supply restriction logic is that developers have to build upwards to generate more supply. This is where the 'skyscraper index' comes from. Property collapses are foreshadowed by new skyscrapers. And we've seen apartment booms across the country.

Putting all this together reminds us of the movie Pirates of the Caribbean. 'Do you believe in ghost stories Ms Turner?' asks Geoffrey Rush. 'You're in one!'

Well, dear reader. You better believe there's a property bubble. You're in one! As for what to do about it, Dan Denning is the man with a plan.

Reader P.B. emailed in his thoughts on the restrictions on housing supply in Australia a week ago:

To: dailyreckoning letters
Subject: New Housing Supply
I am engineer in the land development industry (semi retried).
New housing [construction] is unattractive because:
Banks won't lend to developers to develop new land releases.
Local, state and Federal government charges on a new house and land package are about 40% of the cost of delivery.
New houses effectively lose 40% of their value on the day a first home owner settles. These taxes don't apply to established houses.
State governments stopped investing in infrastructure about 10 years ago so that all the infrastructure is funded by the new home buyer.
Local and state rules drive up the delivery cost of new house and land package. Recent planning and building code requirements add about $50k to the cost of a new house and land package. Again these don't apply to established houses.
New houses are primarily on the outskirts of major cities. Gen Y does not want to be there. Too far from the cappuccino.
Urban sprawl has made living on the outskirts untenable.

Just a few reasons my new housing stock is not likely to take off any time soon. Major problems looming:
Overcrowding
Aging infrastructure will need to be retrofitted. No one except engineers are thinking about this. Who is going to pay for it?
Government is allowing the regions to die a slow death leaving thousands of empty houses vacant in country towns all over the country. You can buy a three bedroom house in Millicent SA for $90,000. Google Millicent and see if you can work out what has happened to a once vibrant town.
Enough depressing news for now.
P.B.