A couple of months ago, I read an article by the ABC citing federal Treasury Secretary John Fraser, who was warning at a Senate hearing that there was no doubt in his mind that Sydney was “unequivocally” in a housing bubble.
“When you look at the housing price bubble evidence, it’s unequivocally the case in Sydney. Unequivocally,” he said.
“Frankly, whatever the data says, just casual observation can tell you it’s the case.”
Mr Fraser said a price bubble also existed in the higher-priced areas of Melbourne, but evidence of a bubble in other parts of Australia is “less compelling”.
This raises a question about the definition of a bubble.
When talking of a bubble, people usually mean one of two things: they may be referring to an environment where prices go up and prices go down. This environment is characterised by movements which are random and unpredictable. This definition of a bubble has no meaning and is empty.
The definition could also be used to characterise a rise in values where the ‘burst’ of the bubble is predictable to some extent. The problem with this definition in a practical sense is there is little evidence in financial markets that anything is predictable. Often, a pattern can only be recognised after the fact.
This is why economists’ future outlooks are largely of little value.
Housing is in an unusual position of being an investment asset class, as well as providing a social need. This is why it is such a hot issue in the public debate.
Yet, perhaps somewhat ironically, it is the ongoing balance of supply and demand for the social need for housing that largely establishes value. A bubble is created when this supply and demand relationship becomes out of balance, usually in an environment characterised by an unusual (and unsustainable) demand or lack of supply.
A bubble is created when human intervention tries to manipulate an outcome.
The US housing bubble in the early 2000s was primarily caused by the US Senate who introduced a new piece of legislation that required lenders to offer loan programs for the financially disadvantaged to assist them to purchase their own house.
The result of this legislation was that it increased the demand for housing – and thus, property prices increased.
In Australia, our lenders’ policies are generally considered prudent. It is not easy to qualify for a mortgage, but it is not too difficult either. It is the correct balance to strike.
So why are Sydney property prices in a bubble, if in fact they even are, as Mr Fraser has argued?
One factor is historically low interest rates. That is a driver of increased borrowing for certain, yet that is not unique to Sydney.
The most logical answer to me would be the increased demand due to increased buyers.
Over the past few years, self-managed superannuation funds (SMSFs) have been permitted to borrow for the purposes of residential property ownership. This has never been the case in Australia before. SMSFs in Australia control $590 billion in Australian assets – by far the largest asset class in Australia. When a buyer group of this size is now permitted to borrow to purchase an asset that has a historically strong performance of growth and stability, then naturally some money is going to flow into this asset class.
The second observation is the increased demand for housing from offshore investors. I will not discuss this, as much has already been written in great detail.
But when the market experiences an increased demand from buyers who were previously excluded from the market, the balance is going to change. In this case, the change is increased property prices.
Whether that increase remains at an increased level depends on whether buyer demand is maintained. If the rules were changed to prevent SMSFs from borrowing for residential property or foreign investment was restricted, my forecast is that pressure would decrease on property prices and value increases would cease. There may even be some decrease in prices, albeit minor.
Given that neither of these policy changes are likely, I disagree with Mr Fraser’s rather unsubstantiated claims of the Sydney property bubble.
Let’s come back to this in three years’ time, where my predictions will be proven to be correct.