Australia: Housing bubbles and declining business investment

The Australian housing bubble is alive and kicking, with house prices growing at close to 10% per year.

Loan approvals are climbing, especially for owner-occupiers. Fueled by record low interest rates.

Causing household debt to soar relative to disposable income.

Business Investment

Nominal GDP growth of 6.34% for the 2017 FY is a rough measure of the average return on capital investment.

With a mean of close to 5% over the last two decades, it is little wonder that business investment is falling. Not only in mining-related engineering but in machinery and equipment.

Capital Misallocation

More capital is being allocated to housing than to business investment.

Returns on housing are largely speculative, premised on further house price growth, and do little to boost GDP growth and productivity.

The result of soaring house prices and household debt is therefore lower business investment and lower GDP and wages growth.

You don’t have to be the sharpest tool in the shed to recognize that soaring household debt and shrinking wage growth is likely to end badly.

Australia: Housing, Incomes & Growth

A quick snapshot of the Australian economy from the latest RBA chart pack.

Disposable income growth has declined to almost zero and consumption is likely to follow. Else Savings will be depleted.

Residential building approvals are slowing, most noticeably in apartments, reflecting an oversupply.

Housing loan approvals for owner-occupiers are rising, fueled no doubt by State first home-buyer incentives. States do not want the party, especially the flow from stamp duties, to end. But loan approvals for investors are topping after an APRA crackdown on investor mortgages, especially interest-only loans.

The ratio of household debt to disposable income is precarious, and growing worse with each passing year.

House price growth continues at close to 10% a year, fueled by rising debt. When we refer to the “housing bubble” it is really a debt bubble driving housing prices. If debt growth slows so will housing prices.

Declining business investment, as a percentage of GDP, warns of slowing economic growth in the years ahead. It is difficult, if not impossible, to achieve productivity growth without continuous new investment and technology improvement.

Yet declining corporate bond spreads show no sign of increased lending risk.

Declining disposable income and consumption growth mean that voters are unlikely to be happy come next election. With each party trying to ride the populist wave, responsible economic management has taken a back seat. Throw in a housing bubble and declining business investment and the glass looks more than half-empty.

Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.

~ Eric Hoffer

Australia faces headwinds

Australian wage rate growth, on the other hand, is declining. is in a worse position, with a dramatic fall in investment following the mining boom.

Source: RBA & ABS

As is inflation.

Source: RBA & ABS

Growth in Household Disposable Income and Consumption.

Source: RBA & ABS

And Banks return on shareholders equity.

Source: RBA & APRA

But not Housing.

Source: RBA, ABS, APM, CoreLogic & Residex

At least not yet.

Falling house prices would complete the feedback loop, shrinking household incomes, consumption and banks ROE.

Platinum founder warns on property “act of faith”

By Leith van Onselen

The founder of Platinum Asset Management, billionaire investor Kerr Neilson, has released an interesting report warning about Australia’s frothy house price valuations and the risks of a correction once “conditions change, [and] a lot of the assumptions are found wanting”.

The report highlights four “facts” about Australian housing:

1. Returns from housing investment are often exaggerated and flattered by inflation.
2. Holding costs of rates, local taxes and repairs are estimated to absorb about half of current rental yields.
3. Long-term values are determined by affordability (wages + interest rates).
4. To be optimistic about residential property prices rising in general much faster than inflation is a supreme act of faith.

It then goes on to examine each of these facts.

On returns, the report notes that “the rise in the price of an average home in Australia…[has] been about 7% a year since 1986. In dollar terms, the average existing house has risen in value by 6.3 times over the last 27 years. No wonder most people love the housing market!”

But rental returns have gotten progressively poor:

…we earn a starting yield of say 4% on a rented-out home or if you live in it, the equivalent to what you do not have to pay in rent. But again, looking at the Bureau of Statistics numbers, they calculate that your annual outgoings on a property are around 2%. This takes the shape of repairs and maintenance, rates and taxes, and other fees. This therefore reduces your rental return to 2%, and what if it is vacant from time to time?

And the prospect for future solid capital growth is low due to poor affordability:

…the last 20 or so years has been exceptional. Australian wages have grown pretty consistently at just under 3% a year since 1994 – that is an increase of about 1% a year in real terms.

Affordability is what sets house prices and this has two components: what you earn and the cost of the monthly mortgage payment (interest rates).

…even though interest rates have progressively dropped, interest payments today absorb 9% of the average income, having earlier been only 6% of disposable income.

Today, houses cost over four times the average household’s yearly disposable income. At the beginning of the 1990s, this ratio was only about three times household incomes. As the chart over shows, this looks like the peak.

Finally, the report argues that for Australian home prices to significantly outpace inflation over the next ten years, as they have in the past, “would require a remarkable set of circumstances”, namely a combination of:

1. Continuing low or lower interest rates.
2. Willingness to live with more debt.
3. Household income being bolstered by greater participation in the income earning workforce.
4. Average wages growing faster than the CPI.

The last point is improbable seeing that wages and the CPI have a very stable relationship, while the other points are not very likely.

Reproduced with kind permission from Macrobusiness.

Household Debt to Income ratio

Barry Ritholz highlights the alarming debt to income ratio for Canada compared to the USA:

How does Australia compare?

Australian household debt to income is similar to Canada’s. There has been discussion recently about whether Australia is in a housing bubble. As Anna Schwartz (joint author of A Monetary History of the United States, 1867-1960 with Milton Friedman) pointed out: there is only one kind of bubble and that is a debt bubble. It may manifest through rising real estate, stock or other asset prices, but the underlying driver is the same: a rapid expansion of the money supply through easy credit.

Australia & NZ: Housing wealth to disposable income

Leith van Onselen posts this chart comparing housing wealth to disposable income. Australia and New Zealand are the worst offenders, with ratios close to 5:1, while the US never reached 3:1 even at its sub-prime peak.

Canadian housing bubble looks ripe for popping | Toronto Star

Adam Peterson writes the Canadian housing bubble is headed for a “slow-motion” crash:

My gravest concern is that Canada is fast approaching a 5:1 home-price-to-income ratio, a benchmark achieved by the U.S. at the peak in 2006. Since the correction, the U.S. ratio now hovers at approximately 3:1.

To compound the problem, household debt in Canada has breached 150 per cent of income and continues in the wrong direction; households are not cushioned against a blow.

Australian household debt is also hovering around 150% of disposable income.

While the price-to-income ratio varies between 4 and more than 6 depending on whether you use national averages or median data.

Read more at Canadian housing bubble looks ripe for popping | Toronto Star.

Unsaving the U.S. economy | MacroScope

Gabriel Burin writes that the U.S. savings rate sank last month to its lowest since November.

“Households were only able to boost consumption in the third quarter by dipping into their savings,” said Paul Dales, senior U.S. economist at Capital Economics, after the Commerce Department release. “Faced with the prospect of major tax hikes in the New Year, however, they will soon become more cautious”……..

via Unsaving the U.S. economy | MacroScope.

Australia: RBA overview

A quick review of the RBA chart pack released today.

Household finances remain in a precarious position with debt at 150 percent of disposable income — three times the level of the early nineties.

Housing credit growth slowed to around 5 percent, but will probably fall further by the end of the cycle — following personal credit into a contraction — in order to reduce the debt to disposable income. Declining growth rates leave a hole in aggregate demand but this is being offset by rising business credit.

Bank capital ratios are improving but these are based on risk-weighted assets. As Deep T pointed out last year:

“……..the average minimum amount of Total Capital against total residential assets held by those [the 4 major] banks is less than 2%.”

They still have a long way to go to build sufficient reserves to withstand a collapse of the housing bubble, brought about by household deleveraging.

Bank interest margins are being squeezed, making them reluctant to expand their balance sheets. Further decline in net interest margins could precipitate a credit contraction.

Bulk commodity prices are falling but the full impact of the sharp drop in iron ore spot prices has not yet been felt on the current account and government tax revenues.

The current account trade balance is improving but, as a net debtor, interest and dividends to offshore investors drag the country into deficit. As David Murray points out: the fact that Australia was unable to post a current account surplus throughout the mining boom indicates we are living beyond our means and will lead to burgeoning debt levels.