Don’t hold your breath waiting for the property ‘bubble’ to burst

Ron Bewley


May 4, 2017

Why is the price of a house in Sydney much more than for a similarly sized house in Wollongong? Silly question, there’s no comparison, right? Hold that thought for a moment.

When I was a young lad, the tallest building in Sydney was a 14-storey edifice in Castlereagh Street. The 50-metre height restriction on buildings was lifted in 1957. There are now 1168 skyscrapers in Sydney, of which, 35 are taller than 150 metres.

When I arrived in Sydney in 1975, there were almost no places to dine outside – it rains in the afternoon when the southerly comes, so I was told – and the Opera House was less than 2 years old.

Now, back to Sydney and Wollongong. If no sensible person thinks comparing prices in the two cities today is meaningful, why compare prices in Sydney now with prices when I was young? And if one of the world’s great financial centres had started in Wollongong 50 years ago instead of Sydney, what would have happened to house prices over time in these two cities?

While it is increasingly hard for people born in Sydney to be able to buy in Sydney, that does not mean there is a price bubble here. A bubble is only a bubble if prices have been bid up above sustainable levels based on fundamentals. And the fundamentals in Sydney have shifted upwards.

The critical bubble question

Whether or not a bubble exists is a question central to the stability of the banking sector, which, in turn, is central to the stability of the sharemarket. The Financials-x-REITs sector is 40 per cent of the ASX 200.
I wrestled with the bubble problem back in 2003-04, after a few years of strong price growth, like now. I concluded from extensive research that house prices in the major capitals – going back to as early as 1900 – relative to general price levels measured by the CPI, move in ‘steps’. On average, the so-called ‘real’ price levels change little for extended periods of time – about 4-7 years, and sometimes as long as 10 years – and then go through a price spurt.

Therefore, it is easy to distort price growth analysis by focusing only on the price spurts.
Why should prices behave like this? It is hard to determine a fair value for a particular house, especially when average prices are rising. It also takes a long time to find a suitable house and then await the auction, so there is a temptation to pay more than one thinks is fair on the day, so long as it might be fair in a few months when that person finds the next similar home to buy.

At some point, people realise prices have moved a bit too much and decline to buy at that or higher prices – and transactions levels fall. Hence the next ‘property price plateau’ is born. And it continues until prices seem a bit cheap after wage growth, and the next price spurt begins.

In about 2004, I presented my findings at a press conference while I was at the Commonwealth Bank of Australia. I’m not sure anyone believed me in that meeting when I claimed that there was then
no bubble and property price growth would just slow down for 4-7 years, or maybe longer.

There was one journalist in particular who was rather rude about not accepting my findings, I recall! And he remarked that it is silly to compare a house price in Sydney in 2004 with one in 1900. Point made. The fundamentals have shifted and more so in Sydney and Melbourne. In Perth’s case, they faced strong house price growth in the mining boom but then the fundamentals fell away.

Numbers dispel the myth

I show in this chart what happened after that press conference, by deflating the ABS Sydney Residential House Price Index using the Sydney Consumer Price Index. This data series starts only in 2003 because many people then said the ABS had got it all wrong. Of course they hadn’t; the bubble-myth people just didn’t understand price formation. Reminds me of climate-change sceptics.

So if I wanted to cheat, I could say Sydney house prices (not CPI deflated) have grown at 13.4 per cent a year since March 2013 (by choosing the period of fastest growth). But, net of inflation, the answer is only 2.6 per cent a year, since the series began in September 2003 – only a bit faster than real wage growth.

Note that real prices had fallen from 2003 to 2013!

And if we go through a new plateau, the 2.6 per cent a year figure will fall. Of course, 2003 marked the end of a price spurt, so the number would be higher if we had a longer time series going backwards.

So I see no mortgage-related problems from bubbles for the banks or the sharemarket but individuals will always find it tough and the prices in individual submarkets may fall.

Back in 1975, I was attracted to work at UNSW because I was going to earn a gross salary of $11,900 a year, which tripled my Manchester University lecturer’s salary. In 1977, it took us two good salaries and parental help to get a mortgage on a two-bedroom unit in Coogee. We didn’t have breakfasts out in cafes and expensive lattes. My wife didn’t go for a “mani and pedi” or a day spa to chill out, and our friends didn’t either. We had to budget. The world has changed.

So will average house prices fall in Sydney? Quite possibly, in the sense of the plateau I show in the chart. But anything worse? No, unless Melbourne attracts the finance industry from Sydney in the way it attracted the F1 Grand Prix from Adelaide in 1996!

TOPICS:   Property markets