02 December 2013

Why there may not be a housing bubble... Our aging population

A great deal of discussion has recently ensued regarding a potential housing price bubble in Australia and particularly Sydney. At this point any strong house price growth and auction clearance rates are limited to selected areas and is not wide spread. Furthermore, such increases whilst pleasing for existing home owners in those areas remain a frustration for those wishing to purchase at ever increasing entry prices in those areas.

So what is really happening and why?

In reality the price of any home is a function of many variables. In economics you examine such matters through econometrics or the statistical side of the “dark art” and from this the current orthodoxy is there are several factors in the composition of house prices. Each factor has different impacts on the house price depending on where we are in the economic cycle.

These factors can be categorised into ‘demand side factors’ and ‘supply side factors’ which can be summarised as follows:

Demand Side factors:

  • relative prices of alternative assets/investments (price of rental substitute);
  • mortgage interest rates and level of credit availability;
  • RBA Monetary Policy and rate of inflation;
  • population growth;

Supply Side factors:

  • government expenditure (extend of crowding out/in private investment);
  • tenancy laws;
  • stamp duty and government charges;
  • availability of existing and supply of new housing stock;
  • land availability and planning law ‘input development costs’;

One of the most important demand side variables is the rate of population growth in the economy; which at this point in Australia is growing strongly with circa 230,000 net immigrants entering our country last year.

One of the most important supply side variables is the availability of housing stock and ease of building more houses which in turn is dependent on planning laws and the overlay of development on cost by local governments to a block of land or the building itself.

It has been estimated that we are almost 1.2 million dwellings behind present expected housing demand. Other current supply-side constraints which arise from local government planning make it very expensive to build new dwellings (the "gold plating effect") and also have hampered a lowering of the price of housing in this country.

If you then provide for a growing population base of over 230,000 new people per year then many are worried that the current house price upward trend may go on forever; and arguably whilst not very attractive for home purchasers to battle ever rising prices, such high prices of themself are not a bubble because such prices are purely being driven by real underlying supply constraints and growing demand dynamics.

A bubble by definition is where demand and supply are out of alignment by a significant unsustainable amount over a sustained period. Recent selective price movements would not meet that definition yet.

What is population really doing?

Recently Labor leader Bill Shorten declared Australia should increase its immigration levels, saying the next arrival could “be the next Albert Einstein or a good taxpayer”.

Speaking about immigration more broadly, Mr Shorten said Labor needed to re-state its support. “Immigration has been a plus for us and we should be certainly as a party being seen to be pro-immigration and pro increasing it, making sure people go to wherever it is sustainable for infrastructure and support, but we are an immigrant country and we shouldn’t ever hide from our destiny.”

What we do know is that this will push housing demand even further causing stronger house prices over time.

Advocates of population growth argue that it is required in order to grow the economy and that, without it, growth would suffer, lowering overall living standards. However, from a narrow economic perspective, population growth (via natural birth rate and or immigration) is beneficial to current citizens only if it raises the real incomes of the pre-existing population (e.g. GDP per capita).

While it is true that Australia’s high population growth over the second half of the 2000s boosted Australia’s real GDP (more labour inputs, other things equal, means more outputs), evidence is sketchy as to whether GDP per capita increased due to population growth.

In fact, as the below chart shows real GDP per capita has remained lacklustre since 2007, suggesting that while the overall economic pie has increased in size because of high population growth, everyone’s share of that pie has barely grown. However we also acknowledge that Australian GDP was negatively affected by global issues unrelated to our population growth.

Indeed, a big factor behind Australia’s world-beating economic performance since the GFC was our strong population growth, which boosted headline GDP. Remove population growth from the equation, however, and you can see that Australia did in fact experience a recession in per capita GDP in 2008, with growth remaining lacklustre ever since. Perhaps this is a reason why governments support strong immigration, since it inflates growth and enables them to claim that they are strong economic managers, even though individuals across the economy are experiencing minimal material improvement.

One negative of high rates of population growth is that in the absence of building more houses and apartments, it places increasing pressure on the pre-existing (already strained) stock of infrastructure and housing, reducing productivity and living standards unless costly new investments are made..

Further, when infrastructure and housing investment fail to keep up, it places upward pressure on inflation, requiring higher interest rates, which can then damage productive sectors of the economy. These dynamics were explained in detail in a 2011 speech by the Reserve Bank of Australia’s Phil Lowe. Currently, housing-related costs – including rents, utilities and the cost of building new dwellings – account for around 20 per cent of the CPI, the largest share of any single group.

Broadly speaking, the housing component of the CPI shows the same general pattern as that in underlying inflation, although the recent moderation is less pronounced.

Why house prices won’t go on forever...retiring Boomers property effect

The United Nations forecasts that the ratio of taxpaying workers to pensioned non working retired dependents (the dependency ratio) in Australia is projected to fall significantly over coming decades as the Baby Boomer generation retires en masse (see next chart).

While the current population growth rate of 1.8% seems fairly benign, due to the powers of compounding, such a rate of growth is clearly unsustainable over a long time frame (see next chart).

Source: ABS

Finally knowing that Australia will continue to grow its population the retirement of the large baby boomer generation – a cohort that represents around 25% of Australia’s population but holds roughly half of the nation’s housing and financial assets – could thankfully present a moderating headwinds for rising asset values, since many boomers would look to divest their asset holdings in order to fund their retirements – a process that would place downward pressure on valuations, again unless offset by large population growth.

The Bank for International Settlements (BIS) Working Paper, published in 2010, agreed with this view, estimating that the ageing of the baby boomers is projected to reduce Australia’s real house price growth by around 30% in real terms over the next 40 years - that’s only around 1% per year (see below chart). The BIS also expects ageing to have a similar impact on the value of all financial assets.

An article published in the AFR claimed that nearly 40% of baby boomers are planning to downsize, potentially flooding the nation with some $500 billion worth of property – equivalent to roughly 11% of the total housing stock …the sky-high price expectations of a generation whose wealth was swelled by surging property prices might be ¬disappointed because of their successors’ inability to pay their asking prices… “This mix of credit boom from the 1990s, ageing demographics of those who got into housing stock early, credit competition leading to a lending boom and higher loan-to-value ratios for the new generation makes it difficult to create a natural new set of buyers,” the article said.

The boomers’ luck at having been born at the right time to enjoy record property growth has been at the expense of their ¬children and grandchildren, many of whom will postpone their parents’ move because they can’t afford to leave the family home and buy one of their own.

It probably wouldn’t be drawing too long a bow to suggest that the current surge in investor demand for Aussie property is being driven by younger boomers – i.e. those aged in their late 40s to mid-50s – who are significantly larger in wealth than their older boomer cohorts and likely scrambling to accumulate assets for their retirement.

As such, the great baby boomer sell-down will likely commence late this decade as the lion’s share of boomers have entered retirement – rather than just the tip of the iceberg, as is currently the case. So it may be the current arguments about the existence of bubble in house prices may be spurious and if anything house prices should, on current supply constraints and growing demand, continue to grow.

It is hardly a scenario for a “burst Bubble” or “crash in property prices” as some pundits are attempting to predict. These doctors of doom may yet again have to be faced with a market where at best prices will deflate, if at all, only slowly and an admission that they were wrong because current price rises where merely reflective of a retracing of value lost during the GFC in particular markets.

Anyway its food for thought...

... That's Lending

Best regards,
Paul Wells, Chief Investment Officer
La Trobe Financial Asset Origination & Credit Division

La Trobe Financial is one of Australia's leading independent credit specialist Fund Managers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 123 staff and has managed over AUD$10Billion covering over 100,000 investment grade assets since inception in 1952.

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