Monday, April 11, 2011

Caldera of Ozzie Ire

TMM probably should have realised that by broaching the topic of Australian rates, the composition of household wealth and thus housing we were walking around the caldera of a very active volcano of debate in both markets and policy. You see, some people like Jeremy Grantham have made the point that Australia is a housing bubble because its growth is so far away from trend, others, admittedly with some skin in the residential property game like Chris Joye at Rismark in Australia have staunchly defended Australian residential real estate prices as more business as usual in affordability terms and the rise in values as being due to secular declines in inflation and therefore rates. Steven Keen and Chris Joye have even debated here. So, what does TMM think?TMM think that rather than throwing peanut shells from the sidelines that its worth taking a step back and ask what a housing bubble is anyway. As with everything, there is demand and supply:

  1. Demand: Real wages, population growth, employment growth, CREDIT, tastes and preferences, cost of capital.
  2. Supply: Costs of construction, real geographical constraints, supply side constraints like zoning, short term elasticity of supply.
  3. Market Microstructure (how 1 and 2 sort it out).

You would be inclined to think the whole world has decided that any real estate market comes down to one variable and one variable only, the one in BOLD above - which is a gross oversimplification that allows journalists to lazily fill column space without doing any real work.

TMM thinks we covered the demand side in Australia pretty well (real wages, employment, rates in the previous piece) and Joye makes a good case that given these ratios have been stable since the late 90s as people's tastes and preferences adjusted to new, lower long term inflation expectations that there isn't anything untoward in house prices' rise in the 2000s.

On the supply side there has not been much work done on the costs of zoning in Australia aside from stuff like this but it appears that the costs are mind-blowingly high. More work needs to be done on this by the RBA and their ilk on how the geography of Sydney and its ring of national parks affects housing but its an article of faith that this is a big deal for affordability. Ed Glaeser covers this well in the US and it is worth noting that those markets that are most constrained like New York have bounced hardest coming out of the crisis, Phoenix and Las Vegas, less so.

Perhaps the "tell" of the housing bubble in the US was that markets with vastly different fundamentals started to perform similarly, in that subprime defaults were mere symptoms of the underlying credit bubble that had manifested itself in increasing leverage across all income, demographic and geographical groups in the US. That does not seem to be the case in Australia right now. As far as the distribution of leverage goes, many bears point to the First Time Buyer Credit leading to a ramp in prices in the aftermath of the GFC. TMM are sceptical on this point given that, unless they misunderstand the ABS's numbers, that only around 220k first time buyers took advantage of this perk. In terms of the effect of such a group moving en masse into delinquency, the numbers are just not large enough to produce a meaningful spill over into the rest of the economy (220k * 300k average first time buyer price ~AUD 66bn). As TMM noted on Friday, the Household Net Worth position in Australia does not show any particular sign of overleveraging, sitting at around 600% of disposable income, relative to liabilities of around 140%. A point often made is that using average wealth and income levels masks the underlying skewed distribution, and is one that TMM are always very aware of. However, in Australia, they do not necessarily believe that there is much wrong with this level of abstraction given that Australia's Gini coefficient sits at just 30.5 (25th lowest in the World), vs. 45 for the US (95th in the World, and below that of the Ivory Coast!).

In terms of geographical distribution, Perth and Brisbane are ripping while Sydney has been flat lining for a long time. To TMM that says a lot about what they pay wheel loader drivers vs what they pay lawyers today and indicates that forces aside from credit are at work here. Note that in these regions there was pretty much no one living in many of these areas.

On market microstructure, the picture is reasonably positive. Most houses are sold via auction in Australia which can induce bidders to bid up but also ensures people know where the next best print is - its hard for a market to go completely illiquid when they know where the next bid is which was a serious problem in some areas of the US where housing seemed more like selling CDO tranches in early 08 than anything else.

Then there is the issue of how that market micro-structure can or will handle "weak hands" i.e. - over-levered players who get stopped out and put a lot of supply on the market as was the case with US subprime... or any agricultural futures expiry this year. As far as TMM can tell, those people have largely been blown out already: looking at the hands-down crappiest securitisation in Australia in 2007 (Mobius NCM-04) losses have already been taken and those loans that are still performing are at much lower LTVs. No one prints this stuff anymore and if deals like this haven't taken down the market they are not likely to anytime soon at LTVs <60%.

Finally, is there any evidence of return-chasing, that other key ingredient of a Bubble? As regular readers will recall, TMM have a particular fondness for considering whether a certain market's returns are auto-correlated as this provides a statistical measure as to whether current returns are explained by past returns (i.e. - did punters see that prices had gone up and decide to buy more?). To that end, TMM have compared the 8-quarter rolling 6m auto-correlation of year-on-year house price growth in both the US (see chart below, red line) and Australia (blue line). In the US, it appears that the bubble began to form in the mid/late-1990s, crescendo-ing into 2005 before crashing spectacularly - the strong auto-correlation from 2007-2010 being a function of house price declines leading to even more declines (leverage working in the other direction). But in Australia, aside from a brief period of positive auto-correlation between 2001-04 at low levels relative to the US, something arguably related to the Zoning issues TMM discussed above, it is not particularly obvious that there was any particular degree of return chasing in the Aussie housing market. TMM would also note that Australian house prices fell/went sideways from 2003-05 and similarly from 2007-9: house price falls are not unusual and therefore embedded into household expectations, unlike in the US where house prices had not fallen on a nationwide basis since the Great Depression.

So, are TMM Aussie housing bulls? Hardly. TMM are less concerned about some inherent instability and fragility in the housing market than they are about broad instability and fragility in the Australian economy. While LTVs may be low going back to those Perth wage changes it is quite clear that Australia has an awful lot riding on the mining boom and implicitly Chinese fixed asset investment. Seeing how much of Australia's total investment is in mining and how average wages in suburbs in Perth have consistently outstripped GDP for some time running, we are also concerned about how a real shock (namely, China slowing substantially) would impact real incomes and in turn housing. Australians have a lot of wealth locked up in housing (around 440% of disposable income) and the tax system encourages people to be long property. It is possible that a real shock could lead to a mother of an unwind but once again, that is a shock from an external source, not some inherent criticality in Aussie housing itself.

TMM can't help but feel that Australian housing is riding the Dragon and little else. Then again, just about everything else Australia is, including the AUD. Looking for the next subprime debacle and opportunity to short billions of mortgages for <100bps per year and watch them go to 20c is not something that is going to work in Australia before a couple of other interesting things happen - like copper going to $4000/ton and the AUD/USD revisiting .70 or worse. Put simply, there are easier trades.

20 comments:

Anonymous said...

Too complicated for a definition and uneccessarily so.
If you look into this historically you will find it much simpler.
A generic housing bubble always is defined simply when the long run affordability ratio becomes detached. Now this will not tell you when the bubble will pop to within a couple of years. It will tell you though that in the future you will be able to buy property at a more affordable ratio.
The problem is markets tend not have much patience so when this ratio is has become detached ,but the markets somehow still not popped the market finds all sorts of reasons why this particular housing market is different.
The fact is they are never different in outcome if you have the patience to wait for it to resolve.

abee crombie said...

as a Canadian I have had a hard time understanding the difference in housing markets (vs the US) particularly in places like vancouver and toronto, where the economy is decent but not gangbusters

I think whenever we talk about housing we have to differentiate btwn stock vs flow. Sure the stock of housing may be "overvalued" but housing is not a frictionless, 100% financially motivated market.

I think its better to look at the marginal buyer vs marginal supply. In equities/FX/fixed income the amount of marginal buyers/sellers is so large that these markets adjust to equilibrium "stock" values much quicker. Not the same in housing. (unless you have a spectacular credit which forces many marginal sellers onto the market) I think if we concentrate on the marginal buyer in these "overvalued" countries we will be better able to pinpoint when the market will start to turn.

As well, when we say 'overvalued' vs income.. what income are we using? average... tsk tsk

zen said...

Another great post on Australia!!! Thoughts from Englishman doing the dinner party circuit in Sydney. Firstly the whole system is rigged for a bubble. In the auctions you mention the seller actually gets one bid on their own property and to rig it even more the seller’s “reserve price” has to be met before the auction is binding. If it is not met then the highest bidder has the exclusive rights to negotiate with the seller. Successful auction rates are around 50% but have ticked up to 60% recently, however that includes deals negotiated with the highest bidder and not actually done at the “live” auction. From the ones I have seen you can safely assume it’s not an auction at all and more a hard sell from the agents who make their UK equivalents look like the hare krishnas.
To pump the price/bubble we have some nice tax incentives where you negatively gear any investment property so you can reduce your tax liability. Australians are a nation of home owners, but the tax minded ones buy an investment property and rent/live in the house next door. Consequently rents are low compared to prices. I probably pay half the financing costs of the house I rent. People are happy to accrue the loss and get half of it back from their tax return with the expectation their capital will appreciate. Take this appreciation out of the expectation loop and then it is not rational to own an investment property. A loss is a loss!!
Anecdotally try and tell an aussie that the property market is a bubble and you get a look as if you’ve just said “the world is flat”.
I’ve probably gone on a bit but there is some rigging the land release too. Anyway for me it is a bubble – what could ever cause it to pop and when that could be is mystery. Australia, as you have noted, is a micro climate in more ways than one!!!

Nemo Incognito said...

abee crombie i think that's right but its covered by this piece - if you have short term inelastic supply bumps in pricing get corrected, ie, price series shouldn't be autocorrelated as mentioned.

Avi said...

sorry nemo I'm not really understanding what you are trying to say..

the only point I was trying to express was that regardless of what you think the value of the total stock of housing is, prices are set at the margin, mostly by new buyers, who apparently can afford the high prices

Anonymous said...

Please do a similar thread on Cdn housind market too. As abee crombie said, I am having hard time understanding Van. and Toronto markets. Some have suggested rich immigrants from Brics(especially Hong Kong, and India) and or cash from sale of B.C. Bud!

Nemo Incognito said...

Sorry Avi the idea is that the overall level of the housing stock vs income comes down to maginal buyers but also marginal supply - if its easy to build then any short term squeeze should be filled by further construction. That means that if house prices pop above demand fundamentals due to short run elasticity they should come back down again as new houses get built. This can take a few years but it just goes to show how insane the US market dislocation was in 98-05.

Viz Canada etc IMHO the jury is out. We could see a lot of marginal demand from Chinese/BRIC buyers but similarly it could be due to rising real wages from mining and other industries (BC Bud). The real tell will be if prices rise a lot, incomes don't AND there isn't any good proof of supply side constraints. I'd wage Vancouver has a somewhat hippie dippie Jane Jacobs influenced mayor who probably doesn't love infill midrise development which may be driving that market on a fundamental basis - after all its a nice place to live.

Anonymous said...

"Signs point to a severe bousing correction". http://www.theglobeandmail.com/report-on-business/

Prices in Canada are way out of line in relation to household income and record debt levels.

I am especially concerned about Toronto and Montreal- export based economy. BOC Gov. must be nervous. Rate decision coming up Tuesday.

Leftback said...

I am not going to belabor any additional arguments on this, as I got a good rubbishing last week, and I am certainly not quite as analytical and data-intensive as some of my betters.

Nevertheless, someone else has Aussie housing on the radar screen today:

http://globaleconomicanalysis.blogspot.com/2011/04/australian-home-sales-sink-luxury-units.html

I would point out that every bubble reaches its top when punters for some reason cease to buy tulips, and then some time after that the price of tulips falls, and articles appear on the "tulip bubble".

Anecdotally, I was visited by a Vancouverite last week who assures me that the BC bubble is now epic and that it has reached the stage where tiny little <1000 sq ft shacks are selling at $1M "in the best neighborhoods". Price/income is definitely in the 10x range. That means the last few fools are being recruited.

This is near and dear to my heart as I saw younger friends in the US make financially ruinous choices and they are now living with the consequences. The demographic and economic details may vary from country to country but the outcome seems likely to be the same.

Anonymous said...

"The demographic and economic details may vary from country to country but the outcome seems likely to be the same."

That's what I said with the first post.
After a lifetime in property I can tell you is ALL remarkably simple.There are no surprises other than the fact that quite intelligent people continue to be surprised that property obeys quite simple rules and when they are violated then if you are an investor you should take the appropriate action AND not wait for the last fool through the door to also become aware of what you should have known for quite some time as these markets do give plenty of warning IF you want to listen to the data.

Charles Butler said...

A couple of suggestions for your demand list:

1). Foreign investment - generally highly correlated with housing price changes. Vancouver and Toronto in the mid-80's with Hong Kong money getting a jump on the repatriation of their island. Spain in the noughties;

2). Perverse hedging - buyers who can't afford to getting in simply because they will be able to afford it less in the future. Kind of the mirror image of speculation. My guess is that this drove a weakening market in Spain from some time in 2005.

Obviously, fate has decided that I should live through the aftermath of two of these things.

Anonymous said...

some decent insights:

http://lorenzo-thinkingoutaloud.blogspot.com/search/label/bubbles

with terms of vs house prices:

http://4.bp.blogspot.com/_c9sjMyNxqqw/TTgJZfGVXpI/AAAAAAAAAeg/gYuKwqy-1vk/s1600/ScreenHunter_01+Jan.+20+21.05.gif

overall, abundant cheap credit (vs inflation or salaries if these track nominal GDP) are icing on cake to bubbles ... their in lies your prickly matter.

ALex said...

Vancouver is an interesting case. I don't have a lot of numbers, but having grown up there as the son of an urban planner, can offer some caveats to the market.
First, the geography of Vancouver is conducive to high prices. Bordered on three sides by the ocean, mountains and the US border, there is really only one direction to build: East. Now they certainly have not run out of land to develop, but the hippy planning department of Vancouver designed the city in order to discourage commuting from the suburubs (read: no real highway into downtown), so the commute times are much worse than in other cities the same size.
Second, as was already mentioned, the off-shore (Chinese) money. People don't really recognize the scale of immigration to Vancouver until they visit: literally half the people downtown are of East Asian decent. One easy way to get your application fast-tracked is to have a whole whack of cash to invest. East Asians seem to love owning property (apologies for the generalization), so there's the ongoing marginal demand (even at current, ridiculous prices).
To give you an idea of the scale of the increase, the house I grew up in has appreciated ten-fold in twenty years. And this isn't from a low base. It was $350K 20 years ago and somewhere in the mid-$3M range today (based on transactions on my block). We're talking 3000 sq ft with basement here.

Note that this is not reflective of housing prices throughout the city (average in the city is ~$750K).

Nonetheless, I don't think there's much argument that valuations are completely detached from fundamentals, but the question is: when does the flood of Asian money dry up?

Buying CDS on property developers in Western Canada may be a pretty good way to short China (not sure/doubt they trade though).

Cameron Murray said...

TMM, you point the finger at zoning for an explanation of house prices. Given that zoning simply controls the location of new development, and not the rate of supply, I would be interested to know why if can have such a dramatic effect on the general price level of homes.

In most cities in Australia there is a huge reserve of development approvals that never make it onto the market. In Brisbane for example, there where 6000-8000 approved house blocks (not including apartments) in reserve at any point in time this past decade. That's about two years supply approved and waiting to be sold into the market.

Given my experience developing land, approvals and zoning do not constrain supply (although they could if there was a quota mechanism). The rate of sales of new dwellings at market prices is the constraining factor.

My thoughts on zoning and housing supply here http://ckmurray.blogspot.com/2011/04/8-lessons-on-planning-and-housing.html

Brisbane stock of approved house blocks here - http://www.oesr.qld.gov.au/products/profiles/res-land-dwelling-activity-lga/res-land-dwelling-activity-brisbane.pdf

abee crombie said...

nemo, thanks for the clarification. now i see what you are talking about.. and I do agree that if marginal supply is able to deal with the new demand that theoretically prices should adjust back to equilibrium. The problem I see is that there is a positive feedback loop during that intermittent period before supply can fully catch up with demand, which attracts even more buyers (FDI and domestic speculators).. Real estate is all priced off of "comps" (not that equities arent too) and the attitude in Canada at least is that Real estate is a great investment (never mind the random pieces in the newspaper proclaiming a bubble, most of the ppl I know dont think that it is)

I am not sure how it all ends but I think prices can remain very expensive for a long time until interest rates rise higher (an educated guess) and affordability is reduced.

Anonymous said...

"most of the ppl I know dont think that it is)"

The above is exactly the mindset that develops in a bubble.When you examine why they think that ,that is the real revelation ,it's quite scary in fact,because you will find it borderline frightening that people you think are intelligent can be that stupid.

Anonymous said...

I'm surprised nobody has mentioned Bill Gross' commentary (a few years ago) about first-time buyers being the plankton at the bottom of the food chain....

LB said...

Yes, all bubbles depend on most people thinking that ever-ascending prices are normal, and that those who don't join in will be "priced out for ever".

Watching one of these happen from the outside does make one feel like Kafka's Gregor Samsa, forever waking up to discover one has become a giant insect.

Lately, the people who used to like houses seem to like silver a lot. Oh, there go my antennae again...!

Anonymous said...

How about valuation of Australian housing from an investors perspective (eg DCF values, particularly adjusting for the huge tax concessions)? Interesting viewpoint (quite neutral) here:
http://www.analystjournal.com/finance-and-business/expert-analysis/460-australian-housing-valuation-bubbles-an-analysis-and-assessment-of-investor-rationality.html

Anonymous said...

Who wants stats with anecdotes like this?

http://www.bloomberg.com/news/2011-04-01/australia-boom-means-men-without-degree-earn-more-than-bernanke.html

Somehow I don't feel that that situation will last forever.