Saturday, October 9, 2010

Morgan Stanley Analyst Sees Bubble in Australia

Morgan Stanley Analyst Sees Bubble in Australia
Australian residential housing is very expensive on standard valuation measures.  House prices appear around 50% above fair value in terms of house prices to GDP per capita.  In terms of value of the housing stock relative to household disposable income, the housing stock appears around 35% above fair value (a trend line based on data until 2000).  With respect to house prices to gross rental yield, prices appear to be around 40% above fair value.  House prices started to move above fair value around 2000 on all three value metrics.
Why are house prices so expensive in Australia?  My view is that the single most-important reason is the increasing willingness and ability of households to increase leverage.  Several factors have come together.  First, Australia has not had a recession since the early 1990s.  There is now a generation of Australians who have never directly experienced broad-based job losses.  Second, financial deregulation loosened supply-side constraints on lenders.  Third, lower interest rates.  ... Now banks often provide discounts on the standard mortgage rate.  Consequently, the average effective rate paid was above the published standard mortgage rate until the late 1980s; now it is below. 
The key message is that real interest rates moved sharply lower from 2000.  The average since then has been the lowest since the early 1970s.  Go back to our earlier valuation measures and house prices also moved above fair value in the first half of the 1970s.  
I could excerpt the whole thing. Reading it is like finding an oasis in the desert.

What caused the bubble? oh, just the same thing that caused those in Spain, Ireland, the U.S. . . . Why this should be difficult for the bank heads in Australia to grasp, I don't know.

Gross Rent Yields is an important measure and an easy one for a house shopper to measure for themselves. Prices in the area you are buying for the type of house you are looking at should not exceed 15 times annual rent. If they do, slightly, you better love the house and expect to get back happiness in exchange for your money. If they exceed it significantly. You are better off renting than buying. Let someone else take the hit, there is no rule that says you have to. Investors form a floor on a falling market. Landlords, the smart ones planning for the long hold, will jump in when the price is right, but that's below 15x rent. When the market is 40% above that, you won't find anyone but suckers jumping in until the real investors show up. Look out below.

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