Smart Investor: Acid Test Feb 2011

Smart Investor: Acid Test, Feb 2011

Should you be worried about Australian house prices?

1. Are you planning on moving? Yes/No

If you’re not, and you don’t own an investment property or plan to do so, then the value of Australian housing doesn’t really matter a jot. So what if your house is overvalued? It’s still the same house. To an extent, even if you are looking at moving house, it doesn’t really matter so much, since the whole market is rising – so a new house would cost you more, but your old one would be worth more too.

2. Are you planning on buying an investment property? Yes/No

This is where house prices do become more relevant. Australian house prices have risen vigorously over the last year or so, and while the extent of the rise varies from place to place, AMP says Aussie house prices are running about 35% above their long term average. So for an investor, the question becomes: will this continue, and make me money? Or are we in a bubble that must burst? To answer that, you need a view on the following questions.

3. Do you think there’s a bubble? Yes/No

To answer this question, look around you. If you notice neighbours’ houses being listed for a lot more than they used to, you might think price rises are out of control. But, come auction day, are they selling? Is the auction packed with people who look worried they might miss out? Actually, auction clearance rates in both Sydney and Melbourne are falling, which is not what you normally see in a bubble.

4. Do you think it’s too easy to get a mortgage? Yes/No

Another bubble characteristic is too easy access to credit from the banks. That’s what started the sub-prime crisis, and subsequently the global financial crisis, back in 2007. Chances are, though, that most Australians do not feel it has got easier to get money out of banks in recent years. It’s tough to get a loan to value ratio rate of 80% these days without jumping through a lot of hoops, and that didn’t used to be the case.

5. Do you think there’s enough housing to go around? Yes/No

This is another crucial part of deciding whether we’re in a bubble or not. It’s simple supply and demand: if there’s not enough housing, there’s a good case for prices to keep going up. If there’s plenty, and still prices are soaring, it’s time to worry. This picture also varies from place to place but in the major cities it’s rare for people to feel there is a major residential oversupply.

6. Do you carry too much debt – and do you think everyone else does? Yes/No

Australians do tend to carry quite a lot of debt, in a variety of different forms from the mortgage to the credit card. One of the toughest lessons of the financial crisis was not to over-extend yourself: you only need a modest knock to your circumstances to find yourself unable to service a loan if you have too much debt on your hands. More broadly, if you think Aussies in general have too much debt, that’s something to worry about at a time of high house prices, as a reversal in values is likely to hit people such as property investors who rely on rental income to service their loans.

7. Do you think interest rates are going to climb quickly? Yes/No

We tend to forget that interest rates have been in double digits not too far back in Australia’s history. How many of us could cope with our mortgages, both on home and investment properties, if that happened again? Nobody is forecasting levels like that in the near future but rates are likely to rise before they fall – steep hikes could prompt a fall in property values as buyers pull back.

8. Do you think shares are a better bet than property? Yes/No

This isn’t a cause for worry, more an investment decision – for a budding property buyer, it’s worth considering if other investments look more promising. Planners tend to see better value in Aussie shares than Aussie residential property right now, but there’s plenty of opinion on both sides.

9. Do you expect unemployment to rise sharply? Yes/No

This is something else that prompts property prices to fall. At the moment, there’s little obvious reason for alarm about the Australian economy: it’s doing vastly better than most others in the developed world, although it is perhaps troubling how heavily reliant the economy is on China and general emerging markets demand for commodities.

10. Do you think there are too many property investors, as opposed to home owners? Yes/No

A final spur for a property bubble is speculators piling in. In contrast, when most home purchases are going to families who hope to live in them, that’s considered a sign of stability. AMP says the proportion of housing finance going to investors has actually dropped, from 50% seven years ago to 39% today.

Mostly yes: Aussie property is due for a fall and you’re worried about exposure. Deleverage yourself and sell at the top.

Mostly no: Just because the market is highly valued doesn’t mean there’s not a good reason for it. No cause for alarm.