Sydney property: Living in a bubble

Sydney's residential property market cannot help but make the headlines week in, week out. Prices were up 16% in the 12 months through April and yet another analyst, this time from Citigroup, has called for the government to do something (but it's probably OK because Australia has "a bit of monetary policy... [and] a lot of fiscal elbow room left", hah!). While we don't cover Sydney in particular, our Australia bubble watch: Housing chart has picked up a significant rise in Australia-wide housing related social media activity over the past several weeks.

aus-social-chatter-june2017.png#asset:5661

A change in direction or significant spike in our social chatter algorithm, which we update every week and thus runs months ahead of the official price data, can act as a leading indicator of what's to come - good or bad. Based on recent volume it certainly appears the subject is again very topical, and why wouldn't it be? Prices are soaring, Australia's banks have been tightening lending standards in the face of regulatory pressure amid rising household debt levels and demand continues to prove insatiable thanks to record-low mortgage repayment rates.

aus-hh-debt-june2017.png#asset:5662

But price rises alone do not indicate the presence of a bubble. There are many industries where prices increase year after year yet no one shouts "bubble", e.g. healthcare, education, taxi fares and licences (pre-Uber!), electricity and gas, water. Consumer price inflation is responsible for some of that but the main culprit is the lack of competition and supply-limiting regulation.

And guess where else we see supply-limiting regulation in abundance? The residential property market! Thanks to decades of "town planning" by local, state and federal governments in the form of limits on new developments, height restrictions, and general NIMBY-ism (not in my backyard), the cost of creating new housing supply in terms of red tape delays and dollars has risen significantly over time.

The end result is what we see before us today: a misallocated housing market, where those who got in early by the good fortune of being born in the right place at the right time have extracted value at the expense of those only now looking to enter the market (economists call this a "transitional gains trap").

At this stage the most likely way the whole thing will come tumbling down and end in a crisis is if real interest rates rise sufficiently and suddenly, e.g. the RBA increases the cash rate or a liquidity crisis forces the banks to raise rates (they are still dependent upon offshore wholesale funding). That will put pressure on marginal borrowers such as investors with high amounts of debt, increasing available supply and lowering prices.

A more sensible way to manage the boom would be to fix the supply restrictions that caused it, but that is a political landmine and so is a very unlikely scenario. Politicians care more about the public's perception that they are trying to fix a problem, rather than actually fixing it. So more often than not we should expect political action that treats the symptoms but does nothing for the underlying cause, such as cash grants, concessional interest rates and access to superannuation savings for first home buyers. But unless real interest rates start to rise or the government's approach to housing supply is drastically altered, prices can and will continue on their merry way.

The next official data release is on 20 June. In the meantime make sure to add our Australia bubble watch: Housing chart to your Favourites for an indication of where things might be headed in the near future.

About the author

Dr Justin Pyvis is the Founder and CEO of Pixelics. Justin is a published academic with a wealth of experience from working at AECOM, a global consultancy on the Fortune 500 and more recently with Asianomics Group, an economic, corporate and technical analysis research company based in Hong Kong.