Expert view on bubble trouble

In a country where the value of property underpins most peoples’ wealth and sense of well-being, we now having visiting experts giving us their opinion on whether Australia is in the midst of a property bubble.

But to put it bluntly ‘It doesn’t matter.’ What really effects everyone is when the market turns down – and it will – does it do it with an almighty crash or just slowly deflate?

Property doyen at the Australian Financial Review, Robert Harley, has been speaking recently with Professor Vernon Smith who’s an expert on bubbles. He won a Nobel Prize for Economics in 2002 for his experimental work, and he has studied property bubbles in the field, particularly the US catastrophe hat followed the global financial crisis

Professor Smith was in Australia to address a Macquarie Graduate School of Management dinner on global property prices and the Australian property market.

And he didn’t equivocate on Australian property : “It’s a bubble, particularly Sydney and Melbourne.” Prices can’t go up 22 per cent in a year (in Sydney’s case) or 40 per cent if you take it out to three years, he added.

“You have a pretty good bubble in Sydney and Melbourne,” he said.

But will it burst as badly as the US bubble? That is a harder question when you compare what happened in American to how Australia stacks up on banks ability to wear some pain on their balance sheets.

“Total equity in all US homes peaked in 2006 at something over $US13 trillion, then hit $5.5 trillion,” he says. “So it was back to levels of 11-12 years earlier.” Professor Smith told Harley that the banks were “symmetrically affected”

But in Australia, flexible mortgages, unlike those in the US, would help ameliorate the danger, Professor Smith said.

He was backed up by observations from CoreLogic’s Australian managing director, Graham Mirabito, who pointed out that many of the property loans remain on the bank’s balance sheets, reducing the velocity of lending. He noted the banks’ overall low gearing with mortgages, with only 5.3 million of the nation’s 9.5 million homes actually having a mortgage.

Supply is also tightening up in other ways with mortgage rates firming, despite a lower cash rate, and the banks moving to reduce the growth in investor lending ahead of tighter prudential controls.

Just this week secondary lenders AMP and ING announced that they were pulling back from the property investor market, which has ballooned, in the past year. Many observers thought they would be in line to pick up business as the big four banks withdrew support.

Professor Smith acknowledged the tightening supply. But he noted that and early indicator of a property crash was weak rents. “And you have rents coming up; in the US bubble, rents were not rising,” he says.

He may be using historic data here because while Sydney rents have remained solid other capital cities are experiencing little growth. And anecdotal evidence in Sydney – as more apartment projects are completed – is tending to show rents plateauing.

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