How to profit from Australia’s pending house price crash

Australia’s housing bubble is one of the largest in the world.

The bad news – for Australians – is that it looks as though it’s on the verge of popping.

That could spell disaster for the Australian economy. One pundit reckons that prices could fall by as much as 60%.

The good news is that you could profit from the fallout – I’ll explain how in a moment…

The birth of Australia’s house price mania

Politicians like rising house prices. They make people feel better off. That means they’re likely to spend more. In turn, this boosts both the economy and also the government’s chances of re-election.

Of course, this wealth effect is in many ways illusory. For a start, upgrading to another, larger home also becomes pricier. And because rising house prices are just another form of inflation, it means that incomes, and cash savings, are worth less than before.

But you don’t notice the downside until the bubble bursts. And your average politician doesn’t think that far ahead. So it’s no surprise that Australia’s house price bubble was initially inflated by the government, starting in the late 1980s.

The 1987 stock market crash had hurt confidence in the economy and also the property market. So in 1988, to perk up home prices, the Hawke government brought back a scheme that gave grants to first-time buyers if they loaded up on home loan debt.

Australians began piling into property. Over the next 12 years, mortgage rates halved from 14% to 7%. But Aussie households took on so much debt during that time, that their interest payments doubled as a proportion of their disposable incomes (if their debt levels had stayed static, the proportion should have halved, which shows you how crazy things became).

This time it’s different – or is it?

After the dotcom bubble bust at the turn of the millennium, Australian politicians were worried about another recession. So what did they do? In 2001, the first-time buyer grant was doubled to give the domestic property market another boost. But it didn’t need it.

Lending secured on property as a percentage of GDP was already soaring: it had trebled to more than 40% since 1988. The government handing more money to property buyers made matters worse. Add in overly-low loan costs in the noughties, which spurred even higher borrowing, and Australia was soon inflating a huge housing bubble.

In nominal, ie actual price, terms, Australian house prices have soared about six-fold in the last 25 years. That’s extravagant even compared with the UK, where values rose just over four-fold between 1986 and 2007. Or the US, where the increase between 1986 and 2006 was about 3.5 times.

Australian mortgage debt has soared to more than 85% of GDP. The debt now equates to 130% of household income: five times the 1988 level.

That level of growth in both mortgage debt and house prices simply couldn’t continue. And home values have now topped out. Yet in the first 11 months of 2011 they only dropped 3.7%, says market watcher RP Data.

Whenever prices hold up in one market but fall elsewhere, there’s always talk that “this time it’s different”. Australia is no exception.

Several experts reckon the country’s property is still a good bet, as lower inflation and interest costs mean buyers can afford to pay higher prices than before.

Mmm… I’m not so sure about that. Here’s why Aussie property prices could be about to plunge.

The Chinese threat to Australian house prices

The global economy is starting to look sick again. Indeed, the World Bank has just warned of a looming worldwide recession that could be worse than the one we suffered three years ago.

This would be bad news for Australia. It’s one of the main providers of raw materials. It has the world’s largest known supplies of bauxite, iron ore, lead, zinc, silver, uranium, industrial diamonds and mineral sands. When the global economy is booming, Australia cashes in.

But the reverse is also true.

“The average Aussie may think the massive demand for Australia’s raw materials will bail the country out of any economic hole into which it risks sinking”, says Ron Fraser in The Trumpet. “That may appear so, as long as… strength in demand continues.” But the country’s problem is that all “its economic eggs [are] placed in one mineral resources basket, being marketed to one major customer – China”.

We also fear the Chinese economy will slow down fast – as the cover story in the current issue of MoneyWeek magazine explains. Subscribers can read it here: Brace yourself: China is heading for a hard landing If you’re not already a subscriber, get your first three copies free here.

But in short, if China’s demand for raw materials drops off, it could crush large parts of Australia’s economy. That will mean lower incomes, more job losses – and much lower demand for houses. Meanwhile, many over-indebted Australian households could become forced sellers.

Leading US real estate analyst Jordan Wirsz predicts that a flood of properties will begin to hit the market in Australia from next year as investors scramble to bail out. In fact, he reckons this could lead to the biggest property crash the country has ever seen.

“Right now is not a time to be buying real estate in Australia”, he says. “Residential prices are likely to fall up to 60%, possibly even more, within five years.”

What does this mean for you? A country’s – or region’s – currency is a useful barometer of investor confidence: just look at the eurozone.

Right now, the Aussie dollar (AUD) is near a 12-week high against the US dollar as AUD buyers hope the looming China slowdown won’t be too bad. But as markets begin to ‘price in’ what less Chinese growth really means, this AUD strength is likely to reverse. A housing market crash would drive it down much more.

One way to take advantage is to use spread betting. Here you can ‘short’, ie sell, the AUD against the US dollar. It’s risky of course – currency markets can be very volatile – so you might like to take some advice. If you haven’t already, sign up for our free email MoneyWeek Trader to learn more about spread betting tactics.

If you’re not keen on the trading risks, you can buy the ETFS Short AUD Long USD (LSE: SAUP) exchange-traded fund. This gives you a built-in short position in the Aussie dollar against its US equivalent.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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27 Responses

  1. 24/01/2012, Kelpie-Capital wrote

    I wrote about exactly this trade on my blog last week. Given elevated market levels I think it represents one of the most attractive risk/reward trades out there.

    http://kelpie-capital.com/2012/01/18/whats-going-down-down-under-the-case-for-shorting-australian-dollars/

  2. 24/01/2012, Chris wrote

    Presumeably they will do exactly what the UK government and BoE have done i.e QE to encourage inflation, encourage even more immigration to put upward pressure on house prices, dramatically reduce new house building, come to an arrangement with the banks not to repossess too many houses, think of another form of inducement for first time buyers and buy to let operators, make saving virtually pointless etc etc etc

  3. 24/01/2012, Bob wrote

    +1 Chris.

    Has Moneyweek given up on a UK house price crash?

  4. 24/01/2012, Tony wrote

    I don’t think Chris is right about immigration, I think the Aussies have got more sense.

  5. 24/01/2012, Jay Goods wrote

    Great article! There’s no doubt Australia is headed for a massive property crush, with one of the biggest bubbles in the world. You might be interested in this excellent discussion from the Australian Property Forum…..

    “Shorting the Australian Housing Market – Make Money From Property Crash”

    http://australianpropertyforum.com/topic/8598890

    Some of the ideas include shorting banks, LPTs, developers, and a few more ingenious solutions.

    There’s also the Rismark derivatives index due to be made available on the ASX this year. There was a thread on APF about this last year but I can’t find it right now – it’s there somewhere!

    Cheers,

    Jay.

  6. 24/01/2012, Carl wrote

    I agree with Chris – the govt/RBA won’t tolerate falling house prices. Interest rates will go to Permanent Zero like in the UK. But what will this mean for GBP/AUD? It is at extreme levels, partly because of the interest rate spread. Nothing is going to lift the GBP side of the trade, but could something at last start to weigh down the AUD side?

  7. 24/01/2012, Don't Prop Up the Ponzi wrote

    Great article, David. We have been overdue for a housing price crash for a few years now, but the question remains: will the government be able to restrain themselves from interfering again? So far, this time, so good – they haven’t done anything but if enough people notice that their perceived wealth has diminished, and it’s not just a blip but a long term trend, will there be an outcry and a demand to prop up the bubble again?

  8. 24/01/2012, Tony wrote

    The Australian house price crash has been predicted for some years now. We are still waiting. The resilience of house prices has been astounding and so far in 2012 they are RISING. Does Money Week know what they are talking about? The economy is growing, government debt is low and there are labour shortages in some parts of the country. Wages have gone up by over 100% in Western Australia in the last decade. We think the China crash will be a reduction in their GDP growth from 9% to 5%, a bigger threat to Australian exports will be the new mineral production coming onstream which will flood the market and drive down prices.

  9. 24/01/2012, Nick wrote

    UK is far more ahead on the house price crash than Australia.

    The markets will soon pay attention to the £1 tn debt.

  10. 24/01/2012, Bob wrote

    And what will the markets taking note of the UK 1 Trillion in debt actually mean for the UK? Rising interest rates? I doubt that very much. IRs will stay low for many years to come I fear.

  11. 24/01/2012, Elvis Presley wrote

    Maybe the 1 trillion (and rising) debt headline will help more people understand the difference between the deficit and the country’s debt. Whenever I speak to anyone about the ‘cuts’ their lack of support for the cuts falls away when I explain the difference.

    Also, the discussion about the benefits cap has not included so far the fact we are having to borrow money to pay these benefits, then pay interest on that borrowed money!

    ‘Not far enough and too slow’.

  12. 24/01/2012, Ravi wrote

    The following are probably the most dangerous words in economics:

    This time is different!

    You cannot go wrong with property investments!

    Australians for Affordable Housing estimates that over the past decade house prices across the country have increased by 147%, while incomes have risen by only 57% during the same period.

    In New South Wales (Australia’s most populous state), the number of people having their homes repossessed by banks rose by 22.5% in 2011.

    Property speculation was the major cause of the financial disaster that has brought the World Economy it its knees.

    The key question is: Will people ever learn?

  13. 24/01/2012, Roberto Birquet wrote

    Correct Ravi.
    But in order to save the banks (and their bonuses), FTBers’ taxes will be used to keep the banks solvent, and allow them not to repossess distressed properties, so that sellers are able to simply refuse “derisory” offers. Welcome to zombie banking and house markets.
    Vive laissez faire, until it kills the golden goose of the rich.

  14. 24/01/2012, Bored of "predictions" wrote

    I do hope he’s used a different crystal ball from Merryns,as I wasted about 8 years of my life waiting for the uk crash that she predicted.

  15. 24/01/2012, ooo er wrote

    It really is a tricky one. I have recently moved over to QLD from London – and keep up to date with the rest of the world via MW and the Economist. The general public (and I mean bankers/accountants etc) still think the mining gravy train is here to stay) however there are signs of strain (recent bank job cuts, China slow down etc).

    The house prices here are ridiculous – not just on typical economic measure (P/E, rent yields etc) but also on a “would you pay that price for this tat” layman measure. All of which means I have no idea which way it will go. Likely that the next rate move will be down and house prices remain flat in real terms .

  16. 24/01/2012, Maggie wrote

    I have just bought a house on the NSW Central Coast. A couple of years ago it was put up for sale for 1.4 million Australian dollars. I have just paid 950,000. Obviously the vendors were sick of waiting and took a low offer. I suspect that the next set of figures will be screaming about the crash. The capitulation here has been sudden and may have further to go.

  17. 25/01/2012, Alex wrote

    Interesting article. My tuppence is that with the AUD having slumped from a record $/AUD 1.10 to $/AUD 1.04 with a £1 a point spreadbet you can assume a worst case loss of £600, if you can withstand that then the possible profits of the AUD falling back to say $/AUD 0.9 over the next year makes for a very nice £1400 profit.

    However another trade not mentioned here is a second commodity dependant economy with many similarities to Australia and with the CAD/$ rate at 1.01 having fallen from a recent 0.98 there is also plenty of scope for the CAD loonie to fall back versus the dollar.

    IMO it’s worth putting as £1 a point on both rates.

  18. 25/01/2012, Matt wrote

    I lived in Australia from 2005-2009 and worked in mostly Government agencies.
    This is the same story all over the world in every major city. However the Australian Government aren’t completely daft because they have realised that by keeping a shortage of housing they can increase demand and consequently drive the prices up.

    Also because Australia’s dominant Asian and European immigration, superior living conditions and English speaking Asian Pacific location, they will always have a high demand for housing..

  19. 26/01/2012, Peter Kellow wrote

    Chris at comment 2. is probably spot on.

    We are used to Ponzi schemes collapsing and the UK and Aussie housing markets are prime examples of such

    Ponzi schemes traditionally collapse because they rely on new entrants and when these dry up it spells the end. But a housing Ponzi scheme seems a little different for if the latest entrants can keep paying the loan because the government has rigged the system with zero interest rates and other schemes the whole inverted pyramid can survive for a while.

    The end result will always be the same as economic reality will out eventually.

    But calling the end may not be easy. As the wise man said being right at the wrong time is being wrong.

  20. 27/01/2012, Boris MacDonut wrote

    Australia is not, and never has been, a country. It is a vast wilderness with some people clinging to the edge. It is a goldmine of resources but is entirely at the whim of China and America’s geopolitical toing and froing.

  21. 29/01/2012, Colin Selig-Smith wrote

    19. Peter Kellow

    “But calling the end may not be easy. As the wise man said being right at the wrong time is being wrong.”

    The end comes when people lose faith in sovereign bonds, and then currency itself. Take Greece as an example, they were chugging along with large public debt, then people started dumping their bonds, clearly they couldn’t pay all the debts back. So had Greece it’s own currency, they would by now have printed hundreds of billions of Drachma and paid off the debt with worthless monopoly money.

    What governments (UK & US) are betting is that people will not lose faith in the currencies. That they will be able to load the private bank debt on to the public purse, then inflate it away. The Auzzies are no different. The Germans, having been there before, are taking a harder line. Having said that the ECB balance sheet is now as impressive as the FED.

  22. 22/02/2012, ooo er wrote

    Guys and girls any opinions on this, given the sharp drop since the recommendation?

  23. 11/03/2012, jim wrote

    youve been saying this for long enough now and i dont see one bit of difference since you said about the bubble

  24. 08/07/2012, J Torres wrote

    I would love to see a spectacular crash here in Australia !

  25. 09/08/2012, SL wrote

    American price is 3.5times whilst Australia is 6 folds? Is this enough to say au’s property inflation worthen than American? Will also need to look at the exchange rate changes for the same period of time?

  26. 07/10/2012, Nick wrote

    Fear! It’s palpable out there with the Ponzi participants, up to their necks in debt. Don’t matter if property prices crash, moderate or go sideways. They sure ain’t going up for a long time to come. I sold the empty nest in early 2010 for just under AUD700K (Sydney Hills District). The buyer spent 80K on improvements, decking, gazebo, etc., and has just managed to sell it (don’t ask me why) after about 10 months on the market for 20K less than he paid me for it two years ago. So with stamp duty, cost of sale and improvements, I estimate he’s down about 120K.

  27. 16/02/2013, Simon wrote

    The crash hasn’t happened yet, indeed property prices seem to be gently rising over the last 2 months. When will the crash come? This year, next year, sometime never?

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