Warnings have been sounding for a long time - sooner or later people will start to believe them
House prices in Australia have been on the rise for a long time, as the chart below illustrates.
But affordability has not kept pace with prices. In their December 2016 report on housing affordability, CoreLogic illustrated the dramatic rise in house prices compared to income levels across the nation.
Just as with other forms of investment, it is easy to imagine oneself as a property genius when prices keep on rising. It’s good to make hay when the sun shines; but we should remember to keep an eye on the weather.
In the latest Australian economic survey, the OECD (Organisation for Economic Cooperation and Development) provides a weather forecast: there could be a storm coming.
House prices and household debt have reached unprecedented highs, in part because policy-rate cuts have lowered debt servicing costs… In real terms, house prices have increased by 250% since the mid-1990s.
Furthermore, the ratio of house prices to incomes has undergone further increase in recent years, straining affordability, … There are signs that the housing market is cooling.
A continued rise of the market, fuelled by both investor and owner-occupier demand, may end in a significant downward correction that spreads to the rest of the economy.
… accommodative policy may be increasingly distorting financial markets and, especially, house prices (which have risen to very high levels). Eventually, rates will need to be normalised, but the timing and pace will depend on developments in growth, employment, inflation, and the housing market.
Major economic trends are pointing the wrong way
Without a doubt, Australia is one of the nicest countries to live in, as the OECD’s ‘Better Life Index’ illustrates.
But along with housing affordability sinking, labour market trends are downwards, household debt is rising, and real GDP growth is falling.
The OECD says that a large drop off in house prices could lead to a cut in household consumption and a rise in mortgage defaults. Since about 57% of Australian GDP is household expenditure (source: World Bank), this would be very bad news indeed for an economy that’s already struggling with poor GDP growth.
Keep calm and consider options carefully.
A key maxim of sound financial planning is to ‘make sure the worst case senario doesn’t happen’. Diversification is essential. Aside from owning our main home, we should approach other property purchases like any other business investment. Unprecendented gains don’t go on forever. As with any business, there can be good times to be in - and good times to be out.
It’s impossible to predict the perfect time to take profits, but we should not be reluctant to ‘leave something for the other fellow’ if we’ve made good gains so far and feel cautious about the future.
Similarly, if you’re contemplating a property investment at the present time, maybe it’s a good time to double check that you have a sufficiently long term view. A house price crash could make your asset worth much less than your loan, forcing you to choose between tying up your investment for years, or taking a ‘fire sale’ loss in an illiquid market.