Hold on tight: the great property sell-off has begun

The much derided prediction of a sell-off in Australian property prices has finally started. Prices in some cities are starting to fall. Rental yields are becoming unsustainably low. And many property buyers are now at the point of ‘no return’ (yes, the pun is intended).

Of course, you wouldn’t think the property bubble had reached its finale if you looked at the headline-grabbing median prices and the ridiculous prices being paid for shoe boxes in Sydney’s Paddington – “Hey, what’s an extra million when the additional interest is $45,000 a year.”

And that is the point. We know that the boom in property prices has little to do with anything other than historically low interest rates, which have made paying an extra million at auction as insignificant as an impulse purchase of a bar of chocolate at the supermarket checkout.

I have now heard every possible explanation for surging house prices and the only one that matters is interest rates being lower than at any time since Captain Cook first sailed across the Antarctic Circle. Surging house prices have nothing to do with a shortage of land; Hong Kong has less land and a much higher density of people per square kilometre and that has not prevented property prices from falling. Surging dividend incomes, retiring baby boomers and Chinese fondness for our climate and air quality are all ‘weight-of-money’ arguments that have never prevented falling prices.

Unwittingly, panicked Sydney, Melbourne and Brisbane property buyers are merely pawns in a global game of Central Bank Chess whose end has arrived. As central bank bond buying, also known as ‘quantitative easing’, pushed government bond yields lower, investors were forced to seek higher returns elsewhere. Corporate bonds were next to surge, then junk bonds, equity and property. And record prices for art, low digit number plates and collectible cars are proof the phenomenon was global and indiscriminate. Sydney property is nothing special, no matter what your real estate agent tells you.

And keep in mind few investors have any experience navigating a sustained secular increase in interest rates and inflation and even less would know anything about ‘credit events’, which long duration assets are always susceptible to.

Property income yields are at historic lows and yet property buyers couldn’t be more enthusiastic. Buyers who tell me that they don’t mind buying on a yield of 2.5% because they will get a capital gain need to understand that the capital gain will only come when a buyer is willing to accept an even lower yield. And yields cannot fall much further when your oversupplied property Is vacant and your yield is zero – as many leveraged Brisbane apartment owners are about to discover. The end of every bubble is marked by the appearance of the the greater fool principle; betting a bigger fool will come along and accept an even worse return. It’s speculation, pure and simple.

If you are buying a property on an unattractive yield, it is not made more attractive by borrowing. Record levels of household debt to GDP, and household debt to income, and record levels of credit card debt, mean that when bond interest rates rise – they’ve already started rising – investors will be able to least afford the additional costs thanks to having previously paid and borrowed too much.

Within 5 kilometres of Brisbane’s CBD, 5500 apartments were completed and available to be moved into by owners or tenants in the nine months to September last year. During the same period, vacancy rates rose from 2.7% to 4.7% – a near doubling – 5 to 15 kilometres from the CBD. Landlords who purchased a flat that has no tenant need to deeply discount their rent or accept zero income. And that puts financial stress on the landlord even if they haven’t lost their job. Most worryingly, another 13,300 new apartments will be completed within 5 kilometres of the CBD before September this year.

Meanwhile, some financial planners have reported to me being cold-called by developers and offered 7% commissions to market properties to their clients. This on top of the free holidays, free cars and free frequent flyer points being offered as incentives to property buyers. As supply increases (see the chart below), the discounts will become more aggressive, ensuring lower prices. Reports of some apartments being revalued 30% lower than 18 months ago isn’t going to help either.

Financial stress is increasing even though employment looks fine. Witness the tripling of calls to national debt helplines with much of the increase attributed to mortgagees with multiple investment properties. Note that at current low interest rates 30% of family income is required to meet mortgage repayments in Australia. And that’s using pre-tax incomes. Financial stress occurs when you lose a tenant, when interest rates move up, and when you have negative equity in your property thanks to the bank revaluing your new apartment lower upon settlement. Financial stress occurs when AMP and CBA, Westpac and others, tighten lending restrictions on particular types of loans or blacklist your suburb, thereby pulling the rug out for any new buyer of your desperate-to-sell property.

Many believe their suburb will be immune. Many believe the falls won’t impact houses and will be quarantined to apartments. Many believe their property won’t be affected because it has some special quality. Such beliefs are nothing more than head-in-the-sand wishful thinking. I have seen the same wishful thinking from 37-year old, newly minted millionaire property developers – customers of Ferrari and Lamborghini dealerships – who believe that their developments of 12, 30 or 60 apartments will be immune from the ravages that will befall their peers and their larger 100–200 unit developments.

My bankers have told me all of their smartest and most successful property investors have sold up or are getting out, and they cannot lend them a cent – they won’t take it.

Drop a pebble in a pond and the ripples will eventually impact the entire pond and everything in it.

Why should Tweed Heads and Bowral prices be 9 or 10 times incomes, when thousands of similarly-sized towns around the world – and the same distance from capital cities – can be purchased at half the multiple? It doesn’t make sense and it isn’t sustainable. And neither are low interest rates. Australia’s debt-fuelled property boom may be handing Australia an unlucky hand. Hold on tight.