Australian home prices are up sharply since 2000 but it looks like the tide is turning. Home prices nationally have fallen slightly from last summer and Sydney is down 4.5%.
I have a bit of real estate bubble PTSD after living through the Phoenix real estate bust when home prices fell by 60% and in some of the poorest zip codes by 80%. During the boom, I knew home prices were crazy high but I never imagined they would fall so I was caught completely off guard by the multi-year train wreck in home prices. Ever since then I’ve been trying to figure out what the heck happened and how real estate bubbles work.
Hopefully, Sydney and Melbourne won’t see those types of home price declines but it looks likely they’re in for some big falls over the next several years.
For the non-Australians out there, here’s a thumbnail sketch from 10,000 miles away of how Australia created their own monster real estate bubble.
1) We’ll Pay You To Buy A House
In 2008 when the real estate busts were going strong in the United States, Spain, Ireland and other countries, the government of Australia stepped in and took bold, decisive action to stop home prices from falling in Australia.
They already had a scheme that provided $7,000 grants to first-time home buyers so a month after Lehman Brothers they increased the grants to $14,000 for existing homes and $21,000 for new homes.
The government essentially paid first-time home buyers $14,000 or $21,000 if they’d buy a house. The program succeeded. Australian home prices soon resumed their upward climb while U.S. home prices fell for a few years.
2) Export Boom Economy
At the same time the world economy was struggling with the Great Recession, the Australian economy was doing great. The economy in China was exploding (in a good way) at the time and the Chinese were buying huge amounts of raw materials like iron ore and coal from Australia. The Australian mining sector was booming and that strengthened the entire Aussie economy.
It’s hard for home prices to fall when the economic tide around them is rising.
3) Big Tax Breaks For Real Estate Investors
In Australia, if you buy an investment house and it loses money, the loss reduces the taxes you pay on your salary income.
So, if you have an interest-only mortgage on a rental house you can deduct all mortgage payments and a (pretend) depreciation deduction as business expenses. Even if the house is appreciating a ton every year and has a positive cash flow, for tax purposes it may be losing money and, therefore, you’d pay less taxes on your salary and other income.
Australians call that tax break, “negative gearing.” The expression is similar to, “negative cash flow” but in Australia negative gearing seems to refer to the tax breaks you get when your investment property has negative cash flow.
In essence, the Australian government will pay for some of your losses from speculating, er… I mean, investing in real estate.
Because of the tax breaks, more people want to buy investment homes and they can pay more for those homes. Both factors drive up prices which make investors even more excited about buying rental properties.
4) Interest-Only Loans Everywhere
I can’t get over this one. About 40% of Australian mortgages are interest-only. Interest-only will likely turn out to be Australia’s subprime.
With the same monthly payment, interest-only loans allow investors to borrow more money and invest more in real estate. Investors maximize their debt but they also maximize their gains when their houses appreciate in value.
On the other hand, interest-only loans also mean when home values fall, those homeowners won’t have as much equity and they’ll go underwater sooner and deeper.
A high percentage of interest-only loans is a sure sign of a speculative bubble. They aren’t long-term investors, they’re just trying to ride the appreciation wave as cheaply as they can.
5) Chinese Investors
This is the most controversial factor. The argument is over whether foreign investors, mainly Chinese, have bid up home prices for Australians or not.
The Australian government restricts foreign buyers but, nevertheless, some report that over the last several years foreigners were buying over 10% of new homes and over 5% of resale/existing/established homes. If those numbers are accurate, foreign buyers had a big impact on Australian home prices.
In an unexpected twist, it seems many of the Chinese buyers just wanted to “park” their money outside of the reach of the Chinese government because after they purchased their Australian homes, they often left the homes vacant.
Nevertheless, the foreign buying frenzy seems to be fading and it’s one reason home prices in Sydney have fallen over the last several months.
Real Estate Bust Reality
The global economy is amazing right now but when the economic tide eventually goes out, we’ll see how much of Sydney and Melbourne home prices were built on luck and state-supported speculation.
I certainly hope Australia won’t see anything like the 50%+ price declines that started in several American cities 10 years ago. That was brutal.
Decades from now, I’m sure many Americans will still be saying the worst time of their lives was when they lost their homes in the Great Recession. In fact, the U.S. homeownership rate fell more in the Great Recession (down 5.5 percentage points from 2006 to 2016) than it did in the Great Depression (down 4.2 percentage points from 1930 to 1940).
And even if they didn’t lose their homes, more and more homeowners went “underwater” on their homes as prices fell. That is, more and more homeowners owed more on their mortgages than their homes were worth. By 2012, over 30% of U.S. homes with mortgages had negative equity and that had a dramatic negative impact on household spending and the economy. Today, some of those homeowners who bought at the top of the market 10-15 years ago are still underwater on their homes.
I hope Australia is making emergency plans for how they would handle the worst case scenario. The time to prepare for a 100-year storm is when the sun is still shining.
It’s too late now to raise the levee to prevent the flood – prices have already started to fall – but the Australian government can greatly reduce the damage if they have action plans ready to go for any scenario.
Ten years ago the U.S. government was caught completely off guard by the size of the real estate bust. Today, the Australian government shouldn’t be.
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An earlier version of this article appeared on Forbes.com.