Investors Start to Think Outside the Box

March 21, 2016
Editor(s): William Wang
Writer(s): Karan Bedi , Haring Kulatunge , Kyle Jackson, Bryan Heng

The rapid rise in Australian real estate prices has raised concerns of a dangerous property ‘bubble’ forming, where the ‘bursting’ would be due to the speculative and distorted valuation of the housing. Due to a plethora of economic and social reasons; the strong emergence of housing demand has been particularly attributed to overseas Chinese buyers, encouraging the outskirt growth of the bubble from initial Eastern suburbs of Melbourne. As the mechanisms of demand and supply become self-perpetuating, the presence of overvalued housing pushes out local buyers and can have detrimental ramifications on the overall wellbeing of society. In conjunction, a ‘bursting’ bubble has the potential to severely shock the Australian economy which is currently riding on the property market boom, thus it requires many corrective measures and regulations to dampen effects of the burst.

Unsurprisingly, Box Hill has long been an attractive destination for Chinese and other Asian immigrants. Fuelled by its convenient location, surrounding services such as prestigious school and professionals that speak Chinese, Box Hill and immediate suburbs have seen a large influx of overseas investors purchasing any available property. The attractiveness of the area caused a large demand boost which has lead to median house prices doubling in the last 3 years in that suburb. This wave has been accredited to recent developments pertaining to both the Chinese and Australian economic environment.

Perhaps the leading cause of the movement is the slowing Chinese economy and subsequent fall in general confidence as even the Chinese lowers its growth targets. The lowered sentiment coupled with the recent stock market volatility and falling Chinese exports has caused a flight to safety for many wealthly Chinese residents as they now look abroad for a safe haven to house idle cash. This movement has been coupled with the Chinese Government loosening capital restrictions in a hope that the freed capital will resurge their economy. However, the inverse has occurred, the newly opened trillions in capital is instead being sent overseas to safe keep from any further volatility in China.

Over the last 3 years the Australian Dollar has depreciated near 50% against the Chinese Yuan, making Australian property not only an attractive investment but now a more permanent option for residency. Exemplified as of last October, a Shanghai couple saved over $557,000 on a Eureka tower penthouse by simply delaying the transaction by 10 months.

When comparing the Chinese property market to that in Australia, it becomes clear why the Australian market appears an attractive purchase to the cash strapped investors. Beijing’s median house prices  have soared to 20 times above median wage and accompanied with rental returns falling year and after year. Rather than gamble in the speculative stock market, the average investor is now favouring locking funds into million dollar properties in Box Hill, which have been netting stable returns for near a decade.

However the impact of the skyrocketing property prices over the past three decades, locals, especially first home buyers, are finding it increasingly more difficult to afford their own homes. The increase of foreigners investing in Australia and the introduction of high net worth customers, they have taken over the entire property market around Box Hill. This proliferation in demand is met with a declining supply, as the government continues to impose land supply restriction. The increasing population of wealthy overseas consumers coupled with the strict land supply restriction imposed by the Government has caused the property price to boom. Considering the expected population of Sydney and Melbourne estimated to hit 6.1 and 6 million people in 2031 respectively, it has become even more unlikely for the property prices to drop.

Combined with the pressure of owning a home, bankers and mortgage brokers have been working overtime to upkeep the increase in demand. However due to the sheer numerical increase of loan enquiries, banks have already begun to tighten the purse strings to cut off borrowers with unsuitable capabilities to sustain the loan.  Buyers will turn to banks or mortgage brokers to help finance the loan. Due to the circumstances of the 2008 Subprime Mortgage Crisis experienced by the United States, banks will definitely be wary of who they extend a loan, solely to lower the amount of risk their investments carry.

However, the tightening policy of the banking industry has created negative ripples across the economy. The lack of freedom provided to credit seekers will result in a reduced number of loan applicants, this could have devastating effects on the economy as it could affect employment rates and financing opportunities. According to Standard & Poor’s (S&P) ratings, there was a significant increase in outstanding payment for Mortgage-backed sub prime loans, from 10.19% to 11.45%. This shows the incapability of borrowers to repay their loan in light of the new policy changes.

There are many negative implications associated with the increasing prices of the properties raging from mortgage loan rejects to inability to repay loans. This will result in a decline of Australian living standards unless more schemes like the First Home Owner Grant are introduced to help locals achieve their dream of owning their own property.

The one question that has been concerning property owners is the possibility of the bubble popping resulting in a drastic decline of demand and property prices. Many stakeholders benefit significantly by climbing the bubble, but lose catastrophically should they fail to exit the market before the bubble “pops”.

A speculative bubble is where there is a spike in a particular industry caused by exaggerated future expectations, price appreciations and other events that may increase the assets value. Eventually, when it becomes clear that the metaphorical promised land is not incoming, traders’ attitudes would reverse, ‘popping’ the bubble. Prices would fall, possibly in a dramatic collapse, to once again reflect the asset’s fundamentals. The price fall would harm investors exposed who not taking a short position.

According to the Australian Bureau of Statistics, 67% of Australian households are owner-occupied. Thus most stakeholders affected are ordinary citizens who are likely not financially literate and understand how to actively avoid harm caused by a bubble collapse. An adverse impact on so many Australians will very likely spread to those not connected to the bubble as well.

In some ways, the situation is similar to the Chinese stock market bubble of the last few years. Retail investors dominated that market, with strong levels of volatility resulting. Around 200 million trading accounts existed, which simplifies down to one in six of the Chinese population. As a result of this high exposure, there was strong government intervention in the form of capital injections and strong regulatory moves to reduce the implications of price falls. This may be viewed as an attempt to make the bubble collapse slower or to push economic growth through to share market to offset a deflating property bubble. Similarly, the Australian and Victorian governments may attempt to avoid risking nation-wide economic adversity through pouring money into the real estate market should speculators begin to flee, thus smoothing the impact of a bubble collapse. They could do so by lowering interest rates further via the Reserve Bank of Australia, or loosen regulations regarding lending within the investment sector, or implement further tax incentives to encourage Australian investors to invest in the property market.

Whilst major banks and players in China are nationalized, they are privately run in Australia. This allows less scope for the government to use innovative regulatory maneuvers to soften a bubble pop. If real estate prices drop, recent home buyers may not have enough assets to back their mortgage, making them “underwater mortgages” meaning homebuyers cannot exit without foreclosing or making up the price difference in cash to the bank. Should house prices collapse, banks that are acting leniently towards underwater mortgage holders could mitigate their clients’ financial distress and foreclosure levels.

Should the bubble collapse, government intervention in making banks lenient and prices fall slower could significantly reduce the damage to the Australian people. However, this help may indirectly benefit the Chinese speculators who caused the bubble – a negative consequence which likely should be addressed by regulation to prevent another bubble or the cost of addressing one in the future.

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