How to spot a housing bubble: 5 warning signs

By Nila Sweeney

Australian house prices fell in eight capital cities by 1.7% in the March quarter – the largest drop since the financial crisis.

The figures have renewed speculation that Australia is heading for a major price correction in the coming years. If you’re looking to buy or sell property, the rhetoric can be confusing.

Here is a look at five common elements that define a housing bubble:

1. House prices

Sharp increases in house prices can indicate the presence of a bubble. In Australia, house prices in capital cities have basically doubled since 2003 (with the exception of Sydney house prices which increased from $573,000 to $671,000 – +17%).  In 2010, house prices reportedly “soared” 20% in the 12 months to March. However, NAB chief economist Alan Oster indicated at the beginning of 2011 that there’s been “a significant downward revision in house price expectation over the next 12 months”. ANZ also indicated prices are expected to plateau over the coming year. Despite the decrease, the national median home price in March was $455,000, according to RP Data/Rismark. The Economist indicated in late 2010 that Australian house prices were overvalued by 63.2%, echoing an earlier study that found Australian property was “the most overvalued of any of the 20 countries we track”.

2. Affordability
Affordability is determined by the portion of pre-tax household income needed to cover the costs of owning a home. The Demographia International Housing Affordability Survey revealed Australian properties were “severely unaffordable” with a house price to household income ratio of 5.1 or above in the nation’s capital cities. However, a cooling housing market has provided some hope for would-be homebuyers. The Commonwealth Bank/Housing Industry Association affordability index rose to 55.7 in the first quarter of 2011, from 54.1 in the final quarter of 2010 as a result of easing home prices. The report is based on the “long-standing premise that housing costs should not consume more than 30% of a household’s income”.

3. Interest rates
The RBA left rates at 4.75% for the fifth consecutive month in May. RBA governor Glenn Stevens noted in a statement that “new loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off”. Despite the rate reprieve, the RBA has indicated it could take its foot off the brake in an effort to curb inflationary pressures. St.George’s Monthly Economic Outlook for May indicated that the RBA is concerned a pick-up in mining investment could exert pressure on wages and other costs. “Recent RBA rhetoric has been more hawkish than previously with stronger references to inflationary pressures building,” it noted. “Importantly, the RBA expects underlying inflation to be towards the top of its 2-3% target by the end of this year, and to exceed 3% by 2013. It means there is little room for error on the inflation front for policy makers.” Further rate hikes could further soften the housing market.

4. Lending criteria
Lending standards in Australia have always been quite high compared to other countries. Nonetheless, lenders adopted stricter lending criteria during the global financial crisis. At the height of the GFC, lenders were looking for 20% deposits and proof of genuine savings. And many pulled back their non-conforming products such as low-doc or no-doc loans altogether. Within the last 12 months however, criteria has relaxed and an increasing number of lenders are offering 95% LVR loans. Credit reporting reforms will also give lenders more information about borrowers, allowing them to restrict individuals with poor repayment histories from receiving a loan.

5. Delinquencies
Australian home loan delinquencies jumped to the highest on record in the first quarter of 2011, according to Fitch Ratings. Mortgages more than 30 days overdue rose to 1.79% from 1.37% in the previous three months. The number of low-doc loans more than 30 days climbed to a record 6.74% from 5.7%. The ratings agency attributed the rise to Christmas spending, a November rate rise and recent natural disasters. Despite the recent uptick, mortgage arrears in Australia are still very low compared to other countries – delinquencies in the UK are around four times higher than Australia and in the US they are around 20 times higher.

More Mortgage News