Popping Timing

Many people ask me recently when prices will fall; when it will hit banks; when unemployment will go up ...

It is impossible to predict timing of a such event. To help us understand timescale of the process I created a charts that show timings of the bubble bursts in Ireland and USA.

USA and Ireland Bubble Deflation Timing

On the chart you may see that house prices started deflating very early (July 2006 in USA and July 2006 for Ireland and few months later in Dublin). At the beginning price correction was very slow. It took almost a year and a half in USA and even longer in Ireland to drop 10% from the peak. It took two years for majority of people to realize that something is very wrong. Even the most involved people like FED chairman Ben Bernanke*, two years after process started were not aware (or willing to admit) that country is facing serious problem caused bu housing bubble burst).

It is even more interesting to see changes in major economic parameters during this period. Prices started falling while unemployment was very low. Even after correction started unemployment continued to be very low and even dropped in USA. It took more than a year after prices started to fall for unemployment to start rising and more than 3 years to reach maximum. GDP growth was very healthy at the moment prices started to fall and remained healthy for a year or more after that.

It is also interesting to see that house prices started falling while interest rates were going up. Than prices continued to fall while rates were stable but fall accelerated with interest rate cuts. Credit was available and  inflation was at normal level for the period; business and/or consumer confidence was very high. Maybe the most revealing part is saving rate. Prices started falling at the peak of the saving as a percentage of GDP. 

Consequences of both bursts were severe: deep recession, high unemployment, deflation, credit squeeze, zero interest rates, drop in saving rates and confidence.

If someone was presented with the charts up to the point of house price burst, he/she would likely say that future is bright because all economic parameters were good. In reality things were much different, high level of debt and long period of misallocation of investments into housing caused one of the most severe recessions in history. Low unemployment, high saving rates, high confidence, GDP growth and high interest rates that in theory should enable central bank to react were not enough to prevent the worst.

What will be timeline of the Australian housing bubble burst is impossible to say. If we can learn anything from this data, that should be caution. At the beginning it always looks harmless - ordinary cycle price correction; nothing more than that. It quickly develops in galloping destruction of the economy and no action form central bank or government is able to stop it. 

* Ben Bernanke (June 10, 2008) “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.” 

Sources:

- http://www.tradingeconomics.com

- S&P/Case-Shiller Home Price Indices

- Economic and Social Research Institute (ESRI), Dublin, Ireland

Construction Response on Rising House Prices

In addition to Rates of Construction and Rates of Occupancy that we presented in our last paper, we want to research construction industry activities. As a measure of a construction industry activities we will use construction employment data for the 15 years period (1996-2010) for Australian and USA states and period 1998-2010 for a few countries (we could not find data for Ireland and Spain prior to 1998). We calculated two numbers: Construction jobs as a percentage of total employment and corresponding Index. Sources of data are OECD, USA Bureau of Labour, Federal Reserve Bank of St. Louis and ABS.

Chart 1 – Construction Jobs in Australia

First we want to show historical change of construction jobs in Australia. Data is available for a period 1984-2010. From the chart we may clearly see increase in the construction jobs during the price increase since 2000.

Chart 2 – Construction Jobs as % of Total

  

From this chart and additional data from Ireland we may see that Ireland as well as Spain have historically higher percentage of construction workers. This may be caused by different construction methods used in different countries. These methods are not equally labour intensive (full-brick and concrete in Europe, veneer brick and wood in Australia and USA). To somehow offset for these fundamental differences we created Index with the 1998 as a base year. This way we may see relative changes of the construction activities over this period.

Chart 3 - Construction Jobs as % of Total - Index

From this chart it is clear that Ireland had huge construction boom from the beginnings of 2000s with the very strong upswing in 2004. This boom lasted until crash of 2007 when construction industry collapsed below 1998 levels. Spain had much lower increase of the construction job share; it grew to 130% of 1998 levels and than dropped significantly (notice on Chart 2 that after big fall Spain percentage is still high compared to USA and UK peak levels). Australian construction jobs also grew significantly, by 2008 almost recording the same increase as Spain two years before. Australian construction jobs are still very high compared to pre-bubble period in other countries.

State Comparison

Most of the construction activities are residential, but not all. We tried to find data that shows percentage of total construction employment that is related to residential construction. We were able to find some data, in our opinion enough to show that significant majority of jobs are related to the residential construction.

Table 1 – Percentage of the Residential Construction Jobs

Chart 4 - Heavy and Civil Construction Jobs

From Table 1 we may see that around 25% of all construction jobs in USA are not directly related to residential activities and around 15% in Australia – slightly lower percentage in Australia. Chart 4 shows that non-building (mining and infrastructure) jobs fell during the same period. This clearly shows that most of the construction boom is related to residential building construction.

Chart 5 - Construction Jobs as % of Total (by state)

Chart 6 - Construction Jobs as % of Total (by state)

Charts 5 and 6 show construction job percentages for large Australian states (NSW, VIC, QLD, SA and WA) as well as some of the USA states used in previous analysis (CA, FL, AZ, NV and TX). We may notice that some states have significantly higher percentage in both countries. We speculate that this is consequence of large non-residential construction activities in these states (resource activities in WA and QLD and military/tourism activities in NV). Unfortunately we were not able to find adequate data to support this view.

In other states, growth was very similar over the period before the crush in USA. After USA percentages dropped in 2007 all Australian states grew even more, reaching highest levels during the period 2008-2010. 

Chart 6 - Construction Jobs as % of Total – Index (by state)

Chart 7 - Construction Jobs as % of Total – Index (by state)

On charts 6 and 7 we plotted construction job index for the same period. Please, notice that almost all USA states recorded smaller increase in construction job activities than Australian states. The only exception is California, that at the beginning of the period, was still recovering from housing bubble crash from early 90s. At that time California had by far the lowest percentage of construction jobs 4%, while the lowest in Australia was SA with 5.5%. SA recored the largest growth of the construction job sector that clearly corresponds to largest Rate of Construction we calculated in our previous paper. 

From all presented data we may conclude that Australian construction response to growing house prices was high relative to historical levels; it was lower than response in Ireland but very close to Spanish and significantly higher than response in USA or UK.

The response in Australian states was at least equally strong as responses in selected USA states (measured by construction employment). These USA states are currently facing huge oversupply of homes and collapsing construction industry. This just confirms our previous statements that Australia has large oversupply of homes build during the price bubble over the last decade. It also suggest potential for a big collapse of the residential construction industry that will certainly hurt overall economy.

Sources:

- Federal Reserve Bank of St. Louis Construction Employment by State

- 6291.0.55.003 - Labour Force, Australia, Detailed, Quarterly, Aug 2010

- OECD Statistics

- USA BOL Nongovernment distribution of wage and salary employment in construction by industry, 2000-2008

- ABC 8772.0 - Private Sector Construction Industry, Australia, 1996-97  ;  2002-2003

- Central Statistics Office Ireland - Index of Employment in Building and Construction

Australian Housing Shortage/Oversupply by State/Territory

Our previous paper showed that there is very likely to be oversupply of homes in Australia. Now we want to see where all that oversupply is located. We will make comparison between different states in Australia and add comparison with some of the states in USA that are well known for their housing bubbles followed by oversupply. This way we may get a feel about different supply/demand values compared to other areas with similar demographics.

We used data is available for all selected states and territories. Population growth and new dwelling construction data is used. There is no data available with detailed breakdown of new resident population for each state or territory. We also compared Australian states and territories with a couple of USA states that had large housing bubbles followed by price collapse and huge oversupplies of homes. We also included Texas, high population growth state that didn’t experienced housing bubble in last two decades, as an opposite reference.

USA is selected for comparison because of very similar demographics to Australia. Main supply/demand demographic measures such are household size and change in household size, median age, population over 65 and under 14, birth rate, dependency ratio, percentage of one person households, urban population growth etc) are very similar. For new construction data in Australia we used ABS New Dwelling Unit Commencements data.  For new construction data in USA we used New Private Housing Units Authorized by Building Permit provided by Federal Reserve Bank of St. Louis. Number of newly constructed dwellings for US is likely to be slightly lower because not all approvals are commenced. We used data for the most recent period from June 2000 to June 2010.

We calculated two simple measures that we call: Rate of Construction and Rate of Occupancy. Rate of Construction is a number that shows how many new housing units are constructed per every new resident. Rate of Occupancy is the inverse number that shows number of new residents per each newly constructed housing unit. After calculation we got a few surprising results:

Table 1. Rate of Construction and Occupancy

Chart 1. Rate of Construction (new dwellings per new resident)

Contrary to widespread belief, Queensland is the state with the lowest Rate of Construction in Australia (NT has even lower rate). South Australia, on the other hand, is the state with the highest Rate of Construction. Expectedly, high Rate of Construction is recorded in Victoria and ACT but surprisingly WA is ranked in lower half, followed by NSW, QLD and NT that had very low construction rate.

Even more surprising is comparison with housing bubble states in USA. South Australia has significantly higher Rate of Construction than any of the famous bubble states in USA. Victoria had very similar rate to hugely oversupplied Florida. NSW has higher Rate of Construction than Arizona, Nevada and almost 20% higher than California, state that is currently dealing with hundreds of thousands of empty homes. On the other hand, all Australian states have significantly lower rate than Texas, state with the large population growth but stable house prices with no housing reported shortage.

All this suggests that widespread beliefs about shortage/oversupply in Australia are wrong. Queensland is the state with the lowest Rate of Construction because its population grew much faster. Almost all Australian States built more dwellings than bubble states in USA that are currently dealing with huge numbers of empty homes. It is also important to notice that at the peak of the price bubble, almost all of these USA states were considered to have a shortage. That was proven to be wrong after bubble bursted and speculative demand fell.

It is very unlikely that there is any housing shortage (on state level) in Australia, but if there was one Queensland and NT were the most likely to have it. This is very surprising because Queensland is the state that will be pointed out as oversupplied state by most of Australians.

Recent data shows that low construction state’s (Queensland and Western Australia) housing markets are falling, with unsold stock growing and oversupply becoming apparent. If these states with relatively low Rate of Construction are facing oversupply problem, we may expect to be followed by even more oversupplied states like Victoria, South Australia, Tasmania and New South Wales.

References:

- ABS 3101.0 - Australian Demographic Statistics, Jun 2000, June 2010

- ABS 8750.0 Dwelling Unit Commencements, Australia, Preliminary Dec 2010

- United States Census Bureau - Census Data 2000 and 2010

- Federal Reserve Bank of St. Louis – New Private Housing Units Authorized By Building Permit

Australian Residential Housing Demand and Supply

By raveswei

This document will try to research one of the most controversial housing issues in Australia – supply/demand issue. Many times we heard arguments that Australia is facing a chronic shortage or that price boom is not followed by supply response. At the same time, some people claim that we have oversupply of homes for decades. In this document we will try to estimate residential demand and supply in recent years. We will focus on demand/supply for dwellings used as primary residence. This is very complex issue because of many unknowns and limited data. We will try to make assumptions that will favour shortage argument. Data for Australian cities are not available so this document will focus on all of Australia.

Document will be organized in the following order: In a first few sections, we will go through the supply and demand calculations for one particular year (2007-08), showing the data sources and methodology. Later we will provide data for a period 1995-2010 calculated using the same data sources and methodology. At the end we will give a conclusion.

All raw data used is provided by ABS or Department of Immigration.

DEMAND

Estimation of the demand for housing is not easy task. Demand is driven by many factors, but two of them are the most important: population growth and household demographics change. Population growth has two components: natural increase and net overseas migration.

Migration

Immigration is one of the most important drivers of the housing demand in Australia. Both immigration components (permanent and temporary), increase housing demand in the short term and should be included in calculations. In 2007-08 there was 277 000 net migrants (number of immigrants minus number of emigrants). There was 149 400 permanent arrivals and 76 900 permanent departures. Out of this number there was almost 38 400 “family immigrants” - large majority of them (80%) being partners and children. It is a reasonable to assume that these immigrants do not contribute to the new housing demand (do not create new households) in the first year after arrival. On longer run some of them will require new homes but that demand will be included in the demand calculation that uses households size changes.

Because of the similar demographics among permanent immigrants and emigrants we may assume that dwellings previously used by emigrants are adequate for the same number of immigrants. This assumption is based on similar age, similar proportion of children, occupation... This leaves only 38 400 permanent immigrants in need for a new home. After taking into account fact that around 15% of them are dependent children, assumption of household size of 2 persons is well on the safe side. In 2007-08 these immigrants created demand for 19 200 dwellings.

Net number of temporary, long term visitor, immigrants in 2007-08 was 205 200 with majority of them being foreign students and WHMs. Around 73% of all long term visitors (long term visitors include following groups: temporary workers, students and WHMs) 149 800 were students and WHMs, majority of them being students from China and India. This group of a temporary immigrants add less demand for new housing than the general immigration population. Some of WHMs stay in hostels and budget hotels, not adding any demand for residential housing. Estimation of foreign student and WHM demand for residential housing is not strait forward, but based on student living habits we think that assumption that average student household size of 2.5 is well on the safe side. There are many student living arrangements that involve 3, 4 or more students sharing the same dwelling. This created demand for 59 900 dwellings.
The rest of temporary immigrants (55 400) are workers and their families. We will use household size of 2 to be on safe side. It is very likely that workers who arrived with families live in larger households. It is also likely that some of the single workers share dwelling with other single persons. They created demand for 27 700 dwellings.

References:

ABS 3412.0 Migration 1995-2008

- Department of Immigration and Citizenship – Migration Program Statistics http://www.immi.gov.au/media/statistics/statistical-info/visa-grants/migrant.htm

- Department of Immigration and Citizenship – Fact Sheet – Permanent Arrivals and Departures - http://www.immi.gov.au/media/fact-sheets/05emigration_1.htm

- Department of Immigration and Citizenship – Population flows: Immigration aspects 2000-2009

- Department of Immigration and Citizenship - Settler Arrivals 2001 – 2010

- Department of Immigration and Citizenship - Immigration in Brief 2000

Natural population increase

There was 289 500 births and 140 700 deaths in 2007-08. This makes natural population growth of 148 800. Births do not directly increase the demand for new dwellings, but they affect household size and distribution. The best way to estimate internal demand for new housing is to determine housing demands generated by demographic changes and natural population increase.

Unfortunately the number of households is available only for census years and the number of migrant households is not available at all. Instead we will use following formula:  

This formula includes new housing demand from natural increase and demand from household demographic changes. Household size change includes all of previous population changes (including divorces, marriages, new household creation, previous migration …). Good way to estimate demand from household changes is to use household size number.

Household size change can be calculated using the closest two census data with assumption that change during short period between two censuses is linear.

It is interesting to notice that according to census based data, household size slightly increased between 2001 and 2006. For the years after 2006 we will use new ABS household projections (Series II) that projects household size shrinking in following decades. This numbers are very likely to be underestimated because two previous ABS projections were wrong (ie. in 2001 ABS projected household size to shrink to 2.5 in 2006, instead household size increased by 0.01).

In year 2007-2008 there was 21 432 000 Australian residents, the projected household size of 2.62 and projected household size change of -0.38%. This data gives additional demand from natural increase of population was 56 800. Demand generated by household shrinking in 2007-08 was 33 600. Combined internal demand for new dwellings was 90 400.

Total demand for additional dwellings in 2007-2008 was 198 900. Please notice that this number is much larger that estimates provided by other people who use population increase divided by average household size (163 000).

References:

- ABS 3236.0 Household and Family Projections (1996-2001-2006)

- ABS 1301.0 Year Book Australia 1995-2010

- ABS 3222.0 - Population Projections, Australia, 2006 to 2101

- ABS Census Data (1996-2001-2006)

SUPPLY

There are two components of a housing supply. The first and the obvious one, is new dwelling construction supply. Second component of housing supply is made of vacant dwellings after resident’s death. In this section we will try to estimate these numbers.

New Construction

For the new construction supply we will use ABS Number of dwelling units Commenced. This number is slightly lower than Number of New dwelling units Approval, what put us on the safer side because not all aproved units are built.

In 2007-2008 there were 158 500 new unit commencements. To get more realistic number of the new residential dwelling supply we have to subtract number of dwellings that were demolished or replaced during the same period. To estimate this number we will use available data from Queensland. During 5 year period (2001-2006) around 1% of housing stock in Brisbane LGA was replaced or demolished. The same report estimates replacement levels of 0.5% in Gold Coast City, 0.25% in other urban LGAs, and 0.1% in the rest of Queensland. To be well on the safe side we will use 1% replacement level over 5 year period for whole Australia. This estimate is likely to be well above the real number because not all of the new construction is done in central LGAs. Using the estimate that housing stock was 1.06 times higher than number of households we got 17 300 demolished or replaced dwellings in 2007-08.

The total number of newly constructed residential dwellings in 2007-08 was 141 200. Some of these homes were holiday homes not available for new residents, so we have to subtract holiday homes from the total number. We will use generous estimate that around 4% of all new dwellings are holiday homes. That makes 5650 of new dwellings holiday homes. So the total number of new dwellings available for primary residence in 2007-08 was 135 500.

References:

- ABS 8750.0 - Dwelling Unit Commencements

- Queensland Department of Local Government, Planning, Sport and Recreation - Household projections, Queensland Local Government Areas 2007- Appendix A

Other Supply

Single person households create housing supply after the resident dies. In this section we will try to estimate number of dwellings made vacant after resident death.

Huge majority of Australians who die are old persons, 80% of persons who died in 2008 were 65+ at the time of death. There were around 140 700 deaths in that year. According to ABS data, in 1996 38% of population 65+ were living alone. This number is projected to increase by 84% in next 25 years. This gives us 50.5% of 65+ people living alone in 2007-2008; to be safely on the conservative side we will use 5% lower estimate - 45.5%. There are also some living alone persons under age of 65 who died but to be on the safe side we will not include them in our calculation.

After taking into account all this we may say that more than 51 000 dwellings are made available by the resident death in 2007-08. This number significantly adds to the supply side and it is often neglected by other authors. Combined, new construction supply and supply from homes vacant after the resident death makes total supply in 2007-08 of 186 500 homes available for new residents.

References:

- ABS 3302.0 – Deaths 1995-2010

- ABS 1301.0 Year Book Australia 1995-2010

- ABS 3236.0 Household and Family Projections (1996-2021, 2001-2026)

TRENDS

In this section we present results that we calculated using the same methodology we used for year 2007-2008. Some data (household size) between censuses is estimated using linear progression. This is likely to be a good estimate because of the nature of data set and short period between two censuses. Table 1 shows estimated demand and supply for period between year 1994-1995 and 2009-2010.

Table 1. Supply and Demand for residential dwellings in Australia

Chart 1. Supply and Demand for residential dwellings in Australia

CONCLUSION

By looking at the results we may see that Australia is facing huge oversupply of residential dwellings. Since 1995, there were only two years of a construction undersupply (2008 and 2009) driven by huge immigration numbers. During the years before that, Australia was building the similar number of new homes while immigration and population increase was half or even third of the 2008 or 2009 levels. After 15 years of construction, almost 950 000 dwellings that now do not have primary resident were built. That is around 10% of total housing stock. This means that around 38% of newly constructed dwellings during this period were oversupply (not used as primary resident or holiday home).

It may look very strange that such a huge oversupply is not easily visible. The reason for this, in our opinion, is the fact that market demand for housing was huge and in large part driven by investors interested in capital gain. Similar market behaviour was recorded in some parts of USA and Europe recently. In all these places, during the period before market crush, many reports were warning of a housing shortage, just to discover huge real oversupply after bubble bursted.  

This is an estimated number, intentionally biased toward the undersupply side and as such, it is good enough to shows that there is significant real oversupply of homes in Australia. Situation in a particular city may be slightly different but after taking into account that combined capital city population did not grow faster than general population we may say that estimates are good for most of the cities. Some of capital cities (Sydney, Hobart, and Adelaide) had slower that the average population growth. Same cities also recorded lower construction activity and slightly larger mortality rates among older population. In addition, Sydney and Melbourne population increase was mostly driven by student population that demands less housing than natural increase or other immigrants. Some of the areas with high construction activity (Gold Coast, SE and North Queensland, Mandurah) were also fastest population growing areas in Australia.   

Huge real (primary residence) oversupply will significantly impact house prices in Australia in future. In the case of market slowdown, oversupply will flood the market driving prices down.  


Calculation table:
table.pdf

The Housing Bubble Arguments (part 1a)

There was a lot of discussion how CPI is not good measure for house price adjustments. I agree with this statement to some extent. To show more realistic house prices we created data set for House Price Index adjusted for all male wage. All male wage is used because it is the longest available wage data set from ABS.

Chart 1 shows House Price Index adjusted for All Male Wage Index. It shows how house prices change relative to All Male wage since 1961. It was oscillating around the average value until late 1990s. To reach now more than twice the average levels form period 1961-1997.

Chart 1 House Price Index adjusted for all male wage

Chart 2, in addition, shows employment index. Normalized employed persons as a percentage of  total population. This series is used to show how increased employment affected house prices. It is clear that slow but constant rise in employment is not responsible for sudden house price jump in late 90s. During the jump in employment in late 70s house prices even dropped slightly.

  Chart 2 House Price Index adjusted for all male wage vs. total employment index 

These two charts clearly show unusual jump in house prices adjusted for the most realistic measure. House prices need to drop more than 30% to return to historical levels. More than 30% drop is needed because increase in employment happened in part-time and women employment. Shown house price index is adjusted for male wage which is significantly higher.

House prices are obtained from  ABS (2006-2010), REIA (1986-2006) and BIS Shrapnel 1960 - 1985.

The Housing Bubble Arguments (part 1)

by Raveswei

Introduction

There are many definitions of a housing bubble and they all have in common a rapid price increase of real estate properties not supported by increase of incomes and other economic elements. Two “arguments” are often used in discussions about housing bubble in Australia: “it’s different now” and “it’s different here”. These are not real arguments, but often heard, so we decided to compare Australia with the Australia and Australia now with the Australia during last 15 years.

House Price Supports

First, let’s see if there was any real house price increase since 1995. Chart 1 compares the nominal established median house price indexes for 5 Australian cities with the CPI index and the average total national wage index for all employed persons. Selection of the average total wage index is good because it incorporates labour and work habit changes. This chart does not compare absolute values but only changes over the time. Change of this wage index is very closely related to change of any other wage index (including part time and full time wage indexes) making this chart reliable comparison.

Chart 1 – Australian House Price Indexes vs. CPI and Wages

From the Chart 1 we can see that in just 15 years house prices outperformed CPI by more than twice and wages by almost a twice. In simple terms, this means that somebody with the average wage income only, has to work almost twice as long to buy house now (with no bank involvement) or to produce more than twice as much CPI goods and services to exchange them for the same house.

We also have to consider changes in the employment because the employment may influence house price growth. From the Chart 2, we may see that total employment as a percentage of population increased by less than 10% (from 46% to 50% of total population). Almost all of the increase happened in part time employment alone; full time employment is almost unchanged since 1995. At the same time average household size decreased so the average number of employed persons per households increased by only 2.8%; from 1.3 employed persons per households in 1995 to 1.336 in 2010.

Chart 2 – Australian Employment

It is hard to argue that house price increase can be justified by wage increase, changes in employment or CPI increase alone or combined.

The other argument we often hear is that house price increase is supported by increase of our wealth. There are two major components of the wealth increase that can support house price increase. First one is a wealth created by production of new goods and services (GDP growth) and the second one is wealth that we receive from overseas. It is well known that equity wealth cannot cause its own increase; it takes additional wealth to push equity wealth up. Following chart shows our GDP per capita growth index and house price index all in real terms adjusted for inflation.

Chart 3 Australian House Price Indexes vs. GDP per capita

It is clear that house prices outperformed our GDP per capita by two to three times. This means that each of us needed to increase production of goods and services twice or three times more than what we did in last 15 years so that our newly created wealth may support increased house prices. You may also notice that our real wages were growing faster than real GDP per capita. Real GDP per capita is almost flat since 2006. All our growth is coming from population increase, while our personal wages are going up. This is by itself unsustainable and will have to end sooner or later.

Chart 4 Australian House Price Indexes vs. Net Foreign Liabilities

Other source of the wealth that can support house price growth is wealth received from overseas – in the form of liabilities (mostly debt). On the Chart 4 we compared nominal median house prices for 5 biggest cities and our nominal total net foreign liabilities. Growth of our liabilities almost perfectly matches growth of house prices. Most of this money is used by our banks to support mortgage credit issuance. It is clear from this data that house price increase is not supported by increase in our newly created wealth, but rather by the increase of our debt. Debt driven house prices are one of the best signs of a housing bubble.

Many suggest that people changed spending behaviour by spending more on housing now than 15 years ago. This way it is possible to increase house prices without income or wealth growth. But, this argument cannot be supported by data because our Final Consumption Expenditure grew (170%) since 1995; close to GDP (164%) growth and wages (175%) growth. People did not reduce general spending as a percentage of income. Spending on “Rent and other dwelling services” (does not includes mortgage payments) was growing slightly slower (160%) than the average spending. This means that rental income (for landlords) and imputed renal income (for home owners) was growing slower than the wages. This means that there was no additional income growth from real estate investments to be redistributed to support fast growth of house prices. More about this in a separate analysis; Ref: ABS 5206.0 Australian National Accounts: National Income, Expenditure and Product - Table 8.

Affordability

The other key element that we want to research is the affordability. Many argue that is equally easy (or hard) to buy first house today than what it was in the past. On Chart 5, we compared average FHB mortgage repayment with the average wage over the last 15 years. We calculated index using Mar 1997 quarter as a reference because this was the first period with the Interest Rate equal or close to the average interest rate for the whole periodt. This way we may see how much affordability changed compared to average Interest Rate for this period. Average state wage data is used because no city wage data is available. Rate of change of median and average house prices was very closely correlated. All these data limitations don’t affect our analysis because we calculated changes - indexes, not the absolute numbers. City wages are slightly higher but the change of city and state wages are very closely correlated. It is also important to notice that wage growth was the slowest in the most populous states with the most expensive houses.

Chart 5 Mortgage Repayment/Wage Index

From the Chart 5 we may see that on average repayment increased around 75% more than the average wage since Dec 1996. In some cities (Melbourne) that increase was two and a half times, in some (Sydney) FHB needs to spend 60% more of the wage income on mortgage repayment.

To show relative affordability between cities we calculated absolute values of repayment/double wage.

Chart 6 Mortgage Repayment/Double Wage vs. Employment (x10)

Double wage income is assumed even though there is on average only 1.33 employed people per family and large increase of single parent families in recent years. Although most of the FHB families in reality have double wage income, significant part of that income goes on day-care and similar expenses that skyrocketed in recent time. Any of these assumptions do not affect our comparison, because we assumed the same conditions for all cities.  We also added change of the average number of employed persons per household to the chart to show that employment could not be cause for house price change. Until early 2000s, average double wage FHB family spend between 20 and 30% of their gross wage income on mortgage repayment. Since then it increased by more than two thirds in most of the cities. Sydney is clearly the least affordable city running constantly 10% above other cities. This numbers may not represent actual percentage of an income spend on mortgage repayments but their changes very well represent differences between the cities and changes in the affordability.

Interest Rate

Many argue that falling interest rates are the reason for the house price growth. The following chart shows interest rate and affordability changes.

Chart 7 Mortgage Repayment/wage Index vs. Interest Rate

From the chart you may notice that the affordability is in some way correlated with the interest rate change. We may also see a general trend of rising cost of housing over the interest rate change. In 1995, interest rate of 10.5% drove repayment/double wage to 25% of double wage income, but the interest rate of 9.5% in 2007 increased repayments to more than 40% for the same cities. If interest rate goes up to 10.5%, repayment as a percentage of double wage income will be twice the percentage in 1995. This means that for the same interest rate it is twice as hard to buy house today as 15 years ago. From this point, following the period of extremely low global and local interest rates it is likely that interest rates will go over the levels in 1995-Chart 8.

Chart 8 Standard Variable Interest Rate from Bank

The normal way how interest rates affect house prices is that rising rates force house prices down and falling rates push house prices up. On the Chart 9 we may see that real house prices were increasing while interest rates were rising during the 2002 – 2007 period. After that house prices fallen together with the interest rates (2008-2009), and house prices went up with interest rates since 2009. There was a complete reversal of the relationship. Most of last 15 years house prices were following rates not the other way around that is common and logical. This does not support argument that falling interest rates drew house prices up. It just shows how unusual house price growth was in 2000s.

Chart 9 Real House Price Index vs. Interest Rate

Conclusion

Presented data clearly shows that there was unusual and disproportional increase of house prices relative to any other leading economic indicator. House price increase cannot be justified by wage growth, CPI, interest rate changes, wealth increase, spending habit changes or any other major economic indicator but the debt growth. Using any definition of housing bubble available, it is very likely that Australia is in the middle of the debt driven housing bubble, where house prices increased at least 60% more than any other leading economic indicator. In this paper we do not reject idea that house price growth can be driven by supply and demand changes. We only presented that real economic parameters were not drivers of a huge house price increase since late 90s. Supply/demand arguments will be analysed in the next paper.

References: 
All data provided by ABS and RBA
Chart  1, 2, 3 and 4 - Table1 and Table2
Charts  5 and 9 - Table3
Charts  6, 7 and 8 - Table4

- “Established Median House Price” (Table 2, 3 and 4) and “House Price Index” (Table 2, 3 and 4) columns for period after Mar 2002 is given and calculated based on ABS 6416.0 - House Price Indexes: Eight Capital Cities – data - Median Price of Established House Transfers (grey data in the Table 2 is given); data for a period Dec 1995 – Mar 2002 is calculated using quarterly change data 6416.0 - House Price Indexes: Eight Capital Cities - data; Table: Established House Prices Percentage Change (from previous quarter) and house prices for March 2002.

- “Per week” and “state wage” columns (Table 1, 3 and 4) are given in ABS 6302.0 - Average Weekly Earnings, Australia, Aug 2010 – Table: Earnings; Persons; Total earnings; - seasonally adjusted. Total Earnings for all Employed persons data (Table 3 and 4) is used because it combines changes in the labour – increase of part-time employees as a percentage of total employed persons and change of hours worked per person

- “Repayment/double wage” (Table 4) and “Repayment/wage index” (Table 3) columns are calculated based on standard mortgage loan (90%LVR; 25 years; average Standard Variable Interest Rate from Bank for a given quarter).

“Saving period” (Table 4) and “Saving period index” (Table 3) columns are calculated based on: saving of 20% of total wage, with the interest rate equal to Standard Variable Interest Rate from Bank minus 2.5%