The “Disorderly” Property Crash and You

If you missed 4 Corners last night you should jump on iView and watch it.  Ostensibly about mortgage stress, it also covered the likelihood of a property crash in Australia.

It covered ground we’ve covered here before.  Australia has the second highest private debt level in the world, the debt to income ratio is 190%, our banks are highly leveraged into one market with 60% of their loan book being mortgages, and now record levels of mortgage stress being experienced by home owners.  It was a trip around Australia from Brisbane to Perth and the view of those being interviewed was we were looking at a ‘disorderly’ crash soon, not an orderly one.  It’s all just too strung out and precarious to end gently.

On this point one economist pointed out the current ‘perfect storm’  of record high property prices, record low interest rates, and low unemployment (not full, but not bad either).  If just one of these 3 factors change – property prices come off (prompting valuation and equity issues), interest rates (and hence debt servicing costs) go up, or unemployment rises (meaning more people can no longer service that debt at all) – the whole thing could spiral out of control and hence the ‘disorderly’ crash scenario.

Whilst the program covered many bases it missed some critical ones, especially in terms of the broader market impacts.  One could think it’s ‘other peoples’ problems’ if you don’t own property.  We think that couldn’t be further from the truth and neither does finance writer for, Jason Murphy who penned this great article recently.

Firstly we have to acknowledge the fact that Australia, having let our manufacturing industry die, is driven largely by mining and property, with the latter being the saving grace since the mining boom ended.  So what happens to our sharemarket if property crashes and mining already has? 

Australia’s sharemarket is more dominated by the finance sector than nearly any other in the world.  Whilst the ASX200 comprises the top 200 publicly listed companies in Australia, 25% of its value is thanks to just the 4 big banks.  As 4 Corners pointed out, and why Moody’s recently cut their rating, they are beholden to home mortgages for a very large portion of their profit in an unstable property market.  But it doesn’t stop there of course.  As Jason points out, we have the so called ‘wealth effect’ of people spending the value uplift in their property by drawing off their loan.  This was a big contributor to the GFC where American’s were buying cars, plasmas, etc etc by increasing and redrawing from their mortgage as their property value kept going up.  It was free money!  But when that stops, so does all that spending that was going into a lot of those other 196 companies.  One can quickly see how, in Australia in particular, a property crash likely means a sharemarket crash too.  Oh, and property crashes tend to be U shaped, not V in that they last longer rather than bounce back.  Since the GFC, US house prices only returned back to square in 2015 and Spain is still over 30% below the 2007 high.  For context, Australia is 50% higher than it was in 2007 and barely saw a blip in the GFC (thanks mining boom….).  One has to ask oneself, does that feel sustainable.

And if you think you neither own shares nor property privately (and have nothing to worry about) you likely do own shares through your managed super fund.  Managed super funds tend to be very heavily weighted to shares and financial markets.  Yet another clear warning to take control and establish your own Self Managed Super Fund ASAP. 

The article also covers the dangers of cash in banks should we see a “major financial contagion” scenario where banks collapse.  Again, we have covered this and point out the shortfalls of the so called deposit guarantee scheme.

Of course, as is sadly true of many main stream economists, the article missed the obvious safe retreat in such a market – gold, silver and bitcoin. 

A stand out memory of the 4 Corners program were the young couple who proudly had multiple investment properties.  They had a combined income of $135K.  They had $1.2m of debt and estimated their houses were all worth $1.5m.  So if the property market drops by 20% they are wiped out.  All their eggs are in one basket rather than balancing across multiple, uncorrelated asset classes.  Crashes have and always will happen.  Don’t underestimate how big the next will be, manage your debt, spread your risk, be ready to capitalise on it.

Topically, the front page of today’s AFR sees property giant Goodman’s sitting on $2b of cash waiting for exactly that…