By Robert Dugan

In the current climate of ‘doom and gloom’ it’s easy to fall under the spell of the mainstream media and the ‘end of the world’ stories. There’s no denying that in the US it’s time for certain sectors of the market to accept that major changes are coming their way.

There will be a wailing and gnashing of teeth but as they say in the US ‘business is business’ and most players will eventually do what is needed to restore order. The United States has been demonstrating their capacity to do this since 1776. So let’s try to get a fuller picture of what to expect and some interesting differences between the US and Australia.

In the US the general consensus is that the average house price nationwide is about 10 percent too high although there will be large variations on that figure from state to state.

This can unfortunately mean that real-estate driven slumps can be extended for years until seller’s and buyer’s expectations meet. Therefore any indications that declines in house values are accelerating in the US may be a cause to be more optimistic; as lenders and financial institutions decide that assets are fairly priced they will return to the market and extend their credit lines. Anyone interested should keep an eye on the Case-Shiller index to track how the US is playing out.

The latest data released in March suggests the US housing market is stabilizing with the latest US home sales figures showing an unexpected rise in February, the first increase in seven months, but also a record fall in prices. The National Association of Realtors (NAR) said that sales of existing homes rose 2.9% in February to an annual rate of 5.03 million units. The median home price fell 8.2% from a year before to $195,900, the biggest fall since records began in 1968.

“The relationship between home prices, interest rates and income has improved to the point where buyers are more serious about making offers,” said Lawrence Yun, NAR chief economist. In a BBC report Pierre Ellis, senior economist at Decision Economics in New York said “It’s clearly a positive indication … It does seem as if we can tentatively call a bottom in existing home sales. There is price weakness, but that was a given.”

In a presentation in late March at the Massachusetts Institute of Technology Bill
Wheaton, a professor at MIT and a leading expert on the US real estate market neatly summarized what needs to happen before the bottom will be reached in the US. “First, construction of new homes has to stop. Second, investors or current renters need to reenter the market and third, the wave of foreclosures has to stop”. Until it does it will just keep adding to excess inventory.

You’ve probably heard that US homeowners in ‘negative equity’ positions are walking out of their homes, mailing the keys back to the bank and leading to a new term ‘jinglemail’. This needs some explaining.

It’s important to know that many mortgages in the US are ‘non-recourse’ meaning borrowers know their bank will not pursue them for the outstanding debt. Also, if done properly, declaring yourself bankrupt while also having a court-approved plan for repaying the debt usually means creditors are only allowed to seize your principal residence.

So, declaring yourself bankrupt and walking out of your family home is not seen as a sign of failure in the US – in fact it can be a smart move if the numbers add up. Although there are many genuine hardship stories, and probably more to come, Kenneth Lewis, the chief executive of Bank of America, was quoted in the NY Times saying more borrowers appear to be giving up on their homes as prices fall, noting a “change in social attitudes toward default.” This is a fundamental structural difference to Australia where bankruptcy laws are different and where it’s far harder and less acceptable to walk out on a financial commitment.

A related question is how deep and wide US foreclosures will spread. A snapshot of
January 2008 from RealtyTrac shows that 11 states accounted for 80% of the foreclosures so the experience for the moment is highly concentrated and there are large parts of the US that are relatively unaffected by the credit crisis so far. It’s timely to remember the old media adage that ‘bad news sells newspapers’ so you do need to dig through the data at all times to get the real picture.

The other major difference is more cyclical than structural and relates to the oversupply of housing in the United States. The growing asset ‘bubble’ in US housing was too tempting for many builders who rushed developments on to the market in the past decade and means there is a growing amount of unsold stock waiting for prices to fall or demand to rise.

The situation in Australia could not be more different as the undersupply of housing in many markets has seen vacancy rates fall and rents rise. Any fall in value of an investment property only increases the yield on that property. It’s significant to remember that as recently as the 1980s property investment was still seen as a ‘yield play’; income was important but capital appreciation was considered nice if you could get it. Those days may return.

Recent commentary, both inside and outside Australia, support the view that residential property remains a good option. In late March Craig James, chief equities economist at CommSec was forecasting residential property prices to grow by 10 to 15 per cent in most capital cities this year while share market investment returns will grow by only 3 per cent. “The rental market is the tightest it’s been in around 20 years and Australia’s rapidly expanding population is expected to put extra pressure on housing … Over the 12 months to September, total population grew by 1.5 per cent to 21.097 million people according to the Australian Bureau of Statistics – the fastest growth rate in 18 years.”

The view from outside Australia is similar with a February report from the The Royal
Institution of Chartered Surveyors (RICS) concluding that low unemployment, record levels of immigration, and wage growth that is outstripping inflation will contribute to a buoyant Australian housing market and their forward projection is for Australian house prices to grow by 7-8%.

With regard to interest rates there is a growing consensus we may be over the worst.

Shane Oliver, chief economist with AMP Capital, suggested in March the RBA would hold back on any further rate rise as the first signs that the Australian economy is slowing become apparent. “I think there’s a 30-40% chance they’ll increase in May then the rates will stay on hold for the rest of the year,” he stated.

At the end of March the first shots in what will be the crucial debate were fired when US Treasury Secretary Henry Paulson released his plan to reform the regulatory environment post-Bear Stearns. An encouraging note was sounded by Prof. Larry Summers (Treasury Secretary under Bill Clinton and now at Harvard University) in the Financial Times1 commenting on the actions taken post-Bear Stearns and “the confidence engendered by all of this has led to some normalization in credit markets …for the first time since last August I believe it is not unreasonable to hope that in the US…the financial crisis will remain in remission”. Let’s hope he’s right.

So we can’t be definitive but if US house prices start coming down quickly to equilibrium (looking more likely every month), some version of Henry Paulson’s plan for increased regulation gets through Congress (too early to say) and Australian interest rates top out (looking very likely) then we could see a return to a more normal operating environment in Australia in the next 12 months.


United States

Australian housing cycle tends to lead other markets & falls in property values may almost be over

US housing still considered overvalued by 10-15 percent

Socially and legally harder to walk away from debts

‘Jingle-mail’ indicative of differing view of bankruptcy and of non-recourse mortgage loans

Outlook for Australian residential property markets good

Outlook for US residential property markets not good until values fall to more realistic levels

Housing affordability down

Housing affordability down

Problem is lack of available credit until securitization markets reopen

Problem is lack of available credit until securitization markets reopen

Problem in Australia is undersupply

Problem in America is oversupply

Outlook for mortgage interest rates uncertain

Outlook for mortgage interest rates uncertain

Rob Dugan is an author, economic commentator and financial planner based in the United States. This article was commissioned and appears courtesy of the Mortgage & Finance Association of Australia (MFAA).

This article is contributed by InvestorsDirect with the aim to help you become more knowledgeable in Property Investment. Visit their website for more detailed information

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