Australian house prices have inflated sharply over the past two decades, increasing by more than 300% since 1997 according to a recent report by Fitch Ratings.
But fortune is fast running out for the Lucky Country.
Twenty years of unchecked growth have left Australia with one of the least affordable housing markets in the world. And an increasing number of economists are now warning of the risk of a housing market collapse, possibly beginning as soon as this year.
Australia’s economy and housing sector faces strong headwinds. The mining boom is over, the jobless rate is rising, wages growth is the slowest on record, and rental vacancy rates are increasing due to an over-supply of new homes. Auction clearance rates in Sydney have plummeted from almost 90% at the beginning of 2015, dipping below 60% near the end of 2015 and struggling to get back above 70%. In WA they’re sitting dismally below 40%.
Australia today, in early 2016, is eerily reminiscent of the United States in the early 2000s, shortly before the US property bubble burst.
With the likelihood of a similar 40% price crash weighing on their minds, it’s no surprise that many Australian property investors are considering the benefits of investing in overseas housing markets.
And the first market that most investors consider is the American market – a sensible choice, considering the fact that US house prices have already fallen considerably from their previous peak, and have recently entered a new growth cycle.
This means the potential for future capital gain in the USA is much higher than in Australia, where the housing bubble is yet to burst.
But that’s not the only reason why the US market is so attractive to Australian investors right now. This newsletter introduces the five key economic drivers that show the time has come for Australian property investors to diversify into the US housing market.
Investors who bought US real estate in 2005 soon learned the hard way that purchasing at the peak of a property bubble is a recipe for disaster. Few would have believed home values would shortly plummet by 40%.
Likewise, those who are foolhardy enough to buy Australian real estate today face similar risks. Australian property values have never been higher, in real or nominal terms. And every other country around the globe that experienced such unsustainable house price inflation suffered the inevitable consequences when the housing market subsequently collapsed.
Since the early 2000s, the Australian property market has been continually re-inflated using artificial stimulus measures like homebuyer grants, interest rate cuts, and tax concessions. But those days are over, and more recently the financial regulator, APRA, has cracked down on risky lending to property speculators, forcing the banks to reduce their leverage and exposure to the investment property sector.
As a result, mortgage rates have already started to rise, with all major banks raising rates in October, outside the normal RBA cycle. With more rate hikes expected this year, and the government openly discussing the removal of negative gearing provisions, there is little political will for further housing stimulus.
The following chart depicts the trajectory of Australian home values compared to US home values over the last four decades. The US bubble (and subsequent crash), are obvious, but what’s more worrying is the magnitude of the Australian bubble in comparison. While the US market has corrected since 2006, the Australian market has continued to inflate.
Following an unprecedented 24 years of growth without a recession, the Australian economy has begun to slow as the commodities boom fades.
Australia’s unemployment rate has gradually increased to 6.2% over the past four years, and most economists expect a further deterioration in 2016.
A rising jobless rate poses a dual risk for property investors. They risk losing their own job, but they also risk loss of rental income if their tenants become unemployed.
Australia’s weak economic outlook contrasts sharply with the United States, where the jobless rate has declined to 5%, and continues to improve.
The following chart highlights the striking difference between Australia’s unemployment trend and the US trend (Australian scale on the right axis, US scale on the left axis).
A similar trend is obvious when looking at wages growth.
Australian income growth has declined steadily to below 2.5% (right axis), the lowest on record, whereas US incomes are rising at a solid 4% per annum (left axis).
The Australian dollar continues to weaken.
Several years ago, one US dollar bought AUD $0.90. Today, it’s closer to AUD $1.30, and this trend is predicted to continue as the American economy improves and the Australian economy continues to decline.
USD/AUD Exchange Rate
As the US dollar strengthens, this presents a unique opportunity for Australian property investors to rapidly grow their wealth. Investors will benefit not only from the rise in US real estate values, but also from the improvement in the value of the US dollar compared to the Australian dollar.
Interest rates are one of the most important considerations for property investors, since mortgage repayments represent the greatest cost component when holding real estate.
In an effort to rejuvenate a flagging economy, the Reserve Bank has cut Australia’s official cash rate to a historic low of 2%, and Australian variable home loan rates have fallen to around 4%, with 5-year fixed rates around 4.5%.
But this is as low as they’re going to get, with the RBA expected to raise interest rates this year, and the major banks already raising rates outside the normal RBA cycle.
Conversely, US home loan rates are lower, with fixed and adjustable rates in the 3% range. Such competitive rates are highly attractive to property investors, making real estate immediately cashflow positive, due to the strong US rental yields and low interest rates.
Australia is currently in the midst of a residential building boom, similar to that experienced in the USA in the early 2000s. Due to this surge in new home construction, an over-supply of rental property has started to flood the market, increasing the national rental vacancy rate, while driving down rents and rental yields.
Gross rental yields are around 3.5% in most Australian cities. This is typically a negative net yield after property management fees, council rates, insurance, maintenance and other costs are deducted.
This negative net yield results in an even deeper negative return when factoring in mortgage repayments, which means Australian investors are losing money, and praying that future capital growth will be sufficient to cover those losses. But that growth appears unlikely to eventuate, given that Australian property is already severely unaffordable.
On the other hand, a recent report by RealtyTrac shows that US investors enjoy gross rental yields of 9% on average, and up to 19% in certain markets. This is substantially more attractive than Australian real estate, with a typical US investor enjoying a positive 5-6% net return after mortgage repayments (versus a negative return in Australia).
Australian property has benefitted from remarkable growth for many years, but all good things come to an end, and the Australian housing market has started to appear decidedly shaky compared to overseas markets – in particular the US housing market.
Australian property is losing its shine as a long-term asset class, with many clear headwinds for investors that outweigh any potential benefits.
It’s hard to imagine Australian home values or rents could increase further at a time when unemployment is deteriorating, wages are declining, interest rates are rising and rental returns are negative.
But fortunately, the outlook for the American property market is much brighter, with an improving economy, rapidly expanding workforce, and strong wages growth.
US interest rates are low and rental yields are high, resulting in positive cashflow for property investors. And the prospect of capital growth is also highly favorable, because the market has already corrected and prices are emerging into a new growth cycle, which may be sustained for many more years.
Finally, the strengthening US dollar will further boost returns for those Australians who wisely choose to invest in US assets.
There has never been a better time for Australian property investors to expand and diversify their real estate portfolios. So if building wealth and protecting your assets is something that interests you, then don’t hesitate to contact American Properties today, and begin your journey to financial freedom.