Thanks for the Manna

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Chris Joye com­ments in his release of the recent RP Data-Ris­mark index that the news of a 0.7% fall in one month will be “man­na from heav­en for the hous­ing mar­ket bears”. Far be it from me to dis­ap­point him, so thanks for the man­na. But what adds spice to the man­na is the way that Chris has attempt­ed to ratio­nal­ize the out­come:

It’s sober­ing to remem­ber here that we have had 17 con­sec­u­tive month­ly increas­es in Aus­tralian cap­i­tal city home val­ues. If the share­mar­ket rose for 17 months straight and then tapered, peo­ple would not think twice about. It might be wise to apply the same log­ic to our hous­ing mar­ket.

That com­ment evinced the fol­low­ing com­ment on Chris Zdat­ap­pone’s report in the Fair­fax Press from the read­er “Dave”:

If the share mar­ket had risen for 17 con­sec­u­tive months, peo­ple would be scream­ing BUBBLE. Some­how this log­ic seems to defy Chris Joye … Oh dear.

Oh dear indeed. In a spec­u­la­tive mar­ket like the stock mar­ket, much of the buy­ing is dri­ven by the belief that prices will con­tin­ue to rise; as soon as that belief evap­o­rates, buy­ers become sell­ers and the price does­n’t “taper”, but plunge. A cer­tain Irv­ing Fish­er once com­ment­ed that “stock prices have reached a per­ma­nent­ly high plateau”, only to see them (and his rep­u­ta­tion and wealth) evap­o­rate in the ensu­ing 3 years.

So the hope for Chris Joye is not that house prices will behave like stock mar­ket prices, but pre­cise­ly the oppo­site. Bears like myself argue that the hous­ing mar­ket has indeed become just like the stock market—a place where lever­aged spec­u­la­tion in the belief that house prices always rise does far more to explain house price move­ments than any appeals to “fundamentals”—and this is the main rea­son that house prices have risen so much in the last two decades.

There is how­ev­er one impor­tant way in which house prices do dif­fer from shares: the first sign of trou­ble is not a sud­den drop in prices, but a fall in the num­ber of sales and an increase in the length of time it takes for prop­er­ties to sell. That sign was evi­dent in the data from the last year or so, which is why I argued that a fall in house prices was immi­nent in a pre­vi­ous arti­cle on Busi­ness Spec­ta­tor. Now that the data are unequiv­o­cal, the fol­low­ing process­es are like­ly.

First­ly, with an increased stock of unsold hous­es on the mar­ket, buy­ers are like­ly to take yet more time to make a decision—which will add fur­ther to the back­log. If prices are falling, why hur­ry? The urgency will leave the buy side.

Sec­ond­ly, so-called investors—whom I pre­fer to call spec­u­la­tors, since 90% of them have bought exist­ing prop­er­ties rather than built new ones—will start to con­sid­er whether they should swap from the buy side to the sell side. After all, no-one in their right mind buys an invest­ment prop­er­ty in Aus­tralia for the rental returns: it’s cap­i­tal gains or noth­ing Dow­nUn­der. Do you cap­i­tal­ize on gains to date, or hang on hop­ing that the upward trend will re-assert itself once more?

Giv­en the skew­ing of our mar­ket away from own­er-occu­piers and towards spec­u­la­tors in the last two decades, this sec­ond effect could cause a sud­den increase in the num­ber of prop­er­ties on the market—at just the same time that buy­ers have become more relaxed about clos­ing a sale. It’s this sort of process in an asset mar­ket that is why asset prices don’t “taper”—or “plateau”, to use a word from an ear­li­er time.

I expect these two process­es to lead to an accel­er­at­ing rate of decline in house prices now, as they did in the USA when “Flip That House” ceased being a win­ning trade.