How Can You Profit from Falling House Prices?

The news that unemployment is set to soar in Australia has gotten me nervous. I still think the property bubble may not pop since the RBA is dropping interest rates, but it all depends on how severe the unemployment will be. We saw what impact a contraction of the finance sector had on the top suburbs. Now that the economic crisis is starting to spread from the finance sector to all other sectors, we may see house prices falling everywhere.

Of course, I am not entirely sure if unemployment will be severe enough to cause house prices to fall. My cross-country analysis of house prices tells me that bubbles can be sustained for centuries. (Look at Amsterdam house prices.)

Suppose I wanted to hedge against falling house prices in Australia. How do I do it? I obviously cannot short-sell houses.

An investment banker friend of mine told me that the best thing to do is to short companies that derive most of their profits from Australian consumers, e.g. Woolworths, but Woolworths sells necessities, so I'm not sure if that will help.

What is the best way to profit from falling house prices in Australia, if it does happen?

 

US interest rates are at 0% and their housing prices are still falling. Low interest rates mean nothing when you are unemployed.

Well the most commonly proposed figure I see thrown around in the media is unemployment will go to somewhere between 6% - 7%, though I'm tending to lean towards 6.5% - 8% due to the overly optimistic media, which will make unemployment around its highest level in a decade and almost double the current level of unemployment.

It will be.

That doesn't look like a "sustained" bubble.

Why not short property groups like Mirvac and Stocklands rather than shorting consumer staple companies?

 

Have a look at the period 1800 to 1900, a 100 year period. Amsterdam house prices went up over this long period of time.

Over the very long-term (300 years) it seems real property prices always revert back to the mean but if we look at specific ranges (e.g. 1800 to 1900) then over time period Amsterdam house prices went up as well as Norwegian house prices.

From 1950 to 2000, a 50 year period, US house prices rose massively.

In Australia, our property boom has lasted for about 30 to 40 years now. Remember from 1900 to 1950, a 50 year period, Australian house prices went down.



Source: The Big Picture | Shiller on Housing

The RBA believes that house prices will not crash because, unlike in the US and the UK, there is no oversupply of houses here. However, Morgan Stanley economist Gerard Minack believes Australian house prices will crash.

YouTube - Gerard Minack on Lateline (Australia)

 

What you need to remember is there is nothing wrong with real house prices going up over time as economies achieve real growth through increased production through innovation, scale, efficiency, etc etc because through growth normally comes real wage growth which justify higher house prices.

So looking at that graph I see little to be disturbed about, other than the obvious dispartity in US house prices spiking in the last decade.

Australian house prices have not been booming for 40 years. They have really only started to boom since the mid 90s, and even in that period would saw some house price declines in 2002 - 2005, although they weren't enough to bring us back to long term trend of price to income ratio of between 3 - 4.



This prevailence of the housing bubble was more than likely due to the fact that interest rates since the early 90s have trended down significantly, in addition to Australia experiencing some of the lowest unemployment levels in decades combined with easy access to capital to mum and dad investors looking to spend their new found wealth in light of their job security.

Well firstly, that interview is VERY old and a lot has happened since then, but I tend to agree with Minack that the Australian housing bubble will be partially deflated once unemployment really starts to rise in Australia, which is already underway, forcing a lot of home owners to sell up once they lose their jobs.

Though on the flip side of the argument, interest rates are the lowest they have been since the RBA's creation, and there is an undersupply of housing with the shortage being unlikely to abate anytime soon and rental yeilds have also been trending up in the last couple of years.

Though, in my opinion, even with all of these factors combined the pressure of increasing unemployment and low wage growth will push Australian housing prices down. At this stage I would think Australian house prices could drop anywhere from 5 - 15%, though realistically they are probably closers to 25 - 40% overvalued.

 

If Australian property crashes, how do you think the big four Aussie banks will fare?

 

Lending...

Hi Norak,

The banks make money by lending money, not by owning property. A drop in home values is probably a good thing as it will stimulate people to buy through borrowing money from a bank. There was an article on money.cnn.com which was talking about a double boom as property prices had dropped significantly (up to 40% in some areas). The double boom was first of all families who previous weren't able to buy their own homes could as the prices have come down and the second boom was that the interest rate had also dropped, which made it even more affordable as the interest charged is also significantly less.

Depending on who you ask, the rate drop in Feb is expected to be between 0.50% to 0.75% but saying that remember when the RBA pulled out the 1% from their hat? That wasn't expected and surprised everyone.

There was another article on $37bn spent before Christmas saying that the December retail figures weren't too bad as the money which the government handed out go some people (not all) out there spending it. While the inflation figure is a lagging indicator it will still be interesting to see where the December 08 quarter inflation rate was when the next RBA figures come out. It'll probably look quite sick compared to the 5% we saw in the September quarter, saying that it's a historical measure which is already out of date when it comes out as it is a constantly changing number. Let's hope it's between the RBA target band of 2% to 3% but it's probably gapped down with things like petrol prices dropping 30% we can expect alone to see a drop of around 1% in CPI as Automotive Fuel is 3.78% of the CPI. That's just with petrol so we are going to see a LOW CPI! (You can download the CPI Weightings here 6430.0 - Consumer Price Index: 15th Series Weighting Pattern (Reissue), Sep 2005

Cheers,

Dan