We started the year with high hopes, but recently RBA Governor Philip Lowe told us that inflation will hang around longer than he had hoped and it won't fall into the RBA's preferred band of 2-3% until 2025.
He also told warned that there are a few more interest rates to come.
Not surprisingly this brought out the usual suspects predicting a bloodbath for Australian real estate likening our housing markets to a speculative Ponzi scheme.
Is this really true?
So what is a Ponzi Scheme?
A Ponzi scheme is a fraudulent investment scheme where returns are paid to earlier investors using the capital contributed by newer investors, rather than from legitimate profits generated by the scheme.
The scheme's operators typically entice investors with promises of high returns that are too good to be true and often use various tactics to create the illusion of a profitable investment opportunity, such as falsifying financial statements, creating fake investment portfolios, or using high-pressure sales tactics.
The Ponzi scheme typically collapses when it becomes impossible to find enough new investors to pay returns to earlier investors, or when investors start to withdraw their funds.
At this point, the scheme's operators may abscond with the remaining funds or face legal action.
The Ponzi scheme is named after Charles Ponzi, who in the early 20th century, perpetrated a scam that involved buying and selling international reply coupons for postage stamps.
Ponzi promised investors high returns of 50% in 90 days, but in reality, he was using the funds of newer investors to pay off earlier investors.
The scheme ultimately collapsed, and Ponzi was convicted of fraud and sentenced to prison.
So is the Australian housing market a big Ponzi scheme?
As I said, there are some claiming that our housing market is a Ponzi scheme created by speculative investors, debt, and migration.
However, that’s not right!
The truth is that the Australian housing market is underpinned by strong fundamentals.
- Our housing markets are underpinned by a high proportion of owner-occupiers.
One of the key factors that support the Australian housing market is the high rate of owner-occupancy in the Australian housing market.
According to the Australian Bureau of Statistics, currently, around 70% of all residential properties in Australia were owner-occupied.
This means that the majority of homes are owned by individuals and families who are living in them, rather than by investors who are purchasing properties for the purpose of speculation.
This high rate of owner-occupancy creates a stable base of demand for housing that is not driven solely by speculation.
In contrast, in some other countries, such as the United States, there is a much lower rate of owner-occupancy, which has led to higher levels of speculation in the housing market.
Another important factor that supports the Australian housing market is the low levels of debt held by owner-occupiers.
Around half of all owner-occupied properties in Australia have no debt against them.
This means that a large portion of the housing market is not reliant on high levels of debt, which can be a major concern in discussions about Ponzi schemes.
In fact, the Australian Prudential Regulation Authority (APRA) has implemented strict lending standards to prevent excessive levels of debt in the housing market.
For example, in 2017, APRA introduced limits on interest-only lending, which had become increasingly popular among investors.
This helped to reduce the level of risk associated with high levels of debt in the housing market.
In fact, it is estimated that the total value of the residential property market of 10.9 million dwellings in Australia is $9.2 trillion and there is only $2.2 trillion in debt against this.
That’s a comfortable 24% Loan to Value Ratio.
- Australia’s strong economy
Another key factor that underpins the Australian housing market is our country's strong economic growth and high employment rates.
According to the World Bank, Australia has experienced consistent economic growth for well over two decades, with an average annual growth rate of around 2.7% between 1993 and 2019.
Australia also has one of the lowest unemployment rates in the world, which creates a stable environment for the housing market and supports the demand for housing.
It also means that despite rising interest rates most Aussies can afford to pay their mortgage and bank mortgage default rates are at extremely low levels.
- Immigration
Finally, the Australian housing market is underpinned by a growing population, which is driven by both natural population growth and migration.
While migration can be a concern for some and has been cited as feeding “the Ponzi scheme”, it remains a fundamental driver of economic growth and demand for housing.
In particular, skilled migration has been a key factor in the growth of our economy.
But there have been housing Ponzi schemes in the past
Property booms usually start with a genuine rise in demand for housing, but sometimes they can turn into speculative bubbles driven by the expectation of higher prices, rather than being based on a genuine need for accommodation.
When this happens, we have the makings of a property market Ponzi.
This was clearly evident in the property mining boom over a decade ago which was based on speculation by investors for property in faraway places with the expectation of continually rising rents and prices.
Of course when the mining boom finished the property Ponzi collapsed.
This type of crash can only occur in markets controlled by investors.
That is why I only recommend investing in locations that are dominated by affluent owner-occupiers who don't sell up when the property market slows down.
In fact, they’d rather eat Maggi Noodles than sell up their homes.
The bottom line
It is encouraging to understand that Australia’s housing markets are underpinned by the stability of a large percentage of homeowners who have purchased a home to live in rather than chasing cash flow or capital growth.
Our housing markets are resilient because they are underpinned by strong fundamentals, including a majority of owner-occupied properties, low levels of debt, strong economic growth and employment, and a growing population.
As with any market, there are risks and concerns that need to be addressed, but overall, the Australian housing market remains a stable and attractive investment opportunity for strategic investors with a long-term focus.
