Australians warned of Irish-style housing crash

Picture the headlines: "Rates cut won't inflate housing bubble", "Policy risks home bubble" and "Fears property market running too hot". Not a Reeling in the Years-style flashback to Ireland in the early 2000s but a flavour of the commentary on Australia's housing market in late 2013.

Developments Down Under are of particular interest in Ireland given the large numbers who have emigrated to cities including Sydney, Perth and Melbourne. Since the economic crash hit Ireland in mid-2008, almost 100,000 Irish people have travelled to Australia in search of work, with some staying on.

Readers in Ireland may be surprised to learn of the nervousness that hangs over the Australian economy. The consensus view is that the country is drifting into challenging waters, and people are edgy. Until now, the economy has benefited from strong demand from large developing countries such as China and India for its natural resource exports .

As a result, mining investment and exports have boomed. Along with a bumper government stimulus, mining activity has helped shield Australia from the worst effects of the global crisis.

However, as the investment in mining-related infrastructure contracts and emerging economies start to slow, Australia will need to look to other sectors for growth to continue.

This impending transition is a major source of worry for policymakers, businesses and households. A lengthy and downbeat election campaign dominated by the government’s deteriorating fiscal position concludes on September 7th. This has been a further source of uncertainty.

It is against such a backdrop that question marks over Australian house prices have materialised, along with inevitable comparisons with Celtic Tiger-era Ireland. House price growth in Ireland and Australia was similarly strong between 2000 and 2007, with prices increasing by 70 per cent after inflation in both countries.

The onset of the financial crisis saw widely differing outcomes; in Ireland, real house prices eventually declined by over 50 per cent from peak and have only recently started to recover. Prices in Australia faltered in the immediate aftermath of the crisis but decisive government intervention arrested the decline and a renewed spurt of house price growth resulted. Population growth of almost 400,000 per year has also supported modest house price growth.

Price trends
Students of housing bubbles tend to devote most attention to price developments in the market to the neglect of other important metrics. Monitoring price trends is certainly vital to detecting bubbles, but price data alone does not suffice.

The experience of Ireland and other economies teaches us that the level of activity in the market is also a crucial gauge of any froth.

As prices increase, the belief that further increases will occur entices speculators to the market. Increased demand from this source not only fuels further price increases but also causes a frenzy of activity to build up in the market.

Home building expands strongly in order to meet the demands of the broadened market. Transaction volumes will also increase as investors ‘flip’ houses in order to realise fast profits.

Ireland saw such a frenzy of activity, with house building doubling between 2000 and 2006 and property changing hands at a fairly frenetic rate. In 2006, the rate house building in Ireland was two-thirds of the Australian equivalent despite having only one-fifth of its population. The post-crash decline in Ireland’s home building volumes was severe, with completions falling from 92,000 per year to just 8,000.

It is in house-building activity that Australia today differs most from bubble-era Ireland. Over the past decade, Australia has struggled to achieve 150,000 house completions per year, despite having a much larger population than Ireland.

Despite the relatively high level of prices, home building and overall market transactions remain depressed. Between 2000 and 2006, house completions rose by no more than 10 per cent.

House building
Since then, activity has drifted downwards. Last year, house building in Australia reached its lowest level in about a decade.

The country's Housing Industry Association projects that building will remain flat over the next couple of years, impeded by taxation, credit constraints, land supply and planning regulation. Sales of second-hand homes have also slumped over the past decade in Australia.

Such low levels of activity are not the hallmarks of a market in the grips of speculative fervour. Though significant challenges lie ahead for Australia’s economy, fears of a housing bubble seem overplayed.

Shane Garrett is senior economist with Australia's Housing Industry Association