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Sunday, December 18, 2011

What drives prices up?

There is common understanding in Australia that FHBs are one of the most important house price drivers. Is this really true?

Let's see what data shows:

Australia Property Investor/FHB market share vs. house prices

It is clear from the chart that there is a weak correlation between FHBs market share and house prices. For most of the time these two series were heading into opposite direction (correlation is slightly negative). On the other hand, property investors (PI) market share is very strongly correlated with house prices. This, of course, does not imply direct causation so we need more information. Just recently, US FED published report* that claims increase in property investors market share was the most important factor that created housing bubble in USA. Lower lending standards attracted large number of highly leveraged investors ready to take big mortgages with expectation of big and quick capital gains. They increased demand and drove prices up. FHBs and upgraders got squeezed and forced to pay ever increasing prices. Increasing prices attracted more investors and feedback started its own life independent of real demand or realistic future prospects. It's almost irrelevant what initiates the feedback loop; once started abundant and easy credit is only thing needed for growth.

According to FED property investor market share in bubble states increased from less than 25% in 2000 to almost 45% in 2006. Similar rise is property investors was recorded in Australia as a whole. In some areas (SE Qld, inner capital cities, ...) significantly higher percentage of investors entered property market and drove house prices by increasing debt to extreme levels. It is hard to imagine this trend to continue for long because of huge debt already accumulated. Once prices stop growing, property investors begin to sell because quick capital gain expectations are gone while big repayment bills continue to arrive every month. Most of highly leveraged and negatively geared investors cannot afford to hold for long without quick capital gain expectations.

Looks like same forces created housing bubbles in USA and Australia. Other minor factors made bubble extents and timings slightly different but core cause for rise and fall seem to be the same.