Morgan Stanley warns Australia’s Ponzi Scheme 40 percent overvalued

Morgan Stanley chief strategist Gerard Minack has today warned clients that Australia’s housing bubble is 40 percent over fair value and could be popped if banks tighten credit or the loss making landlords start to sell.

He claims investors have become “Ponzi borrowers”, relying on capital gains to service massive property loans. Data from the Australian Taxation Office show rents has not covered the costs of an investment property since 2000 and hence property depends upon capital gains to make money.

Already this year, we have seen banks start to tighten credit. In January two of the big banks dropped loan value ratios to as low as 80%. This has caused mortgage approvals for owner occupiers to plunge 28% over the year.

Last month we saw investors start to desert the market with loan approvals for investors also falling. The number of houses on the market is rising consistently, suggesting that loss making landlords are in fact starting to dump their investments as the forecast of large capital gains dissolve, something that is needed to sustain their loss making ventures.

» Morgan Stanley analyst bearish on housing market – The Australian, 17th August 2010.

» Housing bubble trouble for the middle class – The Sydney Morning Herald, 17th August 2010.


  1. I have read a lot of economists from outside Australia predicting a “crash” in property prices.

    One of my family members has an investment property. They recieve around $15k a year in rent and a negative gearing benefit of around 10 k a year. Their investment property cost just over $400 k a few years ago.

    Even without any capitial gains the return on investment is around 6.25%. Even if council rates and other taxes took say 5k off the investment yeild it still comes out to be around a respectable 5% return on investment.

    Where should people invest in?

    * Sharemarket – At the start of this year the ASX “All Ords” index was just under 4900. It is now at 4465 (17th August 2010). A investment yeild of -9%???

    * Gold – Over the last 10 years, gold has gone from $300 to over $1200. Gold bubble? Gold is like owning a house and having no one rent it (similar to land banking). It has very few legitimate uses apart from hedging against economic uncertainty.

    A “crash” seems unlikely if people given property is illiquid and investment yeilds from other investments are poor.

    Unless tax reform in negatively geared properties changes, investment yeilds in overpriced property will continue to give a reasonable return on investment (at least at the lower end of the market)

  2. Adam – I tend to disagree.

    The article about the middle class being the ones holding the ticking time bomb is more then correct – a lot of the ‘smarter’ property investors sold out through early 2010 and are sitting on the sidelines with their realized capital gains. Also, including the negative gearing benefit as part of your yield calculations (and i know all property guru’s do this) doesn’t really make logical sense. This is because the negative gearing ‘benefit’ is only a legitimate benefit when prices are rising and capital gains are being realized (i.e. you sold the property).

    The more correct way to calculate negative gearing would be to actually include the ‘benefit’ as an property improvement expense (in the same way as home renovations) that is used to offset against the realized capital gain when the disposal of the property occurs. Taking the negative gearing ‘benefit’ out of your equations, the property yield is only a raw 3.8% or could be as low as 2.5% after expenses are taken into consideration. Considering you can get 2.5% investing in ‘cash investments’, without the prospect of capital gains down the road, property investment is in essence a dud.

    Unlike shares, gold, oil and other commodities that can be bought and sold, housing is a rather illiquid asset. As a result, unlike seeing the daily prices for the other investments, housing is no where near as transparent. It also takes considerable time to see the trends in the market. This is because the ‘timely’ data that is fed to the market is by an organisation with a vested interest (in Victoria it is the REIV). Up until about 18 months ago, the results of approximately 95% of all property sales were reported by the REIV (that is local real estate agents reporting the results to the industry body).

    However, over the last 18 months we have seen the amount of property sales reported to the REIV drop into the 60% range. This has been because real estate agents are no longer publicly reporting the poorer sales that have occurred on any given weekend. Further evidence of this can be seen when the REIV claim that Melbourne property prices have risen 21% in the last 12 months (based on the 65% they report) but the Victorian Auditor Generals Office (that sees all property transfers through the stamp duty imposed) said that property prises had only risen 8%. So, by individual real estate agents not reporting on their poorer sales, the official industry figures actually look more rosy then reality. Unfortunately the middle class of Australia (the mums and dads and most of my relatives) are not all that smart, and generally get sucked into the headline rates.

    Physical rental amounts cannot increase due to the fact wages are not going up, and capital gains on property seem to be drying up because of the poor yields available to investors and high entry costs.

    Do you still think property is a good investment?

  3. Thats what I’ve been saying for ages. But people on this forum keep telling me there will be a crash. But how when the government allows Negative Gearing to be so goddamn attractive.

  4. Hi Adam,
    Please explain how a property that is losing money – and it has to be losing money to have a negative gearing tax element, can be giving a positive return on investment with zero or negative capital gains.?

    Surely negative gearing equals no return on investment – except capital gains.?


  5. Adam, you are confusing yield and capital gains. In the share market is yielding 4.5%, with 70% franking, it will result in the shares paying a grossed up dividend of approximately 6.45%.

    However we know that in many capital cities properties are selling at a gross yield of approximately 3.5%, less costs. So to buy a house now you are looking at a net yield of around 2.5%.

    The difference between shares and property is that shares have had some downward correction in recent years, it doesn

  6. You cannot compare today’s yield with yesterday’s prices. If I did that, my gross rental yield will be over 10% pa.

    Based on today’s market price of an actual investment property (which is falling with each passing month), my yield is 5.05% or $17,800 pa. Assuming interest repayments based on a 90% loan and cash expenses (management fees, rates, insurance etc. but not depreciation and building writeoff), annual costs are about $22,000. Therefore the shortfall is $4200. On an average wage of $69,000 pa, you are still out of pocket by almost $3000 every year.

    Depreciation and special building writeoff will put a little more money back in your pocket but they run out over time. Also don’t forget negative gearing benefits are reduced if you are under-employed or become unemployed.

    The only way to generate a positive cashflow in today’s housing market is to pay off a good chunk of the loan as fast as you can but that goes against the spruiker’s doctrine of negative gearing.

    I can see why investors will head for the hills when they realise their investment properties are actually making them poorer. It only takes prices to stay flat (and fall behind in real terms) for that to happen, not actual falls. Although a mass exit will most likely precipitate falls in prices.

  7. At 5% ROI, if that is all you are after, I would suggest looking at putting cash in the bank – same returns even with simple savings accounts. I am getting 6.15% annual return at the moment with a fully liquid savings account from one of Big 4 – a “special” deal that required one visit to the branch every four months or so to make sure the “special” is extended.

    $400K invested in a dwelling that requires upkeep, maintenance, and depends on a reliable steady tennant to keep the cash flow, plus reliance on a negative gearing scheme is too many variables that are out of your individual control that can go sour in a hurry. Selling a house in case of a market turning south is also a worry, plus there are always coucil rates, etc. that can be raised even higher, further limiting ROI.

    For stocks, you can find similar returns in a steady blue chip company, with a 5% dividend, if all you are after is ROI. Plus stocks are more liquid. Comparing ASX level of 4900 to 4465 is not comparing ROI, it is comparing capital gain (or loss, in this case).

    For gold, true, it does not return anything, and investment in gold (or silver, or any other commodity) is a pure capital gain play. But gold is not an investment mechanism, per se, it is a means to preserve wealth, if one believes there are storm clouds gathering on the horison. Gold may not increase four-fold over next 10 years, like it did over the previous 10 years, and it does not offer ROI, so it is not an asset class to compare with other ROI producing investments, like property or stocks.

    Of course, if the reason for investing is capital gain, and not ROI, then your approach will be different.

    Just my two cents worth.

  8. Adam,

    you state : “One of my family members has an investment property. They recieve around $15k a year in rent and a negative gearing benefit of around 10 k a year. Their investment property cost just over $400 k a few years ago.”

    So you’re saying you get $15k gross, then on top of that you get $10k back from the ATO through negative gearing? I don’t invest in realestate, but I am aware of the standard quote oconcerning the “spending a dollar to save 50c,” so are you really saying that you get $10k back because you lose about $20k each year? (would depend on the tax rate of the individual)

    Does that mean all up your income is actually $15k + $10k – $20k = $5k ?

    So that return would be 5/400 * 100 = 1.25% ?

    Then as you say if the council and others took another $5k from that wouldn’t your return then be :

    ( $15k + $10k – $20k – $5k ) / 400 * 100 = 0% ?

    I can’t see how a return of 6.25% or even 5% can be achieved.

    Note that I used the $15k figure without deducting any tax from it as well.

    It all sounds a little too good to be true, I think there is a bit more to working out the true return, but I remain unconvinced in the current “hyper climate” that realestate bought now will deliver anything like that.

    As has been indicated time and time again, if it’s negatively geared it’s loosing money.

  9. Ok so a forecast exit from the market by the middle class landlords,
    plus no first time home buyers entering the market as who has a $100k deposit?
    plus fewer foreign investment as laws have changed,
    plus a strong Australian dollar means less foreign investment,
    plus interest rates set to be increased by banks as credit around the world is becomming more expensive,
    plus a potential interest rate increases by RBA by the end of the year,
    plus banks tightening lending to investors and owners,
    plus no talk about this issue in the election (very suspicious !- the UK Labour Party boasted 60 months consecutive economic growth – the UK are now paying for it for the next 30 years!!)
    plus economic stimulus money drying up,
    plus first time home buyers grant slashed,
    plus employers reducing salaries and working hours to cut costs,
    plus cost of living increasing (gas, elec, water, fuel, food),
    plus consumer spending decreasing which is leading to job losses as companies cut costs,
    plus dodgy real estate agents / banks / insurers overvaluing assets,
    plus real estate agents reporting dodgy figures,

    Equals a market set to take a sharp dive or a slow fall for a very long time.

    Only time will tell now.

    How long can they all fudge the figures before it all falls apart

  10. Well said romsey! Was just scrolling down to post the exact figures you quoted!
    I have stated before on this forum how often I come across property investors who have got into ‘investing’ because of negative gearing without understanding it. A lot soon find this out come tax time for the first year of their investment.

  11. Wow, what a lively and passionate debate.

    @ J Hill

    No, I don’t think property is a good investment. Yes, I have noticed a lot of properties on REIWA (WA equivilent of REIV) not listing their sale price. It does suggest that buyers have negiotated a much cheaper price than what the property was listed for. It is sad that mum and dad investors are going to be the biggest losers.

    @ Paul Martin

    As you figured, I am not an accountant. I see negative gearing as a way to divert money that would normally be going to government coffers to paying off a mortgage.

    @ Adrian

    Yes, the net yeild is very low. Illiquidity benefits the real estate market when economic fundementals are strong and people are not forced to sell at discounted prices. I agree that we are open to external shocks like future liquidity crises.

    @ Josh

    As you figured, I am not an accountant.

    @ Max

    Yes, “safe” investments, like termed deposits, are currently paying attractive yeilds. What is the incentive in taking risks in property…

    @ Romsey

    It is not my investment so I am too sure about the exact details. It was just anecdotal evidence from a conversation. But yes, your argument does make me think this family member has fibbed the numbers.

    @ Everyone

    Why is Morgan Stanley so bearish about property and publicly disclosing this?

    It is because American banks have very large short poistions against Australian banks with anticipation that the property bubble in Australia will fall like it did in the US and other parts around the world.

    I hope property does crash so I can afford to buy a house one day!


  12. Its great to see so much understanding of just how risky the current market is, the big question that people are not asking is what happens as unemployment starts to rise? FHB dreamer makes alot of strong points but failed to talk about unemployment. As the unemployment fig’s from last report showed we have just about hit full employment capacity in OZ and thus we have see a small jump in the unemployment fig’s, this trend will continue and the unemployment fig’s will keep heading north as investment drys up due to higher interest rates and slow consumer spending. This spells real bad news for the house market as people will become less willing to take on new debt. The crunch time has arrived and spring will see a big build up in unsold homes then the real price falls will start. If the RBA start to cut rates they may contain the falls to maybe 10 or 15% but it coud be more depending on how much the market panics?

  13. I think you the scenario from the start of 2008 through to mid 2009 will be fresh in most investors minds. A former colleague who had just purchased an overpriced property in Ivanhoe on two high incomes (and struggling to repay) summed up the mood at the time “the government can’t let it crash like america, they have to do something”.

    Unfortunately, the Government did step in and thus I dare say there is a perception within the ‘Joe Average’ investor class that should prices be seen to be declining once again, the Government will once again step in. Investors endured ‘hard times’ of 18 months without capital gains (oh no, its the end of the world!) but came out of the other side of that with a massive uplift.

    It would not surprise me in light of this recent example, the stubborn Australian mindset, and the usual real estate dribble about ‘long term’, that most ‘Joe Average’ investors will hold on until one of three scenarios occur:

    1. Property Investors themselves become unemployed (or underemployed) meaning that they can no longer afford to incur the loss as there is no income to sustain it
    2. Interest Rate rises increase the ‘holding costs’ of property. This would mean that many ‘Joe Average’ investors would no longer be able to cover the loss if their income level remains static
    3. Property Prices have around 3 years of constant 10% per year drops in terms of capital value. This would make some investors switch into cash investments, but I dare say there will be many ‘stubborn’ investors still holding on. There will be an unfortunate perception (potentially led by the 2013 elections) that capital growth is just around the corner – wait for the election campaign in 3 years (increase population to bring back our house price wealth and bring back the first home buyers grant)..

  14. If i recall correctly, one only has to work 1 or 2hr every fortnight to be considered employed! And, we recently just lost a bunch of full time positions. See where i’m going with this? So unless i’m mistaken, if all full time employees in Aus suddenly had their hours cut in half, we’d see no change in the employment figures and see apparent ‘full’ employment.

  15. I just find it shocking that nothing has been discussed in the election.
    It’s as if all parties know there is a massive problem and are ignoring it because they know it is going to bang.
    If this market does not correct it will produce a generation of young people without housing – that is the reality of the situation!
    It will cause massive social implications and family issues with a split class structure.
    Unfortunately the rich will get richer and the middle class and poor will suffer if things continue.

    The answer is more land available for development,
    less restrictions on development applications,
    higher capital gains tax on investment properties or restriction on the number of properties,
    restriction on the amount of debt by banks.

    I am tired of this housing market, really tired, because I have been running this race for a long time and there is no finish line in sight.

  16. FHB,

    More land is not the answer, there is already more property available than people to live in it, flick through the newspaper rentals sections and see listing after listing of available rents.

    Restrictions on property buying is also not the answer, the simple solution that will crush this idiotic emotional belief in the perfect investment medium is to reduce or get rid of negative gearing. Not only will that make the costs decline, but it will save every tax payer a lot of money. Imagine how much better off the country would be if all those refunded losses went to hospitals and schools instead of into the wallets of economic fools. There would be less pressure to increase future taxes as well.

    The usual old argument is then, “well there would be a major drop in available places to live”, well maybe rent wise, but the cost of buying a place to live in would fall too. If someone can’t make a go of successful investing without negative gearing then they are simply not ready yet and have a lot to learn.

    The ANZ bank reported it’s quarterly results last week and made a statement that followed on the heels of the CBA release earlier, they said that the velocity of recovery worldwide was too weak and that it was not beyond the realms for the world to plunge into the next depression, if so, then you monthly pay packet should be enough to buy a house then….. assuming you have a job of course.

  17. I read the property section in the SMH today and it’s ‘business as usual’. 25 yr old aspirational Property Investors living back at home with mum and dad whilst they dream of acquiring 3 or 4 investment properties.

    Housing Speculation – it’s the only thing that matters anymore.

  18. One of the main reasons that real estate in Australia is so overvalued is due to the extreme incompetence of State governments that has led under supply of housing, not to mention the appalling state of transport infrastructure that causes most of us to waste hours commuting to work.

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