The Construction/Real Estate Boom in Oz: Irrational Exuberance Aussie Style

The Construction/Real Estate Boom in Oz: Irrational Exuberance Aussie Style
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Two weeks ago in Brisbane a six minute cab ride at 7:15 am from the edge of the Royal Botanic Gardens to the Lady Cilento Children's Hospital took over fifteen minutes. That doesn't sound like a big deal and in fact, I still had plenty of time to prepare for the presentation I was to give. But the cause of the delay is the topic of this Letter from Melbourne.

Twice on this three kilometre journey the traffic (at 7:15 am!) was completely halted by street closures associated with building construction between my hotel and the hospital. Later that day I checked looking only south and west from the 20th floor of the Stamford Plaza and counted at least 9 cranes. Actually the Financial Review of Australia in March counts 104 active construction cranes in Brisbane. That number is small potatoes (is that a valid Aussie idiom?) compared to 288 in Sydney and 148 in Melbourne. To complete the major Australian cities' construction scene, Perth has 45 visible cranes and Adelaide only 9. All the cities except Perth had seen increases in the number of cranes over the last six months.

This construction boom has been accompanied or generated by an unprecedented rise in real estate values, especially of residential homes and apartments. Indeed, the bulk of new construction in these cities is for high-rise apartment buildings or condominiums. The Melbourne based Age several times a week runs articles of yet another Melbourne suburb's median home price crossing the $1,000,000(AUD) level. These articles have a breathless quality to them but there's usually a lamentable line or two about the unaffordability of housing for first time home buyers.

These items, while Australian, strike this Californian as awfully familiar. I arrived in San Francisco from New York in 1976 and watched a housing boom that began in San Francisco, New York and Boston in the early 1970s last more than thirty-five years until the Great Recession of 2007-2008. I was lucky. I bought my first home in San Francisco in 1980 for $120,000(US). Thirty-six years later I own a very nice home in Piedmont in the East Bay, a Toorakian type inner suburb, whose claim to fame is a pristine school district. The home is probably worth over $1.5(US) million.

Denise would blanch if she knew I was sharing these numbers. At least I've learned not to reveal her age, even indirectly (like mentioning how many years we've been together). But I share this personal experience because I've experienced boom myself. But I also know of other consequences that have boded quite ill for America and are now being recognized Down Under as well.

I can't imagine, for example, how my two sons with presumptive wives, even with major help from both sets of parents will ever be able afford to buy a first home in the Bay Area - and I'm not even talking about San Francisco or the more affluent suburbs. People are regularly driving 90 to 120 minutes (the train systems outside of San Francisco proper, even with BART, are woefully inadequate) to their jobs. This kind of commute is debilitating to the drivers and their families. I see the negative effects on the children all the time in my behavioral pediatric practice in Walnut Creek.

Australia has been in continuous boom since the early 1990s. Their real estate prices climbed with its growing mineral/natural resources boom connected with Asian, especially Chinese, manufacturing and building explosions. The Australian population has increased and immigration is still welcome excluding certain special groups (refugees from the Middle East come to mind). With economic success and a growing population came increased demand for housing.

Construction is the third largest industry in Australia behind only mining and finance. It contributes to 8% of the overall Australian GNP. Over one million persons (out of 23 million total population) are employed connected with the construction industry, compromising 9% of the total workforce. Construction has flowed from Australia's economic growth and now constitutes the main driving force to the Australian economy since mining's decline in the last four to five years.

The Australian government has encouraged home buying. There is no equivalent to the American itemized deduction for mortgage interest for a primary residence. But Australians, considering buying and selling their homes, know that any capital gains on the sale is tax free in a country that otherwise heavily taxes capital gains. That is great for home buyers as long as prices continue to rise.

Battles between Liberals and Labor over the fate of "negative gearing" are nearly daily news items in Melbourne. I was, and virtually all Americans are, unfamiliar with the concept of negative gearing. As best I understand it, someone can buy a residence, rent it out at a loss but use the loss against other business profits in determining overall taxes. Given one only needs 20% cash down to purchase a property, the closest American approximation to negative gearing would be a corporate leveraged buyout where only a portion of the price of a company needs to be in cash. The rest is borrowed and any loan payments or operating losses for the buyer can be deducted from any other profits. But there is no comparable individual leveraged buyout tax scheme for buying homes in America.

Negative gearing appears to favor wealthier property owners who can buy more property based upon borrowed equity to purchase more properties even if the property is not profitable. Negative gearing would tend to drive up home prices and hence construction of new residential properties. But in the end it is only a sensible strategy if property values continue to rise indefinitely.

Foreign property purchases are a final factor driving up residential properties in the major cities (especially in Sydney and Melbourne). Chinese investors represent only 3 to 4% of buyers in Australia but are over represented in high-end properties. While only a small percentage, their influence is huge on market prices because without them, demand would noticeably fall which could cascade into a relative market collapse.

Australian banks are realizing the increasingly perilous position of their home loans based upon foreign investors. Westpac, the second largest bank in Australia, announced this week it would no longer fund residential loans to foreign buyers. Foreign national Chinese buyers as an ethnic group, of course, weren't mentioned but everyone knows that this particular nationality will be specifically hurt by this exclusion. Other banks are expected to follow. The banks, by restricting this foreign-fueled "high octane" on prices in Sydney and Melbourne, hope for a soft landing to the boom, rather than a crash.

The State Victorian government led by Labor Party Premier, Daniel Andrews, (for Americans, he's the equivalent to a major state governor) announced a very ambitious infrastructure road and rail building plan this week as well. With a bulging surplus budget coming from real estate/construction taxes collected, Andrews and company have decided to eschew waiting for federal funds and go at the work alone. The projects will take several years but the belief apparently is that the boom and surpluses will continue. I don't know if they are also saving some acorns (an idiomatic expression Aussies surely don't know because they don't have squirrels in Oz).

But will the boom last? Or is this an Australian version of "irrational exuberance", Alan Greenspan's famously ignored comment/prediction on the American stock market in the late 1990s during the boom? There are already signs of a stabilization/softening of real estate prices and I'm not the only one questioning the boom's continued sustainability. The Business Insider of Australia reports steep declines in the confidence of housing prices and residential construction in the last six month.

The Reserve Bank of Australia (RBA), Australia's central bank (equivalent to America's Federal Reserve) in a semi-annual report two weeks ago warned banks about softening demand for apartment housing on Australia's East Coast which is leading to lower rents, therefore making servicing of loans more difficult for owners and developers. Of course there are always bears out there, but this Californian remembers the realtors' promises in the Bay area of endless price rises - and so many property owners became extremely wealthy just by borrowing on their equity and buying more properties until...

Until "predatory" lending practices led to increasing loan defaults in the weakest borrowers which tended to be first time home buyers in the furthest suburban rings around the major cities of California, Nevada and Florida. Then the declining cascade caught overextended real estate and bank investors - you know the whole story, e.g., The Big Short (that wonderful Michael Lewis book and now a film).

Millions of new homeowners, even if they didn't default on their loans, found the value of their homes suddenly "underwater" (the value of their homes wasn't close to the mortgage they were paying monthly) and many homeowners just walked away, leaving banks with these low valued properties. Without the Bush/Obama Administrations offering major federal bailouts, the U.S. financial system would have frozen and collapsed leading to a second Great Depression.

The U.S. recession affected nearly all the western economies (Australia, as mentioned, with its resources based economy escaped). I clearly remember driving around Spain in 2005/2006 and marveling at the building construction, new tramlines, and new freeways that weren't even on the maps I had purchased (preGPS days). Everyone knows what happened to the Spanish economy by 2008/2009.

Actually San Francisco and Piedmont real estate prices didn't go down. They just stayed the same for about three years and then began rising again. So if you live in Toorak or Kew you're probably okay. But the ring suburbs of Melbourne and Sydney are at high risk as are the condominium owners, landlords and developers of these new inner city high-rise residences.

An Australian-American friend of mine (he has lived in both countries extensively) notes wistfully that there are no sub prime mortgage bundles or their insurance that he can invest on in a "short" position in Australia. He says one's only strategy to profit on the sure collapse of this market would be to short Australian banks. I'm certain there are big players doing just that even as I write.

But beyond the immediate future of Australian construction and real estate, the most disturbing trend is the continuing rise in prices and tax policies that favor existing homeowners Down Under. The growing income/standard of living inequalities in the U.S. have led to social unrest and extremist appeal (both Trump and Sanders). Australia to me, as an American living here for a year, has been the model of a better balance between government regulation and the unfettered efficient, but amoral aspects of market capitalism that have reigned in America since the Reagan years. I pray the Australian ethos and character will be able to withstand the siren song of capitalism's short-term profits. But I am quite worried.


The last Letter from Melbourne on ANZAC Day generated a great response from both Americans and Australians. I am grateful to hear from any of you but especially those who point out my errors. To that end, it was John not George Monash, the great Australian general and strategist of World War I.

But more importantly, an American and Australian both corrected me on the ending of Gallipoli, the 1976 film by Peter Weir. I had the character Frank, played by Mel Gibson, freeze framed machine gunned to death at the end. In fact, it was Archie played by Mark Lee who was killed. This ending is even "better" in that Archie and Frank were both athletic sprinters and mates. They joined the ANZAC together. At the end of the film, Archie is offered the much safer responsibility of being the "runner" between various officers at the front. However, he secretly gives that position to Frank. Frank doesn't know this but knows that going over the top is virtual suicide for his mates. In the end despite his efforts, he arrives just too late with the message to halt the charge to save Archie and his unit. The notion of sacrifice for one's mates, the essence of "mateship" is portrayed in this individual story.

Finally, I must share with you a link that was provided to me by an American reader of the Letter of a music video by the British group, The Pogues, called The Band Played Waltzing Matilda . Having learned more about ANZAC Day and the Australian character, I had trouble restraining my anger and tears upon watching this video. Don't say I didn't warn you.

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