House prices are causing a lot of people sleepless nights. The pace of price falls just won’t stop accelerating. Where will the impact hit? Some commentators keep looking nervously at the banks, which have huge property exposures.
In my view, the people who say our banks will collapse are assuming we are similar to the US. I see big differences. Mortgage arrears are low and our banks are well capitalised. But a sharp house price downturn can still cause a wave of bankruptcies and people losing their life savings.
Banks control about 80 per cent of the mortgage market. That remaining 20 per cent is not small beer. There are billions in housing loans made with other players.
They are not banks because they are not authorised to take deposits, and they don’t face the same strict regulation as banks. If we get a really steep fall in house prices, I’d be shocked if at least one non-bank lender didn’t go broke.
But long before those guys get into any trouble there’s a whole other layer of businesses that could crumble and burn.
PROPERTY IS SOWN DEEP INTO THE SEAMS OF OUR ECONOMY
Property is a massive industry in Australia and there are millions of businesses involved — from major banks through to property developers and real estate agents, small plumbing and bricklaying companies, all the way down to the people that run dodgy property seminars.
As the next graph shows, the rate of insolvencies in Western Australia has risen when house prices have fallen. (Look especially at the more recent results, where the end of the mining boom is long past and less of a confounding factor.)
Business insolvency is no joke. Every blue bar in this chart represents dreams being ruined and families being torn apart.
When a business is insolvent, it is illegal for the owners to keep operating it, and it goes to administrators. Administrators are professional firms who specialise in dealing with insolvent companies. They usually try to sell it off and get at least money back to the people who are owed, while taking a cut along the way.
When a business goes bust, it causes ripples that make other businesses more unstable. It leaves bills unpaid, which can put other businesses into a precarious position. Some of these will be small businesses backed by the owner’s home, meaning the bank can take possession of their home if the business fails. (This could even cause a second round of home sales to hit the market.)
I’m not going to name names here of businesses that could collapse. I don’t want to create panic. I expect all the businesses in this article are probably fine. But we will talk about the types of business that could get into strife.
SPRUIKERS START TO SQUIRM
One of the first to fall could be property spruikers who use complex financial arrangements to help people get into houses.
One property spruiker was recently taken down, not by insolvency but by the consumer watchdog. The company, which made most of its money from running seminars, promised people they could buy a house for $1.
Australian Competition and Consumer Commission whacked the company and its director Rick Otton with an $18 million fine.
“We Buy Houses and Mr Otton peddled false hope to people simply looking to get a foothold in the housing market or invest money in real estate for their future,” ACCC chair Rod Sims said.
“The record penalties imposed against both We Buy Houses and Mr Otton reflect their egregious conduct.”
Then there’s Nathan Birch, a property investor and investment scheme operator, whose website claims he owns more than 200 properties and that he makes more than $500,000 in “passive income” a year.
If these claims are true, we could do the maths and see that each property is making a passive income of about $2500 a year. Less than I would have expected, given that holding property is neither riskless nor effort-free.
Birch uses the hard-sell to make people who aren’t investing in property feel like they are missing out.
“What if I told you that we are living in a system, designed to benefit just a few — at the expense of ordinary people … The fact is we are living in the world’s biggest Ponzi scheme. It’s a system that rips power away from many individuals … and transfers it to a handful of shadowy elites,” he says.
Apparently, he drives a Bentley with the number plate CSHFLO, and Birch says a report appearing in The Australian Financial Review earlier this year claiming he was being sued for missing his mortgage payments was not true.
PORTFOLIOS UNDER PRESSURE
In a property downturn, we can expect more stories like that of Kate Moloney. Kate was dubbed property investor of the year 2012 by Your Investment Property Magazine, but she was deep in the red by 2016. She owned 16 properties in mining towns and said “if we were to sell our properties, we would still owe the banks about $3 million dollars (not including arrears interest and selling costs)”.
I expect journalists will have a field day tracking down all those young people who appeared in the press in “inspirational” (or at least aspirational) stories about owning a vast property portfolio by age 22. Finding out how they are going with prices down 20 per cent will be very interesting.
Real estate agents can’t be finding it easy either. The number of houses trading hands in Australia is at record lows, that means the number of commissions trading hands. (Oh, how my heart bleeds for all those twenty-something real estate agents who won’t be able to keep up the lease payments on their Mercedes!)
But while I might get some personal schadenfreude from real estate agents and all the rest doing it tough for once, it’s not good for the economy.
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