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article imageOp-Ed: Future housing market warning – Negative equity becoming a killer

By Paul Wallis     Mar 21, 2012 in Business
Sydney - It was the Australian housing market, that famous sacred cow, which finally exposed the global risks of negative equity. In a market where mythology and price gouging is legendary, the effects of negative equity are starting to show their deadly side.
According to the Sydney Morning Herald:
…Far North Queensland had the highest proportion of mortgages in negative equity, at 22 per cent, followed by Gold Coast, with 19.4 per cent in the quarter.
Sunshine Coast was in the third spot at 15.3 per cent.
By city, Brisbane fared the worst with 9.2 per cent of property deemed to be "underwater" in financial terms, followed by fellow mining state capital Perth at 7.4 per cent.
This is an interesting for more than one reason. The areas worst affected are those where development and housing markets have been on the rampage for many years. Enormous amounts of capital been sunk into those markets, and the vultures are now coming home to roost.
The negative equity model was the one which virtually annihilated the American property market. Negative equity occurs when the value of a house on the market is less than the mortgage value.
In Australia, a process called negative gearing allows homeowners to write off the cost of investment properties. Large property portfolios are developed in this way, and a lot of money, many billions of dollars, has been sunk into the market. Negative equity could be described as reverse gear for the property market, and it has multiple effects on the property market and the economy as a whole.
The current problems with negative equity are well understood, thanks largely to the American housing apocalypse. Future problems, however, are less well understood, and far more dangerous. If you’re looking for a new home, starting a new family, and trying to get on with your life, you are now looking at a minefield.
Everyone knows that when you take out a mortgage, you wind up paying considerably more than the value of the actual price of the property. With negative equity, however, given that the return actually goes below the initial purchase price, the real cost of a mortgage go from being an inconvenience into a serious risk.
If you have negative equity in a mortgage, even selling the property can leave you significantly behind the eight ball, in debt, and perhaps facing bankruptcy if the outstanding money is more than you can pay. That's a scenario likely to be facing future generations for a range of reasons.
The deadly risk of negative equity is:
Two way price damage – Sellers will be in a very serious position, with property portfolio values undermined and trying to make extra capital.
Buyers will be faced with a demanding market and a likely shrinkage in real options – They may be forced to buy properties based solely on availability relative to income, which could mean paying big money for unsatisfactory premises.
The real estate market isn't going to do very well out of this at all, either. The added level of doubt and insecurity certainly isn't going to help sales. Both buyers and sellers will have to take into account a whole new range of factors.
The banking industry, which is surgically grafted to property markets, is likely to find a lack of demand for finance as a result of a highly paranoid and sceptical market which simply doesn't trust property values.
Perhaps more alarmingly overall, property investors and lenders are likely to lose big money and find themselves in a particularly nasty situation. Negative equity is the spanner or all spanners for them. Not only are they not making money, their financial commitments can turn against them seriously, with their real outlay relative to property values basically destroying their capital. That means private capital, which is heavily invested and committed to the property market, can be destroyed as easily as it was in America, but this time on an ongoing basis.
The property market is not doing itself any favours. The constant emphasis on capital gain and high house prices as an incentive for purchase is turning into a massive own goal, and that situation is likely to get worse. If real return on investment collapses, likely result of the massive drop in housing prices, which may solve negative equity in theory, but in practice will cost hundreds of billions of dollars to existing capital.
Future housing economics – Very different, and much more practical
the trouble with the housing market is that the entire economic model upon which it is based is totally obsolete. The idea of people making a multi-decade commitment to a major capital purchase is becoming highly impractical, and simply doesn't reflect the realities of earning an income in the 21st-century.
During the course of someone's working life, they will have:
1. An average of five or six jobs
2. At least one redundancy or restructuring the leaves them out of work
3. Massive domestic costs, which have been increasing decade by decade
4. Increasing training and education costs, also increasing progressively
5. Quite probably a case of depression or some other medical issue
If you look at the realities of the gigantic increases in housing prices in recent decades, you can see one logical absurdity in the situation – Where are people supposed to get the money to pay for all this?
Add to this the realities of an increasing population, added strains on resources and private capital, and you have a recipe for something which just simply isn't going to work. The hideous irony here is that it's recently been discovered that people who own their own homes are economically more productive. Not having the cost of a home to contend with, they can spend their money productively.
Which means, of course, that the existing housing market really is a major liability in its present form. Like the finance sector, it has developed a degree of remove from reality which simply isn't viable. The simple process of buying a home is now a multidimensional obstacle course for an increasing number of people who really didn't have enough money to begin with.
But future generations, however, if this problem isn't solved, simply won't be able to be economically productive in the same sense that present-day homeowners are. These generations will be battling a highly fluid job market, income insecurity, and simply not able to participate in the property market at all.
Housing prices must be rationalised. That simply cannot be done on an interest rate-based methodology. An alternative method of buying a house would be far simpler – The bank lends you $300,000 on the basis that you repay a fixed figure of $390,000, for example. The difference is that you pay back a flat fee, not an interest rate-based amount.
That's a 30% return on investment. Given this option, you could expect home buyers to pay off their flat fees much more quickly, knowing a specific target for payment. This is quite strange as it sounds – many banks and other financial institutions advertise quick repayment mortgage schemes which provide single figures for repayment over periods of about five years. The trouble is that they don't include interest rate variations, and the very long, drawn-out purchase process adds degrees of difficulty to repayment rather than simplifies them.
The advantage of the single fee approach is that also remains a very large amount of administrative work. Bizarrely enough, banks and lenders expend vast amounts of money in calculating the amounts payable to them, therefore adding cost to themselves, not simplifying a core business operation.
The fact is that the future will have to be very different. The current dog's breakfast simply cannot work any more. Better methods are required, and much more realistic approaches to the property market are desperately needed. Negative equity may be a horrible thing, that it may also be a very appropriate warning to the property market to start getting its act together.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of
More about Negative equity, Australian housing market, Housing investment, Future housing, Negative gearing
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