What would happened to Sydney if the Bubble Burst tomorrow? [Worst Case Scenario]

26 July 2021

I generally avoid using speculation as a mechanism to help make decisions, it tends to lead to decision making toward hopeful outcomes with low probability. Speculation can help us understand the impact of possible scenarios when something changes outside of our control such as “What would happen to Sydney if the property values dropped 30 per cent tomorrow?”

As we speculate the more assumptions we make; the further away we get from reality. Let’s imagine a scenario where the property bubble burst where prices of all properties in Sydney drop 30 per cent overnight. We don’t know why it dropped, but everything else stays the same. What would this environment look like?

Firstly, this would impact everyone who lives in a property. Let’s look at it from the perspective of people who are fortunate to own and live in their own home without a mortgage. This group represents 29.1 per cent of tenure in Sydney according to 2016 Australian Bureau of Statistics (ABS) census data. A $3 million home is now worth $2.1 million. That value is on paper only and only realised if they sell now. If they own their own home without a mortgage. They already have low annual costs for the home and are therefore unlikely to be in a position where they would need to sell right now.

The Wealth Effect

The main impact is the perception of how wealthy they feel. All of a sudden the bubble burst and prices drop, it is a reversal of the wealth effect. The wealth effect is the behavioural economic theory that suggests people spend more as the value of their assets rises. If all of a sudden, you were $900,000 poorer than before, you probably wouldn’t take that holiday, or go out to eat a third time in a week.

The wealth effect affects a person’s perception of their wealth which can influence their spending patterns. If this influences spending patterns across the board, the economic impact can be catastrophic. When people spend less, then businesses make less. If businesses earn less income, people lose their jobs as there is no longer the demand to fill the role. When people lose jobs, there is more people accepting social payments and not paying taxes.

Fewer people paying taxes leads to less budget spending in order to create jobs and spark economic development. It is an easily initiated downward economic spiral. How would this scenario affect those families with a mortgage on their property? This group represents 33.2% of the same ABS census data from 2016. Depending on which point of the loan term the borrower is will determine the potential position of negative equity, whereby the borrower owes more than the property is worth. Imagine you bought a $3 million home and you borrowed $2.4 million to finance the purchase.

Debt Trap

With a 30% drop in the value. The house would be worth $2.1 million. If you needed to sell the property you would still owe the bank $300,000 to settle the debt. In this scenario the borrower is stuck. They are unable to sell nor refinance the loan without being worse off. If this is coupled with a loss of employment and poor economic growth as suggested as being very possible in the example above. This scenario can place people who own property in a very precarious situation. Even on the verge of bankruptcy if they are unable to keep up with mortgage repayments.

Thirdly, renters represent 34.1% of Sydney tenure which means 34.1% of the properties in Sydney are investments. Renters would be unaffected directly by the loss in value of the property that they occupy unless the investor/landlord seeks to cater for the loss in capital by an increase in rental income. A key thing to remember is that 100% of property is owned with or without a mortgage despite it’s tenure type.

Australian Wealth in Property

There is a very delicate relationship between Australian wealth, the property market and the economy. As land and real estate accounts for approximately 52.6 per cent of the total of Australian wealth, there is a very real threat to the economy if property values fall. Luckily for Australian home owners the government does realise this and has a vested interest in maintaining property values. Even without a 30 percent drop in property values, during the start of the pandemic we saw the government’s response to ensure property values were maintained which included mortgage holidays facilitated by the major lenders, access to superannuation payments, Job seeker, Job keeper and Job maker.

For those who are rubbing their hands together waiting to capitalise on the misfortunate of others in bubble burst. They would have to hope for the collapse of the economy and the failure of economic response measures. To hope for a bubble to burst would be the equivalent of hoping for an economic collapse.

Alexander Gibson 

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