The Valor Blog.
Investment News and Views, Direct from Our Team.

The magic ratio of 3.8 is nigh

Japan is widely accepted as the largest and most destructive property bubble ever recorded. In 1989 they reached the magic ratio of property to GDP of 3.8. Australia was 3.7 last month and looks to equal the magic 3.8 in the coming weeks and possibly outstrip Japans title as the worst property bubble in history.

Warren Buffett’s favourite metric for measuring stock market bubbles is the size of the stock market compared to the size of the economy (measured in Gross National Product (GNP)). He has been quoted as saying it is the “single best measure” to measure the markets. Applied to property the same ratios can be used. It makes absolute sense that the property market and the economy must be inextricably linked. The money for the property market must come from somewhere, and that has to be the economy and conversely if the property market does well that must feed back into the economy. Chart the ratio of the two inputs over the last century for most major economies and you have a ratio of closer to 1.5 times the economy.

The US property market reached 1.8 times the economy in 2007. I reiterate that ours is nearly 3.8. Thats right, our property is 211% more expensive than the top of the US bubble which almost brought down their economic system. Their ratio went down to equal the size of their economy at the bottom of the market in 2012.  These events are very recent history. This is not a fantasy of “oh that can’t happen here, just because it can’t”.

If Australia reverted back to the ratio that the US was only 3 years ago, our property would have to fall 73.7%. Our preliminary research suggests that no bubble above 3.6 times the size of the economy has ever survived without falls of close to this magnitude (please contact us if your find an example where we are wrong on these figures).

Having around $6 trillion of property for a $1.55 trillion economy is highly abnormal. The debt load attached to that property is what is most alarming.

I have no idea what is going to happen from here. I am not predicting any specific number that property will fall. The only thing we can know is that good times never last. As Buffett always says:

“Be fearful when others are greedy and greedy when others are fearful”

I highly doubt if there has ever been more greed in the Australian property market. You should be more fearful than you have ever been.