The Speculative Investment Pulse in 1880s Melbourne and Modern Parallels[1]

By: Paul Egan, David Collyer & Philip Soos

The regularity with which real-estate property bubbles have co-occurred with periods of financial instability and banking crises through recorded history is strongly suggestive that the likelihood of a future crisis may be ascertained by closely examining one’s own domestic history. Indeed, many modern day prophets of finance are unaware of basic economic conditions that attended previous severe downturns in Australia, such as the 1890s and 1930s depression. As a consequence, a veil of ignorance has descended upon the mainstream profession, blinding them to large private sector credit cycles that were mal-invested into asset bubbles – primarily the commercial and urban land markets in the 1880s and the stock market in the 1920s – that later burst with devastating force, causing the economy to contract, unemployment to sky rocket and banking crises to ensue, particularly during the earlier depression.

In the 1880s, like today, the Sydney and Melbourne land markets were the key hot spots for speculative investors, although Melbourne took clear first place, experiencing the greatest rise in land values and steepest compound annual rate of return on land. A manic investor herd was also very active at that time, with a seemingly inexhaustible line of greater fools chasing ephemeral capital gains by aggressively bidding prices upwards and rapidly flipping properties every few years. Investors squatted on land on the periphery of the major colonial centres, waiting for reclassification of the land use so they could receive windfall gains; an eerie parallel to today’s land bankers that tie up all fringe land around modern state/territory capitals. Eventually, after eight hard years of euphoria during which land was apparently a fool-proof investment (1880 – 1888), the dream ended and land prices collapsed. This destroyed untold wealth of investors during the process and caused extreme stress upon the domestic banks who had lent heavily into the land boom, tapping significant foreign capital in the process of blowing up the land bubble. The amount of credit extended to the non-financial business sector and the proportion advanced for real estate loans and pastoral securities confirms speculation was indeed rampant, centred in Melbourne.

From 1890 to 1892, 20 per cent of all bank advances were real estate loans and 67 per cent were backed by pastoral securities. Business bankruptcies and loan defaults accelerated as the market value of property and securities fell in the late 1880s.^[2] Between 1880 and 1892, the reported weighted net annual rate of return on land (compounded) was 34.6 per cent, peaking at 78.3 per cent in 1887.^[3] The average net annual rate of return was consistently high across the majority of regions in suburban Melbourne ranging from 28.6 per cent in the south-east up to 45.2 per cent in the north-west, meaning the land boom was not localized in its effect. During the period 1880 to 1892, Melbourne investors held their property for 3.7 years on average before realizing a sale. After 1884, many investors bought land purely for the purpose of lot sub-division (14 per cent of sampled observations), with the allotments in preferred and populous suburbs keenly sought due to the expectation of ongoing price rises that would allow investors to flip the property later for a quick profit. Some of the greatest gains in Melbourne land prices were seen in the 6 to 7 mile radius from the CBD. The reason was many land investors were purchasing semi-rural land with the expectation of a future change in land use gifting them a large windfall.

The average rate of return for acreage was greatest for those parcels sized between 50 to 100 acres, with a return of around 40 per cent a year. Returns on land (by year of sale) did not become negative in Melbourne until 1892, when lots and acreage saw a net annual rate of return of -4.5 per cent and -9.8 per cent, respectively. Except for 1881, 1884 and 1891 land returns were well above rates on deposits, overdraft and commercial paper, and even above yields on speculative gold mining companies. The sum of this information shows land investment was a highly profitable venture between 1880 and 1888, after which time land values and sales fell dramatically, and land forfeitures began to rise.[4] Average land prices in Sydney were estimated to have increased 80 per cent between 1880 and 1884. There are anecdotal reports of Melbournian city blocks almost doubling in value in months during 1887, with the peak of the land boom in Melbourne occurring a year later in 1888.^[5]

Table 1.2.1: Melbourne Land Average Rate of Return 1880-1892[6]

Table notes 

¹ Does not include number of acres involved in lot sub-division or forfeited land. From the total of 11,483 acres purchased and re-sold, 6,564 acres represented purchased acreage and 4,919 acres were resold at complete estates or in large blocks.

² The total only refers to the value of land bought and resold as entire estates or as large blocks.

³ Advertising was normally required to sell land sold in lots. A lot subdivider was not required to provide public utilities under law, meaning the price of lots was unlikely to significantly differ from other categories of land.

⁴ A = average rate of return (%); B = average investment period (months).

⁵ The totals for ‘Acres sold’ and ‘Total value (£)’ refers only to land bought and resold as large blocks or in whole i.e. excluding the value of acreage involved in allotment sales.

⁶ Arithmetic averages for bank deposits, commercial paper and over-draft rates. Yields on mining stocks use the share value in the middle of September for Victorian gold-mining companies only. Estimated rates of return on land are not directly comparable to rates of return on mining investment because the latter relates to current yields while the former relates to annual average compound rates of return.

Conclusion

Economists should bear witness to history and take note of the many parallels between modern economic conditions and investor behavior, and those which prevailed prior to severe economic depressions of the past. While it may be an inconvenient fact, modern day Australia appears to have followed the 1880s path of destruction, mal-investing a huge sum of private sector funds into unproductive land speculation. With a similar euphoria present in today’s investor herd, prices have deviated from all semblance of rationality and have only been sustained by credit acceleration from aggressive bidding by greater fools. A permanently high plateau is not possible in land prices, as it is the expectation of future rises that is required to maintain them. Therefore, as the land bubble deflates, Australians are likely to reap a bitter harvest of falling housing prices, rising credit defaults, rising banking stress and unemployment. Moreover, the unprecedented size of the credit bubble and associated mal-investment implies a longer and more severe downturn than has previously been recorded awaits us.

References

Fisher, Chay and Christopher Kent. (1999). “Two Depressions, One Banking Collapse,” Reserve Bank of Australia, Sydney.

Hickson, Charles R. and John D. Turner. (2002). “Free banking gone awry: the Australian banking crisis of 1893,” Financial History Review, 9(2): 147-167.

Silberberg, R. (1975). “Rates of Return on Melbourne Land Investment, 1880-92,” The Economic Record, June 1975: 203-217.

Simon, John. (2003). “Three Australian Asset-price Bubbles,” in Asset Prices and Monetary Policy, Reserve Bank of Australia, Sydney.

[1] Based upon excerpts from a forthcoming publication by Paul Egan and Philip Soos.