We went to our first house auction on the weekend. We wanted to see just how 'hot' this market is. It was a beautiful sunny day in Melbourne, and there was a small crowd gathered around the 'cosy' (read small) two bedroom weatherboard St Kilda home.

The auctioneer gave a 5 minute introduction, emphasising the house's proximity to cafés and the best scrambled eggs in Melbourne on nearby Carlisle Street (seriously).

Then...no bids. About 30 seconds passed...then a baby boomer made a first bid of $750,000. A few more minutes passed. More cajoling from the auctioneer. No other bids.

So the auctioneer made a vendor bid of $760k, which the baby boomer bettered with $770k. More minutes passed...no other bids. The house was passed in, and the vendor and baby boomer went off to negotiate a sale.

While waiting, we spoke to a bloke who had had previously had a housing inspection carried out on the place. He pointed out numerous structural faults that his inspector had alerted him to, which was why he wasn't bidding.

So our first auction was a bit of a fizzer. One bidder...passed in.

We're not sure what to make of it. Crowds in Melbourne were subdued due to the Cup tomorrow. Perhaps the focus has turned to punting on horses, not houses, for the weekend. So this was probably just an anomaly. Anecdotal evidence elsewhere suggests the boom is still, well, booming.

We've been wrong on the Australian housing boom (and the stock market boom) so far. After experiencing a beating after the booms of 2000 and 2007, we're astounded that investors are back lining up for more just five years later. But they are. Animal spirits are resilient to say the least.

Despite being wrong, we're not about to change our tune. Because like the stock market, the primary driver of the housing market is 'multiple expansion'. That is, the price investors are willing to pay for a stock or a piece of property is rising even though underlying earnings are not.

For example, the house we mentioned above would be lucky to generate weekly rent of $650. According to the agent we spoke to the vendor reserve was 'low eights'...let's say $810k. But the last baby boomer bid was $770k.

Let's assume they met half-way, with the final sales price of $790,000. Add to that stamp duty and transfer costs of $43,940 and you have a total investment price of $833,940.

Assuming the property is tenanted for 50 weeks of the year, that's an income (before expenses) of $32,500. So the gross yield from the property is 3.9%. Taking into account things like rates, maintenance costs and real estate agent fees would reduce the return to somewhere less than 3%.

And that's using an example on a property with one bidder...which was passed in. We can only imagine what the numbers would look like on a place subject to a bidding frenzy.

It's quite clear that property in Australia has little to do with income anymore. Or where it is, it's about gaining tax concessions via negative gearing. No, property is all about the capital gain. When there's no rise in the asset's underlying income, the 'multiple' that investors pay expands, meaning that it's all upside for property.

It's been this way ever since the late 1990's in Australia. Why would anyone think differently? The income gains might be flat now, but they'll come back. (This is despite a darkening economic environment as we move into 2014).

The easy way to make money is in bricks and mortar. Innovation as a form of wealth creation is hard work and too much risk...what if it doesn't work out? No one wants to play that game in Australia. And our woeful productivity performance proves it.

We have a hare-brained theory that the Aussie housing boom - or at least this latest incarnation of it - is directly linked to China's property boom. China's love of property is still going strong. Bloomberg reports that new home prices jumped 1.24% in October, the 17th consecutive monthly increase.

As we've pointed out many times before, China's credit fuelled economic boom from 2008 led to a massive boost in Australia's national income, which provided a fundamental support for our housing market. (Higher incomes mean you can support a higher level of debt...and higher debt levels push up house prices).

This China boom led to a surge in mining investment which was good for employment and economic growth. But the end of the mining investment boom and a slowing of China's economy posed a threat for Australia's future rate of growth. So the Reserve Bank reduced interest rates to all-time lows.

It's these low interest rates that are fuelling the property bubble, not solid fundamentals. China is now in a situation where it needs greater and greater credit growth to generate the same amount of economic growth. That's not a good place to be and we think it's very close to ending.

If China struggles to contain the fallout from its credit boom, foreign investors will turn on Australia. The dollar will fall and inflationary pressures will rise throughout the economy. Just last week, we got a taste of this with higher than expected producer price rises in the September quarter, thanks mainly to surging import prices, up 6% in the quarter. That's the result of a sharply weaker dollar in the June to September period.

So when (not if) China confronts its credit demons, a weaker Aussie dollar will import inflation and make it hard for the RBA to cut further. A deteriorating economy and a hamstrung RBA is probably not what the property bulls are thinking about right now. But it may explain why so many houses are suddenly coming onto the market. While the mainstream media loves to tell you about the strength of demand, don't forget there's plenty of supply out there too.

Notwithstanding our experience on Saturday, this is a sellers' market. There's a reason why so many people are looking to sell now. It might be the best price they'll get for many years.

Regards,

Greg Canavan+

for The Daily Reckoning Australia