AMP Capital: There’s ‘good reason to be concerned’ about Australia’s latest housing downturn

  • Home prices in Sydney and Melbourne are falling after years of relentless growth.
  • According to AMP Capital, real capital city house prices are 27% above their long-term trend, and expensive on almost all major valuation metrics.
  • It doesn’t this will translate to a housing crash unless unemployment and interest rates rise rapidly.

Home prices in Sydney and Melbourne, Australia’s largest and most expensive property markets, are now weakening after years of unrelenting growth.

According to data released by CoreLogic today, prices in Sydney have fallen by 1.9% this year, and by 0.5% in Melbourne, leading to renewed speculation that this could be the start of a damaging price correction.

After doubling since the global financial crisis, it’s easy to see why some are getting nervous about the potential for a crash, especially with many of the tailwinds that helped to propel valuations higher over the past decade now starting to reverse.

Official interest rates are already at the lowest level on record, and are unlikely to fall much further if recent commentary from the Reserve Bank of Australia (RBA) is anything to go by, removing one of the key pillars that allowed households to take on more debt in the years following the GFC.

Throw in higher short-term borrowing costs for lenders, creating the potential for further out-of-cycle mortgage rate increases for borrowers in the months ahead, along with tighter lending restrictions on domestic and foreign investors, a sharp increase in apartment supply and potential changes to tax policy on housing, and it’s understandable why there’s a bit of nervousness about what the future golds.

While such fears aren’t exactly new in Australia, flaring regularly as prices have increased, Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, believes there’s a good reason to be concerned on this occasion, pointing to the chart below showing real house prices are sit well above the long-run trend.

Source: AMP Capital

“Real capital city house prices are 27% above their long-term trend and are at the high end of OECD countries in terms of the ratio of prices to income and rents,” Oliver says.

“The surge in prices relative to income since the mid-1990s has gone hand in hand with a surge in the ratio of household debt to income that has taken it to the top end of OECD countries.”

It’s that leverage, seeing household debt lift to nearly 190% of household disposable income, that’s got many people concerned about the potential for a housing crash, particularly among households who have taken on significantly higher levels of debt than the national average to purchase property in recent years.

For what is an illiquid market, loan serviceability problems among this cohort carries the potential to have significant flow-on effects, especially following a period where prices have increased far faster than the historic trend.

In Oliver’s opinion, while lending standards fell in the years following the GFC, leading to the introduction of tighter restrictions from APRA, whether or not this translates to a potential housing crash will largely be determined by what happens with Australian unemployment and interest rates along with future changes in housing supply.

“While there has been some deterioration in lending standards it does not appear to be anything like that seen with NINJA (no income, no job and no assets) loans in the US prior to the GFC,” he says.

“To see a property crash we probably need much higher interest rates or unemployment or a continuation of recent high construction for several years.”

Oliver says neither of those scenarios is likely to play out, ensuring that the recent Sydney and Melbourne-led downturn will not become something more sinister, even with the potential for further declines in these markets in the years ahead.

“A further tightening in lending standards as banks get tougher on borrowers’ income and living expense levels along with rising supply and more realistic capital growth expectations by home buyers will see Sydney and Melbourne property prices fall another 5% or so this year with further falls likely next year,” he says.

“In contrast, home prices in Perth and Darwin are either at or close to the bottom, [while] price growth is likely to be moderate in Adelaide and Canberra [and] may pick up a bit in Brisbane thanks to stronger population growth.”

And even with the expectation of further price weakness in Australia’s largest markets, Oliver says recent indicators suggest the spillover effects to the broader Australian economy should remain contained.

“A slowdown in the housing cycle can affect the broader economy via slowing dwelling construction, negative wealth effects on consumer spending and via the banks if mortgage defaults rise,” he says.

“Building approvals don’t point to a collapse in new construction and it looks like alterations and additions will rise.

“Negative wealth effects will weigh on consumers but not dramatically if we are right, and in the absence of a property price crash the impact on the banks will be manageable.”

For a housing market valued just a shade under $7 trillion, it’s likely that the vast majority of Australians — especially those who property or bank shares — will be hoping that Oliver’s assessment is right.

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