Morgan Stanley sees trouble brewing for Australia’s housing market this year

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Australia should brace for further house price declines this year.

And the recent strength in Australian building approvals data — which got more than a few excited on the outlook for residential construction activity in the year ahead — is unlikely to last.

That’s the gloomy assessment from Morgan Stanley’s Australian housing model, known as MSHAUS for short, which is currently pointing to sustained declines in approvals and price trends through 2018.

“Updating our proprietary housing indicator for Q3 20117 data [using an estimate for completions], we find MSHAUS has dropped to a new record low of -1.0, suggesting that the recent decline in prices will likely continue well into 2018,” the bank says.

“All categories of the indicator recorded a decline, with the largest moves in credit supply, driven by a sharp decline in the share of interest-only (IO) lending to 16%, following the implementation of lending caps in the middle of the year.

“House Price Expectations also deteriorated notably with the share of households nominating real estate as the wisest place for savings continuing to decline to record lows.”

This chart from Morgan Stanley shows the MSHAUS over the past seven years, breaking down the contribution by individual components in the model.

Source: Morgan Stanley

In the September quarter last year, all components in the model dragged on the outlook for both building approvals and prices in the year ahead.

“Given that our model is calibrated to lead activity by 3 quarters, this quarter’s print suggests that we can expect a further weakening through 2018,” the bank says.

Morgan Stanley says restrictions on interest-only lending introduced by Australia’s banking regulator, APRA, at the end of March last year are only now starting to have a clear impact.

“Since the implementation of the latest round of macroprudential measures in mid-2017, the share of new interest only loans has declined sharply from 36% to 16%,” it says, noting that the subsequent switch to principal and interest mortgage repayments will, on average, reduce household disposable income by around 7%.

“Our Alphawise survey suggests that interest-only borrowers are relatively high risk, as they are more highly leveraged, have fewer savings and are more likely to manage costs through credit cards and consumer finance,” the bank says.

Along with creating additional headwinds for household budgets, Morgan Stanley says APRA’s latest restrictions will likely see housing credit growth slow substantially over the coming year.

“Our analysts expect housing loan growth to slow from around 7% currently to around 4% in 2018 given the combination of more onerous capital rules, tighter lending standards, higher mortgage rates and credit rationing,” it says.

And, adding to the negatives to the housing market, the bank says strong levels of population growth — something many analysts suggest will help underpin housing prices — will not be enough to stop downward pressure on prices given the large pipeline of new housing stock yet to hit the market.

“One positive has been the higher than expected population growth, driven by an increase in net migration. This has supported demand for housing, and reduced the surplus created by the rapid increase in supply over the past few years. This has been particularly notable in Victoria, where interstate migration has also boosted population growth to 3.2%, versus New South Wales at 2.3%,” it says.

“However, on a national level we still estimate that supply of around 225,000 is running ahead of demand at around 185,000.”

So the MSHAUS model is pointing to a pretty downbeat period for Australia’s housing market in the year ahead.

But what specifically does it mean for building approvals and house prices in 2018?

When it comes to approvals, the news is not good for those banking on recent strength to continue.

“As of November, trend approvals have fallen 8% year-on-year to 217,000 per annum, with multis down 15% to 101,000 per annum. We expect a further decline to 187,000 per annum by the end of the year, largely driven by a normalisation in the multi-dwelling segment,” it says.

“While the backlog of approvals not yet completed remains high, we expect some projects to be shelved given tighter credit conditions.”

This chart shows the relationship between the MSHAUS versus annual growth in building approvals in trend terms. The former has been advanced by three quarters to show what’s likely to happen.

Source: Morgan Stanley


While only a model, the past relationship between the two suggests there’s a clear risk that the recent strength in building approvals may reverse in the coming quarters, and by some margin.

As for house prices, while Morgan Stanley freely admits the relationship between it and annual changes in house prices isn’t as strong as it is with approvals, it says the risks at this point are clearly to the downside.

“Price growth remained stronger through 2017 than would have been expected, perhaps buoyed by strong momentum and a pickup in migration,” it says.

“But with fundamentals weak, debt service rising and credit supply tightening, we see risks skewed to the downside.”

Here’s the model overlaid against annual house price changes. Once again, the model is advanced by three quarters.

Source: Morgan Stanley

Should the model be on the money on both fronts, Morgan Stanley says this will represent a meaningful risk to the broader Australian economy.

“This is a substantial risk for the economy, given the vulnerable state of the consumer and their exposure to housing,” it says, adding that during the September quarter, “average household leverage reached 200% of disposable income, with average house prices now 8.2 times average incomes.”