The main thing to fear in Australia's housing market is fear itself

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  • Australian capital city home prices have fallen for eight consecutive months. Recent housing market indicators point to the likelihood of further declines to come.
  • Macquarie Bank believes this housing downturn will be both modest and orderly in nature, suggesting prices may fall a bit further in the years ahead.
  • It says the biggest risk to its view is not from bank lending but a drop in buyer demand.

Australian capital city home prices have fallen for eight consecutive months, led by declines in Sydney and Melbourne, Australia’s largest and most expensive housing markets.

Auction clearance rates continue to hit multi-year lows, foreign demand has weakened and housing credit growth, particularly to investors, has also slowed sharply, pointing to the likelihood that prices will continue to fall for some time yet.

After years of strong Sydney and Melbourne-centric price growth, Australia’s housing market has been turned on its head in the space of just 12 months.

No longer are Sydney and Melbourne the outperformers, they’re the national laggards.

Given 60% of Australia’s housing wealth is located in just these two cities, it’s little wonder why some people are getting nervous, especially given some analysts are warning that lending standards, already more stringent than what they once were, could get even tighter as a result of Australia’s Banking Royal Commission, leading to a potential “credit crunch”.

However, while some commentators believe the recent price declines could get even larger, and faster, Ric Deverell and Justin Fabo, Economists at Macquarie Bank, aren’t all that concerned.

Indeed, despite all the gloomy headlines and statistics that have been resented in recent months, they note the recent market downturn has not been that large at all.

“Price growth has since slowed but to-date the correction has been minor, with national dwelling prices falling just 1% since peaking in mid-2017,” they said in a note released today.

“Despite almost daily negative headlines in the mainstream media, the rate of adjustment has also been relatively orderly.

“Nationwide dwelling prices are currently falling at a 2.5-3% annualised rate, and Sydney housing prices have been falling for four quarters at a broadly stable 4% annualised pace.”

Deverell and Fabo also make the point that while Sydney home prices have fallen 4.5% from their peak, they are still up 66% since 2012.

Macquarie Bank

But, of course, what if this is only the beginning of a major price downturn?

Will it be a case of the bigger the rise, the harder the fall?

While no one can say how it will all play out, Deverell and Fabo dismiss the notion that banks will cut off credit to borrowers, leading to a possible credit-led housing crunch.

“Some have suggested that the Banking Royal Commission could result in a ‘credit crunch’, with an associated acceleration in housing price declines,” they say.

“While nothing can be ruled out, particularly if prospective homebuyers come to expect large price falls, the evidence to date suggests that the maximum impact of credit tightening was in the period 2015 to 2017, with the changes being implemented this year so far more modest in nature.

“We don’t see strong incentives for banks to noticeably restrict housing credit against a relatively positive macro backdrop and given that a large share of their profits — and balance sheets — rely on housing lending.”

That last point is particularly noteworthy.

By restricting credit it would undoubtedly create even further weakness in the housing market, a scenario that would have ramifications for not only their profitability but also the wider economy through slower residential construction, weaker employment growth and the potential for reduced household spending on a reduced wealth effect.

It’s a scenario that all stakeholders would undoubtedly seek to avoid, and one that Deverell and Fabo suggest may not be playing out despite slower loan growth at major lenders.

“With bank lending standards and housing markets still in a state of flux, it is not possible to have complete clarity on developments in the supply of credit and banks’ responses to current public scrutiny,” they say.

“What is clear, however, is that smaller lenders have picked up market share in mortgage markets.”

How households are behaving

As yet, they also don’t see evidence that recent price declines has altered household behaviour.

“There haven’t been discernible effects on household perceptions of the state of their finances which are around average levels,” Deverell and Fabo say.

“Household views on whether it is a good time to buy a home have actually improved a little, albeit from low levels.”

Given current supply and demand-side considerations, along with the view that banks are unlikely to take actions that will exacerbate price declines, Macquarie thinks the current housing market downturn will be modest and orderly in nature.

“We expect the current modest rate of decline in national dwelling prices to continue for some time, but this would suggest a fall of only around 2% over the course of 2018,” Deverell and Fabo say.

“Over the next couple of years we expect national prices to have fallen 4-6% from the peak, with Sydney prices forecast to fall around 6%, to be down around 10% from the mid-2017 peak.”

They also believe that unlike previous downturns, higher mortgage rates are unlikely to create headwinds for prices given the likelihood that official interest rates from the RBA will be left unchanged for the foreseeable future.

“We note that Australia has had six previous episodes of declining housing prices since 1980, with the peak-to-trough range of 2.5% to 8%,” they say.

“Nearly all previous corrections occurred following interest rate rises, a drag unlikely to be repeated anytime soon in this cycle.”

‘The real risk’

As for the risks to their call, Deverell and Fabo believe it will be on the demand side of the equation.

“To us this is the real risk,” they say.

“If households were to lose faith in housing markets, given current elevated prices, the demand for credit could fall more than we currently expect,” they say.

In essence, the main thing to fear for Australian housing is fear itself.

However, in the absence of Australians suddenly losing their lust for property, Deverell and Fabo believe policymakers will be pleased how the current slowdown in the housing market is playing out.

“While market corrections are always worrisome for some, we think the regulators would be largely delighted with the orderly cooling of housing markets so far,” they say.

“RBA Governor Lowe has noted that an optimal outcome would be a sustained period of broadly flat nominal housing prices.”

If that does play out, allowing household incomes to play catch-up to the gains in property prices seen in recent years, it will welcomed by policymakers and potential home buyers alike.

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