Australian house prices are expensive on almost every metric. Check.
Australian households are heavily indebted compared to global standards. Check.
Australia is building a lot of apartments right now, the highest number on record. Check.
Combined, those factors have Australia’s housing bears growling loudly, seen as a potent and damaging cocktail that will eventually lead to a collapse in house prices.
“It’s nothing but a debt-fuelled bubble that’s going to pop in spectacular fashion” is the saying that has been heard over and over again over the past two decades, like a vinyl record that’s been played one too many times.
But that hasn’t happened, at least not yet.
After years of defying those dire predictions, the housing bulls are understandably feeling chuffed right now, often mocking those who believe Australia’s house price train will derail.
It’s a debate that is unlikely to end anytime soon, and one that we will not touch upon today.
Shane Oliver, chief economist at AMP Capital, is not wading into that debate. Instead, he’s produced an excellent note today — precise and even-handed as usual — on what COULD potentially lead to an Australian housing market collapse.
To set the scene, here’s a portion of the note he released today outlining the reasons often cited by those who believe a housing crash is coming — high house prices and high household debt:
The big picture view on Australian residential property is well known.
First, Australian housing is expensive. According to the 2016 Demographia Housing Affordability Survey the median multiple of house prices in cities over 1 million people to household income is 6.4 times in Australia versus 3.7 in the US and 4.6 in the UK. In Sydney it’s 12.2 times and in Melbourne it’s 9.7 times. The ratios of house price to incomes and rents are at the high end of OECD countries and have been since 2003.
Second, the surge in home prices has gone hand in hand with a surge in household debt, which has taken Australia’s household debt to income ratio from the low end of OECD countries 25 years ago to now around the top. This can be seen in the next chart which shows the deviation in the house price to income ratio against its long term average for Australia against the ratio of household debt to income. The shift to overvaluation and high debt mostly occurred over the 1995-2005 period.
The chart below, supplied by Oliver, combines those two metrics together, showing not only household debt as a proportion of household disposable income but also the deviation in house prices to household income from historic norms.
Both are increasing at a rapid pace, particularly from the early 2000s following changes to the tax treatment on Australian housing.
So with debt levels and house prices on a tear, what factors could potentially lead to a collapse in house prices, say of more than 20%?
According to Oliver, there are three:
- A recession – much higher unemployment could clearly cause debt servicing problems. This looks unlikely though.
- A surge in interest rates – but rate hikes are unlikely until 2018 and the RBA knows households are more sensitive to higher rates so it’s very unlikely rates will reach past highs.
- Property oversupply – this would require the current construction boom to continue for several years.
To Oliver, while these are unlikely to occur (a recession appears to be the most likely, and that is almost inextricably tied to the outlook for the Chinese economy), his outlook for the housing market is hardly peaches and cream. He suggests the rapid price growth in Australia’s largest markets will likely slow, then potentially reverse, in the years ahead.
“Nationwide price falls are unlikely until the RBA starts to raise interest rates again and this is unlikely before 2018 at which point we are likely to see a 5% or so pullback in property prices as was seen in the 2009 and 2011 down cycles,” he says, adding that “anything worse would likely require much higher interest rates or recession both of which are unlikely”.
However, he warns that dangerous to generalise when it comes to the housing market, suggesting that “Sydney and Melbourne, having seen the biggest gains, are more at risk and so could fall 5-10% around 2018”.
That warning also extends to the apartment markets in both of those cities, acknowledging that prices in parts of Sydney and Melbourne could fall by 15-20% as investor interest fades as rental yields fall.