Credit Suisse has some bad news for Sydney homeowners

Photo: Getty Images.

Sydney is Australia’s largest and most expensive housing market, accounting for nearly a third of the country’s total housing wealth.

Such is its importance, what happens in the Sydney housing market is often influential on other parts of the economy, impacting interest rate settings from the RBA, the outlook for economic growth, labour market conditions and, in some circumstances, what may happen in other housing markets in the future.

As you’re no doubt aware, prices in Sydney are starting to fall after years of relentless growth.

In December, they fell by 0.9%, according to CoreLogic, extending the decline over the quarter to 2.1%.

And it looks like that trend has continued in the early parts of 2018, driven by a combination of regulatory restrictions on both domestic and foreign investors, an increase available stock for sale and ongoing affordability constraints.

To Damien Boey, Research Analyst at Credit Suisse, the recent falls are only the tip of the iceberg, forecasting that Sydney prices are likely to fall by at least another 5% in 2018.

“This is because demand has weakened, the composition of buyers has shifted unfavourably and new supply remains elevated,” he says.

Helping to underpin that view, Boey says recent data indicates there is a currently a marginal oversupply of homes in Sydney.

On the supply side of the equation, he agrees with the vast majority of economists that dwelling completions are the best indicator of marginal supply.

However, differing him from most, Boey says that housing turnover, rather than population growth, is the best measurable proxy for demand.

“Our preferred measure of demand is residential property transfers, multiplied by the investor and first home-buyer share of new housing loan approvals.”

After calculating the current demand to supply balance, Boey says the ratio of his demand and supply proxies “is a powerful leading indicator of year-end real house price movements in Sydney, with a lead time of roughly two quarters.”

Here’s what it’s currently saying on the outlook for prices.

Source: Credit Suisse

After falling by over 5% this year, Boey says the best Sydney homeowners can look forward to in 2019 is a year of flat price growth.

“The glimmer of hope is that Chinese resident capital flows appear to have spiked higher towards the end of 2017, following a policy change to outward direct investment,” he says, referring to a modest relaxation in Chinese capital controls that were implemented at the start of 2016.

“Accounting for lead time, this potentially bodes well for 2019 housing market prospects.

However, Boey says that “in lieu of negative momentum, tight credit and elevated supply, we doubt that there is enough foreign impetus to cause anything more than a stabilisation in prices in 2019”.

And that leads back nicely to the influence that the Sydney property market has on the broader Australian economy.

What happens in Sydney property does not often stay in Sydney property, after all.

While Boey says policymakers from the Reserve Bank of Australia (RBA) and APRA will initially welcome the pause in Sydney price growth, he says there is a risk the weakness could become even more entrenched.

“At first glance, this L-shaped trajectory for house prices over the course of two years may be to the liking of RBA officials. After all, they would be able to claim that macro-prudential tightening and hawkish rhetoric have been successful strategies to protect the integrity of the financial system,” he says.

“However, there are tail risks to be wary of.”

Those “tail risks”, says Boey, are twofold.

“Investor interest [could] fall faster than first home-buyer interest rises. The share of net new buyers in the market could fall, with more negative repercussions for house prices,” he says.

Also, “demand could fall in such a way that unemployment rises, contributing to higher levels of insolvency activity and greater housing supply”.

Boey says not only does this create downside risks for prices, he says it could also elicit further rate cuts from the RBA.

Yes, rate cuts, not hikes, as most currently expect will be the next move in interest rates, and only because of price declines in Sydney.

“An L-shaped trajectory in house prices implies weaker consumption growth, which in turn could contribute to unemployment, more CPI disinflation and possibly more weakness in house prices,” he says.

“All that we have presented in this article is a first-pass attempt to forecast house prices. We have not factored in the second-round consequences of unemployment and deleveraging.

“Indeed, in history, the very reason why we have not seen these effects is because RBA easing has negated them before they could get started.

“In this context, we believe that falling house prices will remain a dovish concern for Bank officials at least until they can see a sustained uplift in housing demand from outside the system.”

When the RBA Board last met in December, it described the outlook for household consumption as a “significant risk” for the economy “given that household incomes were growing slowly and debt levels were high”.

Linked to that assessment, it also noted that “nationwide measures of housing prices are little changed over the past six months, with conditions having eased in Sydney”.

And suggesting that restrictions on housing lending could actually increase, rather than reduce, in the period ahead, the board again warned that “growth in housing debt has been outpacing the slow growth in household income for some time”.

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