Aussie house price correction deepens - Milford Asset

Aussie house price correction deepens

David Rigby

Senior Analyst

David is a Senior Analyst, based in the Sydney office, with a particular emphasis on Australian equities, including IPOs. Prior to joining Milford in March 2014, David was a senior equity research analyst with Goldman Sachs and Credit Suisse in London covering the support services sector. In his 10 years overseas his remit spanned small caps to FTSE100 firms in industries as diverse as recruitment, temporary power, equipment rental, distribution, testing & inspection, facilities management, BPO and credit analytics. He holds a Masters of Management Studies and a BSc from Victoria University of Wellington, where he studied Technology Management, Physics and Mathematics.

Since our last blog on Australian housing back in July, conditions have continued to deteriorate. According to Corelogic, as at 30 November home price declines are more than double what they were mid-year: the national average is 4.5% below its peak (from -2.4% on 30 June), with Sydney’s prices down -9.5% (from -4.8%) and Melbourne -5.8% (from -2.0%).

The outlook has also worsened, with many market commentators now expecting average price falls to eventually reach c.10% across Australia and 15-20% in Sydney and Melbourne. On the positive side this would only take prices back to 2014/15 levels, and most homeowners would still be sitting on significant capital gains. However, it would also be the largest decline in Australian house prices since at least the 1960’s and mean that, in inflation adjusted (real) terms, eroding nearly half the gains of the 2011-17 cycle.

AU home price index (nominal terms)

AU home price index (real terms)

Source: ABS

So what’s changed?

Since the middle of the year, banks have continued to tighten lending standards and reduce borrowers’ capacity to buy. Lending to investors and interest only loans were initially reduced in response to regulator-mandated restrictions, but have softened even further. The Royal Commission has led to much stricter interpretations of responsible lending obligations, increasing scrutiny of expense disclosures in mortgage applications, reducing loan to income ratios and lowering bank valuation ranges. The initial sugar hit from last year’s first home buyer incentives has also faded.

On top of this, with a general election due early next year, polls that were neck and neck in July are now showing a sizeable lead for Labor over a Coalition government that has recently performed poorly in local by-elections, lost its majority in Parliament and subsequently suffered the defection of MP Julia Banks to the cross benches. As highlighted in our blog two weeks ago, Labor’s policies include a raft of changes that are likely to be negative for home prices, including reducing Capital Gain Tax discounts and eliminating negative gearing.

Yet, despite all the negative headlines on property, building approvals have declined only gradually. Deliveries of new homes are at record levels, but there is still a significant backlog due for completion over the coming year. This creates the prospect of a temporary oversupply, especially in Sydney and Melbourne apartment hotspots.

Putting all of this together it is perhaps not surprising that, although it is hard to distinguish in the data, there are now numerous anecdotal reports of buyers choosing to step back and wait for lower prices – even if they have managed to get financing.

Growth in lending to investors is still constrained

The proportion of new interest only loans is also below restricted levels

Source: APRA

Where to from here?

At present a lot of work is going into estimating the likely second order impacts of a falling property market. Eventually residential construction jobs will decline, while a negative wealth effect has already hit sales of big ticket discretionary items such as new cars. Because many small business owners use their homes as security, SME lending has also been impacted.

But all is not lost, and the early new year should provide some much-needed clarity on key issues. In particular, the Royal Commission is due to report final findings 1 February, NSW will have its State election on 23 March, and the federal general election is due by 18 May. Once the standards expected of the industry are known, banks and regulators alike should then know exactly how much tightening is too much. A new government with a fresh mandate and (so long as commodity prices hold up) a healthy budget position may also have the fiscal firepower to cut taxes or, as was the case after the recent Victorian State election, fund additional large infrastructure projects.

Longer term, expectations of when the Reserve Bank of Australia will start lifting rates have also been pushed out towards 2020, meaning lower mortgage payments for longer. The gradual roll-out of Open Banking should also allow automatic and accurate assessment of borrower expenses, making the lending process smoother and more objective in the long term.

Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser. Please note past performance is not a guarantee of future performance.

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