The house price fall we had to have

House prices are falling by more than $1000 a week in both Sydney and Melbourne, and auction clearance rates are at levels last seen during the global financial crisis. Sydney’s just fell below 40 per cent.

Yet at the same time Australia’s economy is growing at the fastest rate since 2012 and unemployment is down to five per cent.

It’s unusual for the economy to be strong while housing prices are weak. What’s up?

It’s important to understand how we got here. When China’s economy began to slow in late 2011, Australia responded by cutting interest rates. That saw us step neatly from a China boom to a house price boom. 
In turn, the house price boom meant a matching boom in household debt as our housing prices streaked passed all measures of fair value in recent years.

Chances are that history will judge that shift from China boom to house price boom pretty happily.  But higher debt means greater vulnerability. That’s why it’s good news that house prices are now falling, as they’re doing so against the backdrop of a strong economy.

That’s the safe path for the house price fall we had to have.

So why is housing in reverse while the economy is motoring?  It comes down to tighter credit availability, higher interest rates, fading funding from foreign buyers, and policy uncertainty:

1. Money is tight:  The big four banks are tightening the spigots on housing credit.  Partly that’s backwash from the current banking Royal Commission.  Given the public reaction to some of the stories arising out of the Commission’s hearings, the big banks are now being super careful about complying with every requirement before saying yes to a loan.
2. Rates are rising:  Another key factor is that rising global interest rates have been pressuring the cost of funds to the banks.  That’s why some second tier banks have already raised their lending rates by some 30 basis points, and three of the big four banks have gone about half as far as that.
3. Fading foreign funding:  Further downward pressure on investor demand is expected as Chinese authorities get serious about cash deserting China’s shores and heading for foreign housing markets. A wave of capital control violations suggests regulators are turning less of a blind eye. 
4. Policy uncertainty:  Finally, remember that the Coalition leadership-merry-go-round has notably increased the chance of a Labor win at the next Federal election, and hence a switch to tougher policies on negative gearing and capital gains taxes. (For the record, we broadly agree with the latter proposed policy change and disagree with the former.)  Although the market impact of that is likely to be less than horror headlines are suggesting, it too is weighing on market sentiment.

That combination has had a particular effect on investors, given that regulators have been actively trying to freeze them out of housing markets for some time.  Investors accounted for comfortably more than half of all mortgage demand in Australia in mid-2015, but they’re now down to close to 40 per cent as a share of the total, and the trend is not their friend.

And all these factors have come together at a time when housing prices were already falling, thereby adding further still to the existing market fragility.

Yet there are some factors on the other side of this particular set of scales. Most notably, Australian population growth remains pretty good.  Measured against global yardsticks, it continues its tearaway speed. Since a late 2015 low, population growth bounced back to being over 400,000 people through the course of 2017, and is travelling at just over 380,000 at present.  And they’ve all got to live somewhere: remember that, with Australian-style population growth, we’re adding close to an extra Canberra to the national population every year.

At the same time the level of building approvals may be down more than 13 per cent from their peak almost a year ago, but remain well ahead of their longer-term average. In part that may be because, despite their deteriorating fundamentals, the profits on offer from developing a block of apartments are still pretty enticing.
So yes, housing prices will fall further – perhaps another 5–10 per cent in both Sydney and Melbourne from current levels.  

But no, we’re not expecting a house price collapse.

In fact, if we’re lucky, Australian house prices in five years’ time from now may not be much different than where they are today.

That will mean that, as a nation, we will have seen housing prices return to sanity without doing particular damage to our economy as they do so.