Australia is known to have some of the most overpriced property in the world. With only 45% of Australians in their mid-thirties owning a home, compared to 58% in 1986, wouldn’t we all be better off if the property market fell? This is exactly what has been happening since late 2017 – although to our misfortune, data suggests that the price slide could lead to consequences which would dwarf any of the perceived benefits in terms of scope, scale, and impact.
Since the peak of the Australian housing market in late 2017, Sydney and Melbourne property prices have now dropped by 11.1% and 7.2% respectively. This is a massive swing in momentum when compared to Sydney’s 20% surge in housing prices in 2016. This sentiment has been echoed by housing markets in other major cities such as Perth and Brisbane, signalling a nationwide downturn.
The possibility of a housing crash has alarmed many economists and financial modellers, as such a crash would not only have major implications for Australia, but also the international economy at large. Torsten Slok, Deutsche Bank’s chief international economist, stated that a “house price crash in Australia and Canada” ranks alongside a no-deal Brexit, the US government shutdown and the escalation of the US-China trade war in the bank’s list of events that have potential to cause financial distress to the world economy (Zhou, 2019).
The percentage fall in Australian house prices has now exceeded the fall in market prices during the Global Financial Crisis. So what is to blame for such a steep decline? In the wake of 2008’s GFC, Australia’s housing market was saved from significant decline by the mining boom, which gave the Government the financial freedom to implement ‘the first home buyer boost scheme’. This scheme succeeded in providing short term relief for the economy, although in the long term has helped housing prices increase to precarious levels. This has amplified the effects of recent market shocks such as the Royal Banking Commission, probable negative gearing changes, and decreasing foreign investment.
The Royal Banking Commission has forced banks to tighten their lending policies, making it much more difficult to obtain a mortgage. The squeeze has been drastic – banks will now go so far as to ask how much an individual spends on Uber Eats and Netflix per month. The equation is simple – if banks are now lending buyers 20% less than what they were before, buyers will have 20% less to spend on purchases than they did before. This phenomenon has reduced the demand for housing, despite prices being significantly cheaper than those seen over the last two years. When paired with record high levels of household debt, it becomes clear why investors and first home buyers alike are throwing in the towel.
If Labor wins the next federal election, they plan to halve the long-term capital gains tax discount from 50% to 25%. This is compounded by their plan to implement a negative gearing policy which will prevent investors from writing off the losses from their investment properties against the tax they pay on their wages. Under the current system, investors using negative gearing have access to significant benefits, as they are able to write off their operating losses in full whilst getting taxed for only 50% of their capital gains. However, if Labor’s proposed changes were to be passed, property developers would no longer be able to write off losses, and when properties are sold 75% of the profit would be liable for capital gains tax. This will further reduce house prices due to a fall in demand from property investors. If these policies are implemented it is predicted that housing prices could fall by up to 12%, while rents could rise by 15% as investors scramble to make up for their losses. With many Australian Property developers already believing that the Labor party will win the next federal election, the market is already beginning to respond with cautious anticipation.
Chinese policy changes are also to blame. In recent years, Chinese investors have shown strong interest in the Australian market, contributing to its steady incline. However, between the time Chinese deposits were paid, particularly for units, and final payments were due, the Chinese Government brought in new regulations limiting the amount of money that could be taken out of China. This has resulted in a withdrawal of Chinese buyers from our market and added to the fall in prices.
A fall in property prices can affect the economy in a variety of ways. As prices fall, property developers scale back their projects due to lower returns on investments. This results in lower activity and employment in the construction industry. In 2018, Australia’s construction industry made up 8% of Australia’s total GDP – lower activity in this market can have dire consequences on the wider economy. This is compounded by the wealth effect, which can occur on a large scale when housing prices fluctuate. Falling house prices result in lower housing wealth, which decreases consumption growth below the rate of growth of disposable income as individuals decrease their spending levels disproportionately. The resultant fall in consumer spending leads to a slowing of economic activity, cascading into slower growth in employment, wages, disposable income, and hence, real consumer spending.
Capital Economics calculates that a 12% peak-to-trough drop in house prices can result in a $800 billion loss in household wealth – effectively a reduction of 0.3% of GDP growth each year for the next 3 years. Consequently, falling housing prices can have dire effects in all corners of the market. With lower housing prices property investors are likely to slow down development due to lower returns on investment, and with first home buyers struggling to obtain loans they will struggle to utilise these lower housing prices.
It is important to note that at the peak of the recent property boom, interest-only loans accounted for 40% of new mortgages issued. Under this type of loan, an individual is required to only pay the interest on their mortgage for a fixed time period, after which they must also begin paying off principal. In Australia, the majority of these loans are designed to rollover to principle plus interest between 2018 and 2022.
The increase in repayments can be as high as 35% or more. The RBA estimates that a total of $360 billion worth of interest-only loans will roll over to principal-plus-interest loans in the next 3 years. This is expected to result in the average borrower having $7,000 in extra repayments per year (Hobday, 2018). This will likely result in an increase in mortgage defaults, as many of these mortgages were given to those who won’t be able to afford a repayment hike (Australia’s overall household saving rate is sitting at a measly low of 2.5% of wages). Hence, there is expected to be an increase in the number of fire sales, resulting in an increase in the supply of houses, with no increase in demand. This will result in a further fall in Australian housing prices for a couple of years to come.
With lower housing prices and APRA having put a 30 percent cap on the percentage of new loans which can be interest-only, lenders have increased the interest rates for investment loans for both new and existing borrowers. This will result in property developers struggling to find investments with returns they were previously achieving. Additionally, with a whole chunk of individuals failing to be able to meet repayments when their interest-only loans switch over, fears of a mass exodus from the investment market might prove to come to fruition.
With banks having tightened their loan requirements, the housing market is unlikely to see any relief in the near future. Also, with more individuals being on interest-only loans, and Australians already having a low household saving rate, there is likely to be an upcoming credit crunch. Overall, it is likely that the property market will continue to be fragile and see further falls in the upcoming year. But not all is bad. With current market sentiment and wage growth being particularly low, the RBA is expected to hold the cash rate for at least the next year, with even the possibility of further cuts. Therefore, investors aren’t going to see any further unforeseen increases in their expected loan payments. Also, due to the reduction in housing approvals, it is likely that in future years the number of property’s available will be lower than the supply required. Hence, cashed up individuals may see now as a great time to purchase a home, with demand looking to pick up in the coming years.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
