CBA: Why house prices will continue to fall

By Gareth Aird, Senior Economist at CBA

Key Points:

  • Australian residential property prices have fallen over the past nine months.
  • Further declines appear likely over the next year due to softer credit growth, a continued lift in apartment supply, less foreign demand and more rational price expectations from would-be buyers.
  • We retain our view, however, that a hard landing looks unlikely and is not our central scenario.

Overview:

Australian capital city dwelling prices, led by Sydney and Melbourne, have fallen over the past nine months. The correction is occurring after five years of incredibly strong price growth. It is our view that prices will to continue to deflate over the next year as evidenced by the leading indicators. Credit standards
have been tightened and this will continue to weigh on the flow of new lending, new dwelling supply will remain elevated, mortgage rates are more likely to go up
rather than down and buyer expectations have adjusted downwards from exuberance to more sober levels.

We do not expect a hard landing, however. Population growth, driven by net immigration, is expected to remain strong. And rental growth is still positive, which
ensures yields look reasonable in a low interest rate world. We also expect the unemployment rate to gradually drift lower, which means that the risk of default is low. Against this backdrop we have the RBA on hold for at least another year. In summary, we expect the orderly deflation in dwelling prices to continue against an
economy that is performing relatively well from an output and employment growth perspective.

While predicting property prices can look foolish retrospectively, our quantitative assessment of the residential market overlaid with our qualitative views leads us to conclude that national property prices are likely to end the year down 3¼% (i.e. down by 3½% from the peak in December 2017). Further falls of around 2¼% look likely in 2019. As is generally the case, there is likely to be significant variation in outcomes by capital city. We expect Sydney and Melbourne to underperform
relative to the national average. This note discusses our outlook for Australian residential property prices and tables our forecasts by capital city.

Latest data

Dwelling prices in the eight capital cities combined fell by 0.4% in August. This was the eleventh consecutive monthly fall. Dwelling prices are down 2.9% over the year
and 3.1% from their peak in September 2017 (chart 1).

Units have generally been performing better than detached houses. Over the year, unit prices were down by 1.0% while detached houses were down 3.5% (chart 2). Units are generally cheaper than houses and the bottom end of the market is holding up better than the top (chart 3). That’s in part due to first home buyer assistance measures in NSW and Victoria that came into effect last year.

Why are prices falling?

Changes in dwelling prices are impacted by a variety of factors. At present, several of the factors that influence prices are working in a way that is putting downward
pressure on values.

First, although the RBA’s policy rate has been on hold since August 2016, some mortgage rates have risen. Regulatory changes introduced to slow the flow of credit to investors as well as growth in interest only lending has resulted in higher mortgage rates on some types of loans. These higher mortgage rates have dampened the appetite for credit amongst investors. As a result, the total flow of credit has fallen and this is weighing on prices (chart 4).

Second, foreign investment in Australian property has waned a little (chart 5). That is, the foreign investor share of property purchases has fallen. Controls on Chinese residents looking to deploy capital outside of China have had an impact. And the lift last year in State Government stamp duties levied to foreign investors in NSW and Victoria has dampened the overall demand for Australian property by international investors.

Third, expectations around property price appreciation have adjusted downwards. According to the WBC / Melbourne Institute, the proportion of households expecting dwelling prices to rise over the next twelve months has fallen to its lowest level since the question was first asked in late 2009.

Four, total listings remain elevated, particularly in Sydney. Five, there is a general fatigue in the market which is to be expected after such a prolonged period where
price growth outstripped income growth – there is a limit to the amount of debt that households can take on relative to income. Debt to income is currently at a record high in Australia (chart 6).

How far will prices fall?

We have developed a model that puts the annual change in national dwelling prices as a function of the annual change in mortgage rates (1 year advanced), the annual change in the flow of credit (six months advanced), auction clearance rates (four months advanced) and the house price expectations index from the WBC/MI Consumer
Sentiment survey (2 months advanced). The model explains trends in dwelling prices very well (chart 7).


Clearly, we can’t forecast auction clearance rates or the household perception around the future path of dwelling prices. But we have the latest data on both of those measures which helps us to project near term movements in prices. In addition, the flow of credit and changes in mortgage rates have historically had a lagged impact on dwelling prices of between six and twelve months. So we believe that we can forecast dwelling prices over a six-twelve month period with a reasonable degree of confidence.

Our base case for property prices has them down by 5%pa in Sydney and Melbourne by end 2018. That would take the fall in Sydney prices from its July 2017 peak to around 7½%. For Melbourne, prices would be down by around 5% from their November 2017 peak. Some further dwelling price deflation looks probable in 2019 and we see the peak to trough being around 10% in Sydney and a little less in Melbourne. For Brisbane, we see prices trending broadly sideways over the next 1½ years. Dwelling prices are likely to stabilise in Perth in 2019 as vacancy rates decline and rents trough. Nationally, we think prices will end the year down by around 3% with a roughly
similar outcome likely in 2019.

That would mean the total correction in dwelling prices is not too dissimilar to the corrections of 2010 and 1989.

Table 1 details our point forecasts by capital city. They have been prepared on a no policy change basis.

Why not a crash?

A crash could be broadly defined as a fall from peak to trough of around 20%. Many international observers (and a few local ones) expect this result. But that would be a significant correction and would require a lift in the unemployment rate or materially higher interest rates. We have neither outcome in our central scenario. We see the unemployment rate as more likely to drift a little lower from here while any tightening in monetary policy is likely to be very gradual.

In addition, Australia’s high population growth rate, which is driven by a large intake of around 200k migrants each year, looks set to continue. Despite concerns being raised about Australia’s strong population growth, there is bipartisan support from both major political parties to run a big immigration intake each year. This props up the underlying demand for housing and has kept a lid on vacancy rates despite record levels of dwelling investment (chart 8). In fact, as dwelling commencements edge lower policymakers may revert to talking about a “housing shortage”.

The latest data on vacancy rates, to June 2018, has rates moving lower in Melbourne, Perth and Brisbane. Strong population growth is the cause.

Finally, rental growth remains positive in Sydney and Melbourne (chart 9). We don’t see rents falling in Sydney or Melbourne without a change in Australia’s immigration policy. This provides a natural floor on how far dwelling prices can correct lower given interest rates remain around historic lows.

Risks

Downside risks:

In our view there are three key downside risks to our view on property prices. First, higher interest rates. We expect the RBA policy rate to remain on hold until late 2019. But if the RBA was to tighten policy before then it would likely result in dwelling prices falling faster than we anticipate. In addition, any further material out-of-cycle interest rate hikes by the major lenders in Australia would put additional downward pressure on dwelling prices given the relationship between mortgage rates and
prices (chart 10).

Second, a reduction in the migrant intake. We are heading into an election year and there is a risk that one of the major parties opts for a different policy stance on immigration (i.e. they lower it). A decision to drop the migrant intake would reduce the demand for housing while it would have no short term impact on dwelling supply. As a result, prices would be lower than otherwise. And growth in rents would also be weaker.

Third, a change in the taxation treatment around housing. Specifically, reforms around negative gearing and the capital gains tax discount that reduce the attractiveness of property from a tax minimisation perspective would result in lower dwelling prices relative to our forecasts.

The Australian Labor Party has stated that it will reform negative gearing and the capital gains tax discount if they win government at the next election. They have not provided any specifics around timing, however.

Upside risks:

We consider there to be two key upside risks to our property forecasts. First, lower interest rates. We expect the RBA policy rate to remain on hold until late 2019. But if the RBA was to loosen policy before then it would likely result in dwelling prices not correcting as low as we anticipate. Second, any policy change to boost housing demand such as first home owner grants or lower stamp duty (to domestic or foreign buyers) is an upside risk to our base case.

Comments

  1. harry petropoulosMEMBER

    watch cba change their view again when house price continue to decline…………..this is why I never listen to them as they are full of b/s

    • Not really, they are telling the truth about the Population Ponzi and Quantitative Peopling:

      Why not crash?
      Australia’s high population growth rate, which is driven by a large intake of around 200k migrants each year, looks set to continue. Despite concerns being raised about Australia’s strong population growth, there is bipartisan support from both major political parties to run a big immigration intake each year. This props up the underlying demand for housing and has kept a lid on vacancy rates despite record levels of dwelling investment

      a rush of immigrants will rescue us from any crash. The government, whether Labor or Lib will just open the gates to more people to stop things crashing.

      • This assertion rests on one central premise: that the strayan economy can continue to offer jobs to these people.

        If we have an economic slowdown or recession things will get pretty tough for those ‘students’ whose plan it is to stay on.

        It’s been said a hundred times but I’ll say it again: 99% of migrants don’t arrive with a trust fund in their pocket. They need to be able to work or they’re toast.

      • CBA and the rest of the big 4 have enough control over the government to determine the fines they got for breaking the banking regulations. If they can do that, they certainly will be able to influence the immigration policy – to their benefit.

        They might be worth listening too, because without the banks excessive influence, the housing market should have crashed years ago, yet it continues to defy both logic and mathematics.

      • Australia, I think, now resembles Spain and Ireland prior to 2008. In spite of high migration in both of those countries the property markets of both countries collapsed and temporary residents left. There is this dull belief that simplistic supply and demand concepts can be applied to the current circumstances and explain what is going on. When asset prices drop buyers disappear and sellers start to panic – typical of the end of a debt binge. The reality is that you can’t build an economy based on debt. Especially when the vast majority of your ‘investments’ go into assets that generate no future value.

      • I think there is a difference. We basically have an open border with China and South Asia.

        Poles are poor, but Poland is still a decent place to live. India is a shithole, conditions are getting worse with water shortages, woman shortages, and overpopulation. I think the immigration supply into Australia is endless.

  2. “decision to drop the migrant intake would reduce the demand for housing while it would have no short term impact on dwelling supply. As a result, prices would be lower than otherwise.”

    Hey hey, what are CBA smoking? Don’t hey know that migrants don’t matter because they are por and can’t get mortgages? How can migration possibly affect price levels?!

    • Look here – our immigration program is so bloody good that it absolutely doesn’t cause house price rises (so we can keep immigrationat its current level as it does not make housing more expensive for aussies) but it definitely prevents house price falls (meaning we need to keep immigration at its current level so no one loses the equity they have built and ends up under water).

      We r smrt in straya

  3. A 40% drop would still make houses overpriced.
    Everyone on a manufacturing site I know of is being asked to take pay cuts of between 30 to zero percent eg no pay rise for X amount of years and starting new starters on a second tier pay system. All the Baby Boomers are for it . Shafting their kids is the new game in town and since most of the workforce is BBs it might get up.👎
    House prices need to reset and then wages can reset , not the other way around.
    Houses for homes, not investments! ✊

    • Houses used to be ‘consumption items’ until the monetary system changed and the housing market became financialized. I’m sure this will change again in time.

      As for investments, I remember chatting to some hedge fund guy at a function and he was saying that property should never be viable for mom ‘n pop investors under any normal regime as they suffer from a lack of economic scale i.e. it takes almost as much resource to manage one property as it does ten properties or ten properties as it does a hundred, etc. In other words, resources consumed managing properties can be more efficiently amortised over a large portfolio (hundreds or thousands of properties). The only rationale for individuals to dabble in IP is the promise of capital gains or, said otherwise, a bet on rising prices. That’s flat out gambling — nothing else.

  4. So despite we still have a large intake of immigrants , the prices are falling ??? Why economists seems to have “No Logic at all” minds ??

    It cannot go both ways

    • I don’t see this as a mystery.

      Typical migrants coming to Aus to work in typical rorted ‘skilled’ visa positions for $30,000 per annum / deliver Pizzas can no longer borrow enough to buy a $780,000 2BR flammable clad dogbox in Western / South Western Sydney, whereas they could as recently as 18 months ago.

      • Still the economists logic always connected the immigration intake to this monstrous housing bubble and blamed almost nobody about the availability of credit and poor lending regulations . The defenders of the bubble were arguing that the immigration was a key factor of all of it. Now the immigrants are not capable of borrowing is just the opposite of what they always tried to convince us with. Why logic changed now in the face of facts ??

    • Exactly. Prices ARE falling under current immigration and supply settings.

      Unless there is some big policy change, prices will not stop falling until the factors causing the fall have ceased to exist.

      According to the CBA, those factors are annual change in mortgage rates, the annual change in the flow of credit, auction clearance rates and sentiment.

      Rates may go up only very slightly due to BBSW / price of funding, or down very slightly if RBA cuts (banks won’t pass on much of the cuts). Flow of credit should keep falling given tighter lending (totals lent down 30-40% compared to last year) and IO reset, neither of which will change soon. In theory credit could fall 30-40% to the marginal buyer. Clearance rates who knows but they are numberwang and they mostly reflect credit and sentiment anyway so I’d ignore them as a separate factor. And sentiment can go bottomless if it turns.

      So two factors broadly neutral and two heavily negative. CBA’s prediction of 3% falls is hopium pure and simple.

      But they have to say it because they have a huge mortgage book and are terrified things might get worse.

      • Notice how every ‘prediction’ once house prices started to fall is basically inline with the current trend eg earlier they were expecting mild growth of 3-5% in Sydney and Melbourne for 2018 (once that was basically the current YOY growth). Now that prices have fallen 3% they expect a 3% fall. These predictions are actually just commentary of the current data +-5% (so it’s not oobvious. These guys know exactly what’s going on but don’t want to spook the punters. By predicting what is currently happening they can look back and say ‘see our predictions were in line with the data we had at the time’..thus hoping to maintain a level of credibility to the masses. In the meantime they are busy trying to clear the crap off the books!

  5. Luxury car sales came off the boil in 2018 or 2017 after 10-15 years of solid growth (growing faster than the sales of normal cars).

    Perhaps that was the canary in the quarry.

  6. It has been a while since I have made a comment here and maybe it is time to add my two bobs worth:

    Too often forecasts are made by relying on the past. Most, if not all, look at the future in the context of previous experiences, rather than through the trends that are shaping what lies ahead. This appears to be the case there too.

    I am not saying that I have the answers. I spend a lot of my time these days saying, “I don’t know”.

    But I do use three ‘tools’ to help assess what the future may hold when it comes to the residential market. These work for me and they might work for you too. They cover three time periods – now, soon and later.

    Go here: https://matusik.com.au/2018/08/30/now-soon-and-later/

    In short more time should be spent thinking about the longer term rather than trying to score a short-term sugar hit or avoid a bout of housing depression.

    In the next decade (maybe longer) there are very few trends that will drive housing prices and rents generically up, and heaps more that will keep them flat at best, but mostly lead to declines in real terms.

    Michael

    • Sincere thanks for posting.

      To be honest your full post was pretty vague for mine. It pointed out some factors but didn’t say which way you think most will go, or why.

      Which does support your conclusion of “I don’t know” I suppose.

      Perhaos you could elaborate on why you think the economic, political and social, in lockstep, will turn against housing growth in the long term?

    • Aaah – Pullenvale Hall! I used to agist there, just across the road. Pullenvale – the Lexus suburb. The only reason they didn’t kick me out of the suburb was because I told them that my Camry was basically a Lexus…

  7. Asking CBA which has ~60% of their assets comprising of mortgages and is heavily reliant on continued credit growth for housing via positive sentiment from consumers, is like asking the Winkelvoss twins whether they think Bitcoin will be a success in the future. Such views by any of the banks need to be heavily discounted as are unlikely to be anything resembling impartial.

    I keep hearing the well-worn argument of immigration, low unemployment, low rates scarcity of land etc. as putting a floor under house prices but no real evidence tends to follow. But these have been present in other historical housing bubbles too. Low rates and credit growth in excess of income and GDP have been the main driver in pushing house prices up along with perverse tax incentives to favour investing in property. But if these things reverse there should in theory be similar downward pressure on prices. If not then we may have found a magical asset class with the perfect asymmetric risk profile where upside significantly outweighs the downside and prices rise follow by small adjustments and then continue rising again. Sharemarkets can do this but companies generate earnings and grow those earnings, which compound over time. Property is an unproductive asset, based on a premise that someone else will pay more for the exact same asset.

    The comment about healthy yields are perplexing as in the biggest markets (Syd, Melb) have net yields that are almost zero. Rental growth has not followed house prices. In fact, all those who negatively gear which is a sizeable portion of the investor cohort are actually running losses so there is no yield at all. Income has never been the central thesis for investing in property.

    I also find it interesting how pundits are willing to put a number on house price falls. Whereas with stock markets and other risk asset classes there is less of a tendency to try and predict a correction. But with housing experts are confident in stating they will fall 5-10% or 10-15% often without reasoning but perhaps based on recency bias and what has occurred in the past. And what happens when the do fall by this amount? Does credit demand suddenly start growing again? Debt/disposable income will then push through the 200% barrier if income don’t catch up. To put debt levels in context, we are currently at 190%. The US, with their highly levered households was at 115% right before GFC. Unless we can pull off a miracle some painful deleveraging will be required at some point, which is a natural occurrence of debt cycles.

    Given all the slack in the labour market and lack of wage growth it will be interesting to see what happens when households have to start paying off principal and interest and go back to creating equity the old fashion way by paying down debt. My worry is about what happens to consumption, which makes up 50% of GDP when more and more income is being devoted to paying off massive mortgages. With a savings ratio of 1%, there is also very little left in the well for emergencies.

    At the end of the day nobody knows how this will play out but the risks look firmly tilted to the downside based on a number of key fundamentals. With an absurd national price to income ratio of 6 (insanely expensive) there needs to be a correction of some sort and a re-balance back towards more productive means of generating wealth.

    • It’s interesting to see price falls even while we maintain a high immigration rate. Perhaps this is the factor that has prevented a harder, faster fall. However continued falls must produce an inflection point where sentiment changes. It’s hard to see where a property boost would come from. Not overseas investors certainly. This continuation bias is always tempting, gradual for ages. But every crash has had an inflection point. We have the conditions for one.

    • Lol

      I love watching the official line evolve from “prices can never fall” then “only certain markets will fall” then “these widespread falls will not persist for long” to “honestly, seriously guys, they won’t crash”.

  8. ” But that would be a significant correction and would require a lift in the unemployment rate or materially higher interest rates. We have neither outcome in our central scenario.”

    Why do people persist with this rubbish? Prices start to fall, then you have a situation where many projects become unviable. Then people start to lose their jobs. Then unemployment rate starts to rise. Then their are less credit worthy borrowers, which leads to less overall borrowing at the margins. Which leads to more price falls. And so on.

    The reverse happens when prices rise. More projects become viable leading to more employment. And so on.

    The only question is can you keep the credit spigot turned on at full blast to enable the price rises rather than the falls. And I think we know now that the answer in the current environment, is no. They have long since used up the majority of the credit worthy borrowers and they (the banks) have been engaging in massive fraud to make sure that non-creditworthy borrowers get loans that they shouldn’t. Likely with tacit approval of government because it keeps the economy booming.

  9. Hill Billy 55MEMBER

    The above discussion ignores the elephant in the room. Issuance of Government Debt. Since the GFC, both sides of politics (whilst in power) have gone on a debt binge, raising debt from 9.7% of GDP (in 2007) to 41.9% of GDP in 2017. This cannot go on, particularly if the ALP win the next election and the LNP start their usual Debt and Deficit argument against them.

    At the moment, the increase in government debt is being funnelled into infrastructure projects to the extent that our construction workforce is now 12% of total employment. This is massively inflated on normal levels and, when it reverts to normal levels, there will be nothing to employ these people in. Throw in the NDIS jobs that have increased over the last couple of years, and the possibility of significant deterioration in employment prospects going forward is pretty well baked in.

    Worsening employment guaranteed will see many of the recent migrants heading for the exits. Anecdotally, some already are.

    One of the rating agencies said that our AAA rating will come under pressure when the Net Government Debt reaches 30%. By my calculations, it is currently just above 26%. We do not have much wriggle room there.