More pain ahead for the housing market

The Australian property market has remained weak coming into 2019.

CoreLogic data shows property prices fell in all the major cities, except Canberra, in January. National capital city prices fell 1.2 per cent and are now down 7.8 per cent from their September 2017 highs.

The weakness continues to be led by the previous boom cities of Sydney and Melbourne. Sydney prices are down 12 per cent from their highs and Melbourne is down nine per cent.

We’re also seeing ongoing weakness in Perth and Darwin as the impact of the mining investment slump continues to weigh on those cities, while the other cities are showing weakness but not too much.

So when will the market bottom?

More downside

We see more downside this year. It’s impossible to be precise, but top to bottom, we expect property prices to fall around 25 per cent in Sydney and Melbourne, which implies falls of another 15 per cent or so (possibly a little more in the case of Melbourne) to come.

As for the rest of Australia, property prices will be affected by some of the factors driving prices down in Sydney and Melbourne, but they are probably a bit better placed – either they didn’t have a boom, and therefore probably won’t have a bust or in the case of Perth and Darwin the bust has already happened.

Top to bottom, we’re looking at national prices falling another five to 10 per cent, again, with most of that concentrated in Sydney and Melbourne.

Five key factors

A combination of five factors are driving prices lower:

1. Tighter lending conditions triggered by the actions of the banks in response to the Australian Prudential Regulatory Authority (APRA) over the past year or so. Bottom line, it’s harder to get a loan but I don’t see the release of the final report of the Royal Commission into misconduct in the banking, superannuation and financial services industry adding to that tightening.
2. An increase in supply, particularly of units in Sydney and Melbourne.
3. Reduced foreign demand because Australian authorities have made it harder for them to buy. (Chinese real estate investment in Australia has slumped 70 per cent since 2015).
4. Uncertainty about tax. Labor, if elected, is proposing to change negative gearing rules by limiting it to new properties from a yet-to-be-announced date after the election. They also propose to halve the capital gains discount for all assets sold after that date.
5. Uncertainty caused by some investors being forced to switch from interest-only loans to principle and interest loans. 

All those things are coming together to give us falls, but again they’re particularly concentrated in Sydney and Melbourne where you have a much bigger investor base and where you have also seen a much greater increase in the supply of housing.

Clearly negative

A weak housing market is quite clearly going to be a negative for the economy for two reasons.

Firstly, residential construction activity looks like it’s going to fall this year.

And secondly, falling home prices act as a negative wealth effect. Even if they are not forced to sell and their losses are only on paper, Australians - particularly those who bought relatively recently - will feel poorer and likely spend less, therefore there will be a drag coming through.

Where’s the bottom?

Investors are now asking the obvious question – what will cause the property market to bottom out?

It’s going to be a combination of several factors. Firstly, improved affordability as prices come down and owner occupiers and investors start to see value.

Secondly, lower interest rates later this year, with the bulk of cuts expected to be passed on to the buyers by the banks, will also help.

Ultimately, we see the softness in the economy prompting the Reserve Bank of Australia to cut interest rates a few times this year. We think the cash rate will be around one per cent by the end of 2019.

On top of that, it’s possible the next federal government, whether it’s Labor or the Coalition, will introduce another first home owners’ grant scheme.

All of these factors should see property prices bottom out late this year, or more likely sometime in 2020.