At a glance
For a country used to ever-rising property prices – they have soared more than 370 per cent in the past 30 years – a new reality of shrinking property values and is taking shape.
Since the market peaked in September 2017, the home value index compiled by property market analyst CoreLogic has slid 1.3 per cent, including a 0.2 per cent decline in June 2018.
The searingly hot Sydney market has been hardest hit. House prices there have tumbled 4.6 per cent since the peak.
Nevertheless, so far the damage to balance sheets has been limited. Nationally, longer-term homeowners have held on to virtually all of their capital gains – prices are still 32.4 per cent higher than they were five years ago.
The property market is deflating, but with a gentle hiss rather than a cacophonous bang.
Nervous mortgage holders and aspiring homebuyers nonetheless wonder how long this decline will last, and how ugly it might get.
Applying the brakes to property prices
Part of the answer lies in understanding what pushed prices so high in the first place, and why they have since turned down.
CoreLogic research director Tim Lawless says easy credit and eager investors underpinned much of the increase in recent years. Buoyed by low interest rates and strong capital gains, investors piled into the property market.
By early 2015, the value of mortgages taken out by investors outstripped those to owner-occupiers, many of them riskier interest-only loans.
At one point, almost half of all loans being written were interest-only.
However, the downturn in house prices has not been driven by higher interest rates or borrowers getting into financial distress. Instead, it has been engineered by regulators, says property analyst Pete Wargent of WargentAdvisory.
Worried by the surge in investor borrowing, financial regulator the Australian Prudential Regulation Authority (APRA) in 2014 placed a 10 per cent speed limit on the growth of loans to investors. Three years later the regulator clamped down on interest-only lending, which had been growing rapidly, imposing a 30 per cent cap on the proportion of new mortgages that could be interest-only.
Taken together these measures, says Wargent, were “pretty unique” – and effective.
Within a few months of the investor loan cap, borrowing slumped, dropping by almost a third through 2015, and it has continued to decline.
By April this year investors accounted for just 42 per cent of home loans, the lowest proportion since 2012, and growth in investor lending had dropped below 5 per cent, down from a high above 10 per cent.
Interest-only borrowing, too, has wilted. It accounted for more than 40 per cent of loans approved in 2015; by early this year the ratio was less than 20 per cent.
The regulation-driven credit squeeze has dampened housing markets. Auction clearance rates have slumped to less than 57 per cent nationwide, and are the lowest they have been since 2012, according to CoreLogic figures.
APRA released the brakes on investor lending in April but has no intention of relaxing the pressure on lenders, demanding they limit new lending at very high debt-to-income levels, and set debt-to-income levels for borrowers.
Australia: headed for a property crash?
However, the risks already built up in the system are not going away in a hurry.
The Organisation for Economic Cooperation and Development (OECD) has flagged household indebtedness as the economy’s biggest risk. The ratio of total household debt to income has jumped almost 30 percentage points in the past five years to reach 189 per cent in December 2017, and mortgage debt alone was 139 per cent of income.
Although wealth has grown even faster, some who have borrowed heavily may be vulnerable.
University of New South Wales Business School Professor of Economics Richard Holden puts the chances of a house price crash at 30 per cent, most probably triggered by widespread defaults on interest-only loans.
Although Holden says it is most likely that the property market will avoid a collapse, the risks created by more than A$100 billion of interest-only loans are “non-trivial” and cannot be ignored.
The Reserve Bank of Australia (RBA) estimates that each year until 2021, about A$120 billion of such mortgages will convert to traditional principal and interest loans, forcing up repayments by between 30 and 40 per cent.
The RBA thinks most households have enough of a financial buffer to absorb the increase. However, Holden warns that if even just 10 per cent struggle to make their repayments and are forced to sell, that could be sufficient to trigger a crash.
“I’m not really worried about what happens in Point Piper, Double Bay or Toorak,” he says. “I’m worried about what could happen in the western suburbs of Sydney and Melbourne. If there are big forced sales there, then great damage is going to happen to people who can afford it least.”
Interest rates: the price of money
A sudden jump in interest rates is another risk.
Few expect the official cash rate to budge from its current record low of 1.5 per cent before late 2019 at the earliest.
However, this doesn’t mean borrowers won’t feel some financial pinch.
Wholesale funding costs on international markets are increasing, and already some smaller lenders are responding by pushing up interest rates on selected mortgages.
Lenders including Macquarie, the Bank of Queensland and Auswide Bank have increased rates on variable interest mortgages by an average of between 0.08 per cent and 0.27 per cent, and Lawless expects larger banks will eventually have to follow suit.
Still some life left in the market
Even if the country avoids a default-induced property crash, economists expect that tighter credit standards and the chilling effect of the banking Royal Commission on lenders will force house prices down for some time yet.
Fifteen economists polled by comparison website Finder.com.au tipped that prices in Sydney and Brisbane could drop by as much as 6 per cent by the end of the year, 4 per cent in Melbourne and Hobart, and 2 per cent in Perth, Adelaide and Darwin.
ANZ Banking Group is even more bearish. It predicts prices nationally could fall by 6 per cent from September 2017’s peak to a trough in 2019, including a plunge of up to 10 per cent in Sydney – a view shared by Macquarie Securities. AMP Capital warns they could drop by as much as 15 per cent by 2020.
However, Australia’s status as a destination of choice for migrants may limit the extent of any decline.
The country, particularly its biggest cities Sydney and Melbourne, has been a magnet for immigrants and Australia’s population is growing close to the fastest among developed countries.
Professor Holden says it is on track to expand by 1.6 per cent this year, and all these people have to live somewhere.
With the supply of dwellings set to tighten – building and home loan approvals nationally have both dipped recently – pressure on home prices could again build.
Australia’s seemingly tireless property market might have more life in it yet.