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Brace for hard landing in Aussie property market, OECD warns

Glenn Freeman  |  10 Dec 2018Text size  Decrease  Increase  |  
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A global forum has swooped on the decline in Australian housing prices, warning investors to brace for a ‘hard landing’, which it says could have a ripple effect across the economy.

A large drop in house prices could cut household consumption, prompt collapse in the construction sector, increase mortgage defaults and freeze back lending to businesses, warns the Organisation for Economic Co-operation and Development.

To prevent the worst-case scenario interest rates should be gradually lifted, as growth continues and inflation slowly rises, the Paris-based OECD says in a report out today.
The OECD also recommends the federal government bring the budget back to surplus.

The report coincides with other local forecasts that suggest house prices could fall by up to 20 per cent, with the biggest falls in Sydney and Melbourne, according to modelling by AMP chief economist, Shane Oliver.

The Reserve Bank of Australia has kept the official cash rate at its record low of 1.5 per cent since August 2016 and has signalled it is unlikely to change for some time.

Morningstar's head of equity research, Peter Warnes, says house prices is the "big daddy" of Australian economic indicators, as even small movements outweigh similar shifts in other segments.

"In isolation, the effect of the current bout of house price weakness would likely be more pronounced on economic activity and GDP growth than it currently appears,” Warnes says.
There are also several offsetting factors to the broader economy, including exports, the balance of trade and infrastructure spending.

But given household consumption consistently contributes 55 per cent to 60 per cent of Australia's gross domestic product growth, "it is the 'big daddy'" Warnes says.
Small falls in this “wealth effect” – whereby people spend more because the value of their assets is rising – affect the purchase of big-ticket items. The bellwether example is motor vehicles. New vehicle sales have fallen sharply to 90,000 units in October, from 130,000 in June.

house

 

Housing prices are intrinsically paired with household consumption and GDP in Australia

Warnes points to metrics on consumer views on price expectations from Westpac and the Melbourne Institute, which show a pronounced weakening since July.

"At 102.61, the national index is well above its 2017 average of 95.7 but is weak compared to the long run average of 127," he says.

Warnes argues a decline in household balance sheets – across all asset categories including family home, non-housing assets such as cash, direct shares and superannuation – would have a severe impact on GDP growth and economic activity.

Oliver warns against panic

Despite forecast falls of up to 20 per cent, AMP’s Oliver says some capital cities – other than boom cities Sydney and Melbourne – show promise. A key risk is access to credit, which could affect prices, he says.

Falls in the other capitals have bottomed out, says Oliver, who also cites tighter credit limits as a contributing factor to the broader weakness in property prices. 

"Home prices in Perth and Darwin are either at or close to the bottom having fallen back to levels seen more than a decade ago, and prices are likely to perform a lot better in Adelaide, Brisbane, Canberra and Hobart along with regional centres as they have not seen anything like the boom in Sydney and Melbourne,” Oliver says. "But they will see some impact from tighter credit.”

Oliver, however, sees no cause for panic. A national fall in average prices is still unlikely, he says, unless declines are accompanied by other macro factors. These include higher interest rates, a rise in unemployment, a collapse in immigration and a continuation of high construction output – all of which are unlikely, he says.

"However, the risk of a crash cannot be ignored given the danger that banks may overreact and become too tight and that investors decide to exit in the face of falling returns, low yields and possible changes to negative gearing and capital gains tax," says Oliver.

The tide turns

Oliver notes several causes for the fall in house prices. They include:

• The high prices have reduced the pool of would-be home buyers

• Tighter lending standards, particularly in the wake of the banking royal commission

• Banks shifting borrowers from interest-only loans to principal and interest loans over the next few years

• Banks curbing lending to self-managed super funds

• Out-of-cycle mortgage rate increases.

However, Oliver puts proposed changes to negative gearing and capital gains tax regulations at the bottom of his list.

"On their own some of these are not significant, but together they risk creating a perfect storm for the property market," Oliver says.

Tighter lending behind the falls

Others warns against taking a knee-jerk reaction to falls in housing prices.
Nikko AM fixed income portfolio manager, Chris Rands, warns against attributing the housing price movements over recent months to "housing stress".

Housing stress is said to occur where more than a third of the household goes toward to mortgage repayments.

Rands says the downturn in prices is due to tightening lending standards, which are constricting credit supply.

"While this means house prices can continue to fall over the next 12 months, it reduces the risk of a crisis occurring through the housing sector," he says.

Rands assesses Australia's housing market in the context of debt-service ratios, repayments, loan to valuations, arrears and household stress levels. Household debt is high, but debt service ratios indicate the average household debt level "is by no means stretched", Rands says.

This aligns with RBA's October 2018 Financial Stability Review, according to which “total payments as a share of income have remained broadly in line with their levels over recent years”.

Similarly, loan-to-valuation ratios – a measure of debt compared to the value of the housing asset – indicate the majority of borrowers have LVRs of less than 10 per cent. 

"This means the moderate declines we've seen in the housing market will not create a situation of negative equity for a meaningful share of borrowers," Rands says.

Furthermore, the average borrower is three years ahead of their required loan repayments – a considerable buffer against mortgage stress, says Rands, citing RBA statistics. In short, it’s a stark contrast to the US housing market blow-up that fuelled the 2008 global financial crisis.

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is senior editor for Morningstar Australia

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