A near-perfect storm is hitting housing - and prices could fall 10%

• The slump in national average home prices continued in August with prices down 0.9% according to Cotality, their fifth monthly fall. The fall in July was revised down to -1.2% with August likely to be revised down too. Capital city prices fell 1.1% with data now showing that falls have been accelerating in the prior boomtime cities of Brisbane, Adelaide and Perth.
• Further falls are likely as we continue to expect another RBA rate hike by November, possibly in September, the negative impact on investor demand from the tax changes in the Budget will impact for a while yet and confidence is likely to remain weak.
• We now expect national average property prices to have a top to bottom fall in prices of around 10%, of which they have done 3.6% so far. Capital city prices are likely to see a top to bottom fall of 11%, with Sydney around 13% of which its already done 7.1%.
• Prices aren’t expected to bottom until around the June quarter next year and should start a modest recovery in 2027-28 as the RBA starts to shift to rate cuts.
• We are probably only about 35% of the way through the slump both in terms of the percentage fall and months.
• Units and lower end property are not immune but are likely to hold up better as they didn’t go up as much, are more affordable and are benefitting from the expanded FHB 5% low deposit scheme. The tax changes also favour properties with higher rental yields.
• Asking rents rose 0.4% in August, with annual growth of 5.7%yoy. Vacancy rates have risen but remain low. This remains an ongoing problem for inflation.
• The home price slump will weigh on economic growth, but is not significant enough yet to change the direction of the RBA rate moves from up to down given the inflation problem.

The home price downswing is getting worse

Cotality data shows national average home prices fell 0.9% in August, with capital city prices down 1.1%, their fifth monthly fall in a row. This followed a fall of 1.2% in July which had been revised from 0.7%. Given the downswing the 0.9% fall in August is likely to be revised down next month as well.

Prices nationally have now fallen 3.6% from their high, with Sydney leading the fall with a 7.1% drop. 

The boom in Brisbane, Adelaide and Perth is well and truly over as they are seeing accelerating falls too. Cotality data also shows that 93% of capital city suburbs saw a price fall over the last three months indicating that the downturn is broad based.

The downturn in the property market started to get underway late last year and reflects a combination of rate hikes, the Budget tax hikes on investors, poor affordability and depressed buyer confidence. 

Still working the other way though is the chronic shortage of housing in Australia and a boost from the expansion of the 5% low deposit scheme for first home buyers. 

The latter combined with poor affordability pushing buyers into lower price points is showing up in relatively stronger conditions in lower quartile property prices and in units, but they are not immune to the downturn.

While auction clearances rates appear to have stopped falling for now this reflects a plunge in listings as vendors hold off for better prices.

Were it not for three key supports the property market would be a lot weaker.

First, there remains an accumulated housing shortfall – of 200,000 to 300,000 dwellings - that has built up after years of very strong population growth and an insufficient supply of new homes.

With rising rates, high and rising construction costs and falling prices making new builds less viable, along with ongoing problems for property developers, housing supply is likely to remain well below the Housing Accord targets and so a quick resolution to the housing supply shortfall is unlikely.

Second, vendors don’t appear to be in a rush to sell just yet with new listings down from year ago levels, particularly in Sydney and Melbourne, suggesting that they are waiting for better prices and that distressed selling is not an issue at present. This is being aided by still low unemployment. A pickup in listings in the Spring selling season could test this though as could the impact of further rises in interest rates and unemployment.

Finally, the expanded first home buyer 5% deposit scheme is helping to support lower priced entry level houses and units. But the bring forward of FHB demand due to the 5% deposit scheme will likely hit an air pocket next year.

However, while the housing shortage, weak new listings and the expanded 5% first home buyer deposit scheme should help head off a crash in property prices (say 20% plus), the Australian housing market is likely to weaken further as higher mortgage rates, the removal of most property tax concessions, record poor affordability and poor confidence continue to impact.

Rate hikes

We continue to expect one more rate hike by year end as inflation is still too high and likely to take too long to get back to target threatening higher inflation expectations. July inflation data released last week only served to reinforce this assessment with the risk being that we may need two more rate hikes.

Rate hikes have usually been associated with some softening in property prices or slower growth. This is because they cut how much buyers can borrow, hit confidence and can boost distressed sales. Of course, this is not always the case as other factors can intervene like the population surge did in 2023, but that looks very unlikely this time around.

The Budget tax hikes on investors

The move to curtail access to negative gearing and return to the taxation of real capital gains with a minimum tax rate of 30% is driving a big decline in investor demand for residential property in the near term because it means a significantly lower after-tax return for investors. 

This is confirmed by banks reporting a 20% plus fall in investor applications for housing finance since the Budget and sharply lower growth in investor credit. See the next chart but note that credit data lags housing finance applications. 

It makes sense for investors to sit on the sidelines until they see lower prices or higher rents or some combination of the two resulting in a higher starting point rental yield before they invest to compensate for the higher tax rate they now face. 

This impact could be quite significant – for example if a new investor wants to see a gross rental yield of say 5% rather than 4% it would mean a 25% increase in rents or a 20% fall in prices or some mix of the two. 

I suspect that rental affordability constraints may mean that the impact is skewed towards price falls rather than rent hikes in the short term, but it may be more even over the long term.

Given that we have not seen such a structural change like this for decades it means significant uncertainty around the size of the impact with the risk likely on the downside for prices – particularly if supporters of the Budget changes are correct and the tax concessions were a significant reason for the surge in property prices relative to incomes since the 1990s.

Poor housing affordability - the ratio of home prices to wages and incomes is still around record levels.

In combination with the rise in mortgage rates this has led to a widening gap between home prices and what an average buyer can afford to pay for a property. 

While home prices have fallen recently, as can be seen in the next chart it’s just a flick off the top after a 50% surge since the pandemic and some of the benefit has been offset by the impact of higher mortgage rates.

Poor buyer confidence – while there has been some improvement from recent lows consumer confidence remains depressed as are perceptions of whether it’s a good time to buy a dwelling. 

And consumer expectations for home price growth have fallen sharply. The rebound in petrol prices back above $2 a litre and a gradual loosening in the labour market driving higher unemployment won’t help.

With a near perfect storm continuing to hit the property market, further price falls are likely and reflecting the recent acceleration in falls we now expect a top to bottom fall in national average property prices of around 10% (revised from 7% previously). 

This is deeper than the range of average capital city property price declines seen over the last 40 years or so but is consistent with the increase in taxation of investors which represents a significant structural change for the property market along with the RBA likely to take the cash rate above its last cyclical high.

This involves a 6% fall this calendar year and an 8% fall in the current financial year. Given the uncertainty around the full impact of the property tax changes on demand and the upside risk to interest rates, the risk remains on the downside. For capital cities we expect an 11% top to bottom fall.

By the June quarter next year, property prices are likely to bottom with the market starting to anticipate RBA rate cuts – we expect the RBA to start cutting through the second half of next year but a sharp fall in home prices could bring this forward to the first half as falling prices depress wealth which weighs on consumer spending which in turn would bring inflation back to target faster than the RBA is currently assuming (ie, by 2028).

We continue to expect a wide divergence between cities and property types. In terms of price to rent ratios adjusted for inflation as a rough guide to whether a market is over or under valued houses are 38% overvalued nationally compared to units at just 8%. See the next table. So, houses overall are far more vulnerable to a fall in prices than units are.

In terms of houses, Brisbane, Adelaide, Sydney and Hobart are the most overvalued and vulnerable and so are likely to see falls in excess of 10% top to bottom.

And in terms of units, Brisbane, Adelaide and Canberra are the most vulnerable. Melbourne is the least vulnerable city and could benefit if political change there leads to a more property investor friendly environment.

Is this the end of the 30-year super cycle upswing in property prices?

The combination of a rising long-term trend in mortgage rates after the long term down trend that ran from 1989 (when they peaked at 17%) to 2021 (when they bottomed around 2%), the virtual removal of property tax concessions, record poor affordability and a political shift towards lower immigration after nearly 20 years of relatively high immigration may mean the 30-year super cycle upswing in home prices may be at or close to over. 

This saw average property prices rise dramatically faster than their long-term trend and incomes since the mid-1990s.

In particular, the swing from a long term down trend in interest rates to what now looks to be a rising trend combined with a far less favourable tax treatment of property investors (who account for 30-40% of the home buyer market) are major structural changes that both point to higher residential property rental yields, via some combination of higher rents and lower than otherwise prices. 

This could start to reverse some of the downswing in rental yields that was a key aspect of the super cycle upswing in property prices over the last three decades, particularly for houses.

If the property super cycle upswing is over it could mean a decade or so of real house prices ranging sideways and a moderation in home price to income ratios. It could also mean that cyclical downturns in property prices are deeper and upswings take longer for prices to reach new record highs.

Of course, the ongoing housing shortage remains - which could be made worse by having less investors involved in the property market – and is the key sticking point, so it’s hard to be definitive as to whether the property super cycle has ended or not!

The property price downturn and the economy

There are several implications from the slump in home prices for the economy. In particular:

· A drag on consumer spending – with the RBA estimating a few years ago that a 10% fall in home prices will reduce consumer spending by around 0.8% after two quarters and 1.6% over the long run. So far home prices have only fallen 3.6% from their high so the wealth impact is minor, but that will likely change;

· Less incentive to build new homes – as established dwellings fall in price relative to increasingly costly new dwellings. This could have a further adverse impact on the economy via less home building and less demand for goods and services that flow from new home building;

· Taken together less consumer spending and less home building will mean less demand in the economy so eventually it should start to contribute to a fall in inflationary pressures, but it’s still early days;

· Increased negative equity – where a homeowner’s mortgage debt is worth more than their home. This is estimated to be low at present and is really only an issue (beyond the wealth effect) if the homeowner has to sell. But it will impact those who bought say around the end of last year with small deposits and could become an issue if unemployment rises.

· Rising bad loans for the banks and less demand for credit – the former is not a major problem for the banks as they have significant capital reserves (even if there were a 20% fall in prices) but the latter has started to weigh on their share prices through the recent reporting season.

At a high level this means that the home price downturn will mean less upwards pressure on interest rates. At present though the fall in prices – which is just a flick of the top – is not enough to offset the problems the RBA faces around excessive inflation and so it’s unlikely to prevent a further interest rate hike (or two) by the RBA. 

However, if as we expect the property price downturn continues into next year it will likely eventually become a factor in seeing rates peak and the RBA pivot towards rate cuts later next year.

What to watch?

The key things to watch with respect to the next 12 months will be interest rates, consumer confidence, unemployment and investor demand. Several more rate hikes, a sharply rising trend in unemployment and a big drying up in investor demand could result in much bigger price falls than the top to bottom 9% fall that we are expecting.

On the flip side a quick move to rate cuts and a subdued investor response to the tax changes could drive a renewed upswing in property prices from later this year and through next year.

Overall, the risks for home prices over the next 6-12 months seem skewed to the downside but note that in the absence of much higher unemployment causing forced or distressed sales, a property price crash (say a 20% fall or more) is unlikely. A crash would require wide scale forced selling by homeowners – but without much higher unemployment forcing homeowners to sell this is unlikely.

Note that both New Zealand and Canada which have seen 15-20% home price falls have much higher unemployment at around 5.6% and 6.4% respectively compared to 4.5% in Australia.

In terms of the 30-year super cycle upswing in home prices – many of its key drivers (notably falling mortgage rates and high immigration) are now reversing or fading but the housing supply shortfall is key. If it closes quickly thanks to stronger supply and/or a faster fall in immigration, then the super cycle upswing is even more likely to be over.