Australia’s Housing Correction Could Have Further to Run

Australia’s housing market is undergoing a significant correction, and the evidence increasingly suggests that the decline has further to run. House prices have already fallen rapidly across the major capital cities, but the combination of higher interest rates, weaker investor demand, slowing population growth, tighter credit and deteriorating government finances creates a very different environment from the one that supported the previous housing downturn.

Cotality’s five-city index is currently tracking around 5.1% below its peak, while the quarterly rate of decline is approximately 3.9%. The largest fall previously recorded by the index was around 8.6%, during the 2017–19 housing correction. At the current pace of decline, that record could be surpassed before the end of this year.

That does not necessarily mean Australia is heading for a sudden housing crash. But it does suggest that the current adjustment should not be viewed simply as another temporary downturn before the next property boom. There are several structural changes underway that could result in a much longer period of weak housing prices.

Why the Current Australian Housing Correction Is Different From 2017–19

The 2017–19 housing downturn provides a useful comparison because the forces behind it were, in some respects, similar to those affecting the market today. Lending standards tightened following the Banking Royal Commission, investor demand weakened and the prospect of changes to negative gearing and capital gains tax created additional uncertainty for property investors.

The downturn was eventually interrupted by the 2019 federal election. The Coalition's unexpected victory removed the proposed changes to negative gearing and capital gains tax, while concerns surrounding the Banking Royal Commission also faded. Housing prices subsequently resumed their upward trajectory.

There is no equivalent catalyst currently visible. Instead, several of the forces working against housing demand are becoming more pronounced.

The Reserve Bank has already increased interest rates three times, and markets are pricing in the possibility of two further increases. Mortgage rates are therefore putting further pressure on household borrowing capacity at the same time that lending conditions remain relatively restrictive.

Investor demand is also facing a structural change. The abolition of negative gearing for established housing and changes to the capital gains tax discount have reduced the tax advantages associated with property investment. Combined with restrictions on borrowing through superannuation, these changes have significantly reduced the amount some investors can borrow.

This is particularly important at the more expensive end of the market, where investors and highly leveraged buyers have historically played a larger role.

The correction is broadening

Sydney has so far led the decline, with prices around 7.5% below their peak, followed by Melbourne at approximately 6.8%. But the other major capital cities are increasingly showing signs of catching up. Perth is now around 3.6% below its peak, Brisbane around 3% and Adelaide around 1.8%.

The increase in listings is particularly notable. Brisbane and Perth have both seen the number of homes listed for sale increase by approximately 53% over the past year, while Adelaide is up around 41%. By comparison, listings have increased by approximately 11% in Sydney and 14% in Melbourne.

The combination of more properties coming onto the market and longer selling times suggests that the markets which initially appeared more resilient are now beginning to experience the same pressures that affected Sydney and Melbourne earlier.

Brisbane provides a clear example. Median time on market has increased from around 15 days a year ago to approximately 35 days. That is a substantial deterioration in market conditions over a relatively short period.

The affordability deterioration in Brisbane, Perth and Adelaide is also important. These markets moved from relatively average levels of affordability to being among the more expensive markets in Australia in a very short period, particularly following the pandemic. Some of that increase is now being unwound.

Higher-priced properties are carrying the greatest risk

The correction is also uneven across different parts of the housing market. The top 25% of properties by value are experiencing the largest declines, followed by the middle of the market. The bottom 25% are also falling, but have so far been more resilient.

There are several reasons for this divergence. First-home buyers supported by the government's 5% deposit scheme remain active, concentrating some demand towards the more affordable end of the market. At the same time, investors have less borrowing capacity following changes to tax arrangements and lending rules. This is effectively compressing demand towards cheaper properties.

That dynamic can also distort the headline median price. If the lower end of the market is relatively well supported while expensive properties are falling more sharply, the median will not necessarily capture the full extent of the decline occurring at the upper end.

There is another limitation in the way housing price data captures changes in property quality. A house can undergo extensive renovations without its basic characteristics changing in the datasets used to construct price indices. A four-bedroom, two-bathroom property remains a four-bedroom, two-bathroom property even if hundreds of thousands of dollars have been spent renovating it.

As a result, some of the apparent price performance in the data can reflect improvements to the underlying housing stock rather than genuine capital growth. This means the decline in the value of comparable properties may be somewhat larger than the headline indices indicate.

At the extreme end of the market, some properties have experienced substantially larger declines. Pandemic-driven "sea change" coastal markets are an obvious example, with some properties that roughly doubled immediately after the pandemic subsequently giving back much of those gains. These are not representative of the national market, but they demonstrate how large the adjustment can become in markets where valuations moved furthest from underlying fundamentals.

Population growth is becoming a smaller support

Population growth has been another important source of housing demand, particularly in the rental market. That support is now expected to weaken as Australia moves towards lower immigration.

The exact size of the reduction remains uncertain, but there is broad political support for reducing migration from current levels. The current government's approach is more likely to involve tightening visa requirements and administrative processes than the explicit numerical reductions implemented by Canada. Nevertheless, the effect should be slower population growth over time.

Canada provides an interesting comparison. After a period of rapid population growth, the Canadian government reduced its permanent migration target and established targets to reduce the number of temporary residents. Canada subsequently experienced negative population growth, while rents declined for 23 consecutive months.

Australia is unlikely to follow exactly the same path, but a lower rate of population growth would reduce the amount of new housing demand generated each year.

This is particularly relevant because housing demand is now also facing a change in the direction of fiscal policy.

During the pandemic, governments transferred substantial amounts of money into the household and business sectors. Some of that stimulus ultimately flowed into housing. The fiscal environment is now moving in the opposite direction, with state and federal governments facing high debt levels, rising interest costs and pressure to reduce spending.

Fiscal austerity would therefore represent another reversal of one of the major forces that supported housing demand after the pandemic.

Housing supply is unlikely to provide an easy solution

Ordinarily, falling prices should eventually improve affordability and stimulate demand. But Australia's housing supply problem makes the adjustment more complicated.

There is a substantial pipeline of homes that have been approved or commenced, yet completions remain weak. Construction is being constrained by higher interest rates, rising building costs, labour shortages and tighter credit conditions.

The problems in private credit are particularly relevant because private lenders have become an important source of funding for property development. The failure of major developers has created additional pressure within that market, potentially making it harder for developers to secure financing for new projects.

There are also practical supply constraints. Shortages of equipment and infrastructure, including electrical transformers, are extending construction timelines. Projects that previously could have been completed within relatively predictable timeframes are increasingly taking longer.

This suggests that dwelling construction could remain weak for several years, despite the large number of projects already in the pipeline.

That should provide some support to rents, but even the rental market is approaching an affordability constraint. Advertised rents were increasing by around 5.7% over the year to August, compared with CPI rents of approximately 3.6%. The difference reflects the lag between the price paid by new tenants and the rents being paid across the existing stock of rental properties.

However, households ultimately have limits on what they can afford. When rents consume too much of household income, people can respond by sharing accommodation, staying with parents for longer or reducing other spending. That creates a natural ceiling on rental growth, even when housing supply remains constrained.

Is Australia Entering a Structurally Different Property Cycle?

The broader issue is whether Australia is approaching the end of the housing cycle that has dominated the past three decades.

Australian property investors have become accustomed to an environment where leverage, falling interest rates, population growth and capital gains reinforced one another. The result was a persistent belief that housing was an asset where buying during a downturn was ultimately rewarded.

The conditions supporting that cycle are changing.

Interest rates are now structurally higher than during the period of ultra-cheap credit, while the market entered this correction from historically high valuations. Australia's ageing population, weaker productivity growth, changes to investor tax settings and potentially slower immigration all point towards a less supportive environment for sustained house price growth.

That does not necessarily imply a prolonged collapse in nominal prices. A more benign outcome would be a significant initial correction followed by an extended period in which house prices move broadly sideways while wages and rents catch up. This would restore affordability gradually without requiring widespread forced sales.

New Zealand and Canada provide examples of how such an adjustment can occur. Both experienced significant housing declines, followed by prolonged periods of relatively subdued prices rather than an immediate return to another boom.

For Australia, that would represent a fundamental shift in how the housing market behaves. Rather than relying on ever-increasing leverage and capital gains, housing returns would increasingly need to be supported by household incomes, rents and underlying economic fundamentals.

For now, the evidence suggests the adjustment is still underway. Auction clearance rates remain weak, prices are continuing to fall across the major markets, and the possibility of further interest-rate increases could add to the pressure.

The combination of expensive starting valuations and multiple weakening sources of demand means there is a meaningful risk that Australia's housing correction becomes considerably larger than the declines seen in previous cycles. The eventual outcome may not be a dramatic crash, but a transition towards a more normal housing market in which affordability, income growth and rental yields matter more than the expectation of perpetual capital gains.

These findings were originally featured on Episode 430 of Nucleus Investment Insights, where I talked about the fall of housing price with Leith Van Onselen.

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