Macro
Christopher Joye

In my column today I reveal that Australia is now officially experiencing the biggest house price falls on record in almost 40 years: home values across the five largest capital cities have officially fallen 8.3 per cent from their late 2017 peak according to the top index provider, CoreLogic, which is the biggest decline since records began in 1980. The correction in Sydney has been steeper again with prices off more than 12 per cent from their September 2017 high watermark (click on that link to read or AFR subs can click here). Excerpt only below:

In April 2017 we were a lonely voice calling the end of the housing boom and a national peak-to-trough decline of up to 10 per cent after previously forecasting strong capital gains between 2013 and 2017.

In early 2018 we upgraded this projection to a 10 to 15 per cent retrenchment as a result of the impact of the royal commission, which was forcing banks to punitively ration credit to safeguard against irrational regulatory interpretations of the responsible lending laws, and because of the higher probability of a Labor victory at the election. The latter event in particular would almost certainly drive more adverse housing outcomes given Labor’s core policies of lifting capital gains tax by 50 per cent and eliminating negative gearing for all buyers of established investment properties, which research suggests will be equivalent to a 23 per cent increase in mortgage repayments.

CoreLogic’s head of research, Tim Lawless, says that the acceleration in house price declines in recent months has indeed been driven by “reduced credit availability and the spectre of changes in housing tax policies if we get a change of government, which are clearly weighing on the minds of property investors”.

If Scott Morrison pulls off a miracle and wins the May election, housing conditions should stabilise as investors pile back into the market to pick-up cheap assets once the threat of Labor’s deleterious tax changes is removed.

I also expect the accessibility of credit to improve following the royal commission, which has wasted time questioning residential lending practices that are among the most conservative in the world judged on the basis of Australia’s mortgage default rates over the last 30 years (notwithstanding that our home loan rates have been lofty by global standards).

If, on the other hand, Labor prevails, our extant forecast of a housing draw-down of up to 15 per cent stands, with values in cities such as Sydney likely to fall by more than 20 per cent.

This is one reason why we took profits on more than $300 million of residential mortgage-backed securities (RMBS) in February 2018. As house prices slump and the leverage underlying RMBS spikes, the required risk premium on these securities is rising quickly, slashing their prices... (We have been seeking to short RMBS since mid 2018.)

The orderly correction in house prices, which is viewed as “credit positive” by Moody’s and Standard & Poor’s insofar as it reverses financial imbalances, might explain the very strong recent bid for the major banks’ senior-ranking bonds. CBA, Westpac and ANZ have issued $8.9 billion of these securities in Australian dollars this month alone to sate enormous demand. It also doesn’t hurt that the credit spread offered on the major banks’ senior bonds is at its highest level since 2012 and more than 10 times higher than it was in 2007. This is partly a function of the fact that the gap between the bank bill swap rate, which reflects pure major bank credit risk, and the RBA cash rate is artificially wide because of enormous offshore demand to borrow money in Australian dollars via secured repurchase (or "repo") agreements, which has in turn pushed unsecured bank bill rates higher.

Read the full column here.

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Charles Algert

What are the investment implications, aside from shorting RBMS? If Labour's proposed policies get implemented, will that semi-permantly affect the investment case for developers as well as investors? Investors who would consider buying a new unit would still get to negatively gear but would be aware that when they want to sell it, a potential buyer will not have that possibility. Does this ultimately downgrade the prospects for all developers?