The Australian home price downturn continued in September - we now expect a 10-15% top to bottom fall

Key points

• The slump in national average home prices continued in September with prices down 1.1% according to Cotality, their sixth monthly fall. Capital city prices fell 1.2% and previous months were revised to show bigger falls.
• Further falls are likely as home prices are being hit by a perfect storm of rate hikes, tax hikes on investors, poor confidence and poor affordability depressing demand with a high risk of distressed sales flowing from higher mortgage rates and unemployment.
• We now expect national average property prices to have a top to bottom fall in prices of 10-15%, of which they have done 5.2% so far. Sydney, Brisbane and Adelaide are likely to see the deepest falls, whereas Melbourne is likely to have a shallower decline.
• 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.
• 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 0.3% in September, with annual growth of 5.5%yoy. Vacancy rates remain low but have risen contributing to some slowing in rental growth.
• The home price slump will weigh on economic growth, but as we saw this week its not significant enough yet for the RBA to shift gears to cutting rates given high inflation. But it likely will be by the second half next year.

The home price downswing continues

Cotality data shows national average home prices fell 1.1% in September, with capital city prices down 1.2%. This followed a fall of 1.2% in August which has been revised from 0.9%. September’s fall is likely to be revised down too. Prices nationally have now fallen 5.2% from their high, with Sydney leading the fall with an 8.6% drop. 

All cities except Darwin are now seeing falls with the decline in Brisbane, Adelaide and Perth accelerating. Melbourne is seeing a moderation in falls though – it’s not as overvalued having not gone up as much in recent years. 

Cotality data also shows that 97% of capital city suburbs saw a price fall over the last three months indicating that the downturn is broad based.

The downturn reflects a perfect storm for the property market of rate hikes, the Budget tax hikes on investors, poor affordability and poor buyer confidence. These are swamping the still positive influences coming from the chronic shortage of housing in Australia and the 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.

Note that while the pace of decline looks to be slowing in the next chart, recent months were revised weaker and September is likely to be revised down too.

While auction clearances rates appear to have stopped falling this reflects a plunge in listings relative to a year ago as vendors hold off for better prices. This will likely be tested this month as the spring selling season hots up with more listings at a time of poor demand.

We now expect a 10-15% top to bottom fall in home prices

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

These are: the accumulated housing shortfall of an estimated 200,000 to 300,000 dwellings; vendors not being in a rush to sell just yet aided by still low unemployment; and the expanded first home buyer 5% deposit scheme which is helping to support lower priced entry level houses and units. 

However, despite these supports, the Australian housing market is still likely to weaken significantly further as higher mortgage rates, the removal of most property tax concessions, record poor affordability and poor confidence continue to impact at a time of a rising risk of distressed selling. In particular:

The pressure from rate hikes is intensifying with the RBA’s latest hike this week.

• Rate hikes are usually associated with falling property prices or slower price growth. This is because they cut how much buyers can borrow, can boost distressed sales and hit home buyer confidence.
  

• This week’s latest RBA rate hike has taken the cash rate to its highest in nearly 15 years and the flow through to mortgage rates will reduce how much a buyer on average earnings with a 20% deposit can pay for a home by another $11,000 which taken together with the first three rate hikes this year will mean a total hit to their capacity to pay of near $45,000. This is occurring at a time when poor housing affordability, ie the surge in home prices relative to wages and household incomes to record levels, had already led to a $400,000 or so gap between home prices and the capacity to pay for a home. See the next chart.

• The drip feed of higher rates will also put more pressure on existing homeowners already suffering from mortgage stress which when combined with rising levels of unemployment risks a rise in distressed home sales and defaults. At present distressed home sales and the proportion of homeowners struggling with their mortgage is low. But as can be seen in the next chart the share of household income devoted to mortgage interest payments is already pushing up to the highs reached in 2024, which was not far from the pre-GFC high. And this chart only goes up to the June quarter so does not fully reflect the May rate hike let alone this week’s additional rate hike. The latest hike means roughly an extra $110 a month in mortgage interest payments for mortgage holders and a total increase of $440 a month since January or $5300 year – which is quite an impost and runs the risk that we may be close to a tipping point for some mortgage holders. Rising unemployment risks also adding to distressed sales as some homeowners may experience a loss of income. Increased distressed sales will add with already weak demand to downwards pressure on home prices.

• While we think the RBA has already done enough to slow demand in the economy in order to cool inflation and so see the cash rate as having peaked the risk of further hikes is high and in any case RBA commentary is likely to continue to lean hawkish warning of more hikes to come for a while yet and we don’t see it cutting rates until the second half next year. So, absent a crisis rate relief is a long way off.
• The Budget tax hikes on investors - the move to curtail access to negative gearing and return to the taxation of real capital gains is continuing to drive a big decline in investor demand for residential property in the near term because it means a significantly lower after-tax return for investors. 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. 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 stretching over a lengthy period until prices and rents adjust.

• Poor buyer confidence –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 to around $2.40 a litre and a gradual loosening in the labour market driving higher unemployment won’t help.

With a perfect storm continuing to hit the property market, further price falls are likely. We have been expecting a 10% top to bottom fall in prices but with prices already down 5.2% with no loss of negative momentum, the drags on demand set to continue for a while yet and a likely rise in distressed selling likely to add to listings particularly as unemployment increases, we are revising our expected fall to a range of 10-15%, with a midpoint of a 12.5% fall. 

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 perfect storm now hitting the property market and in particular the structural shifts in terms of the taxation of investors and the rising trend in interest rates along with the rising risk of a sharp rise in distressed selling on the back of rising unemployment.

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.

However, 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 undervalued houses are 35% 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 Canberra are the most overvalued and vulnerable and so are likely to see bigger than average falls. And in terms of units, Brisbane, Adelaide and Hobart are the most vulnerable. Melbourne is the least vulnerable city and consistent with this the downwards momentum in property prices in Melbourne is already starting to slow.

The 30-year super cycle upswing in property prices may be over?

The combination of a rising long-term trend in mortgage rates after the long term downtrend 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.

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!

That said if One Nation comes to power or anything like its migration plan is implemented the housing shortfall could quickly be wiped out as its policies suggest that underlying demand for housing would run about 110,000 dwellings pa less than under Labor’s immigration targets for three years.

Falling home prices will become an increasing drag on economic growth

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;
• Less new home building – as established dwelling prices fall in price relative to increasingly costly new dwellings it reduces the incentive to build new homes;
• Increased negative equity – where a homeowner’s mortgage debt is worth more than their home. The proportion of homeowners in negative equity is likely 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 been weighing on their share prices recently.

At a high level this means that the home price downturn will mean an increasing drag on economic growth and demand in the economy. So far, the fall in prices – considering that they are still up 50% so far this decade - has not been enough to offset the problems the RBA faces around excessive inflation. However, if as we expect the property price downturn continues into next year it will likely eventually become a factor in capping interest rates and the RBA pivoting 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 further drying up in investor demand could result in bigger price falls than the top to bottom 10-15% fall that we are expecting.

Overall, the risks for home prices over the next 6-12 months are skewed to the downside but note that in the absence of much higher unemployment causing widespread forced or distressed sales, a property price crash (say a 20% fall or more) 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 4.6% currently in Australia. Of course, other factors also impacted both NZ and Canada as well.