The property market perfect storm: Why a 15% fall is now looking likely

Cotality data shows national average home prices fell 1.2% in October, with capital city prices down 1.4%. This followed a fall of 1.3% in September which has been revised from 1.1%. All cities fell in October except Hobart and Darwin, but Melbourne is seeing a moderation in falls – probably because it’s not as overvalued having not gone up as much in recent years.

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 continue to be revised down, and October is likely to be revised down too.

Prices nationally have now fallen 6.7% from their high in March, with Sydney leading the fall with a 10.1% drop. While national average property prices are still up nearly 50% this decade, average dwelling prices in Melbourne have fallen back to around early 2021 levels and those in Sydney are back to around late 2021 levels.

Auction clearances rates rose from their mid-year lows in recent months helped by a plunge in new listings relative to a year ago as vendors hold off for better prices. However, they are weakening anew with Sydney falling to new lows in recent weeks. A further leg down is a high risk as continuing rate hikes and a deteriorating labour market potentially push more homeowners over the edge boosting distressed listings.

The weakness in the auction market is also showing up in depressed sales.

The perfect storm impacting the property market has more to go

The Australian housing market is likely to weaken significantly further as higher mortgage rates, the removal of most property tax concessions, the starting point of record poor affordability earlier this year and poor confidence continue to impact at a time of a rising risk of distressed selling flowing from rate hikes and a deteriorating jobs market.

The pressure from rate hikes is intensifying with the RBA having already hiked four times this year and looking like it will hike again this week taking the cash rate to its highest in 18 years.

Rate hikes are usually associated with weaker property prices and this cycle is proving to be no exception. This is because they cut how much buyers can borrow, can boost distressed sales and hit home buyer confidence. Of course, they can be offset by other factors like the surge in immigration in 2022-23 that pushed prices up in 2023 despite ongoing rate hikes at the time. But that is unlikely this time around with immigration levels now falling.

Each 0.25% rise in rates knocks around $11,000 off the amount that an in individual buyer on average earnings with a 20% deposit can pay for a home, so the four rate hikes seen already this year mean a total hit to their capacity to pay of around $45,000. For a couple, it’s around double that. 

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. And with rising mortgage rates depressing borrowers’ capacity to pay the gap has is little changed despite falling home prices, with the impact of higher rates offsetting the impact of falling prices. See the next chart.

The drip feed of higher rates will also put more pressure on existing homeowners already suffering from mortgage stress. At present distressed home sales and the proportion of homeowners struggling with their mortgage is low. But the share of household income devoted to mortgage interest payments as at the June quarter was already pushing up to the highs reached in 2024, which was not far from the pre-GFC high. And this does not fully reflect the May rate hike let alone the September hike and a likely hike this week. 

Another rate hike in the week ahead will mean roughly an extra $110 a month in mortgage interest payments for mortgage holders and a total increase of $550 a month since January or $6,600 year – which is a big impost and runs the risk that we may be close to a tipping point for some mortgage holders. 

The weaker jobs market and rising unemployment risks also adding to distressed sales as some homeowners may experience a loss of income or will be less able to work more hours to cover their extra mortgage payments. Increased distressed sales will add to already weak demand to put more downwards pressure on home prices.

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. This is evident in sharply slowing housing credit for property investors. 

It makes sense for investors to sit on the sidelines until they see lower prices and/or higher rents resulting in a higher starting point rental yield to compensate for the higher tax rate they now face before investing. 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 on the downside for prices.

Poor buyer confidence – consumer confidence is running around levels often associated with recession not helped by rate hikes, the rebound in fuel prices, broader cost of living problems and a gradual weakening in the labour market. While there has been some improvement in perceptions of whether it’s a good time to buy a dwelling, it remains very weak.

We now expect a 15% top to bottom fall in average property prices out to the September quarter next year. We have been expecting a 10-15% top to bottom fall in home prices. But with price falls now the most rapid on record since 1980, average prices already down 6.7% with no loss of negative momentum, the drags on demand set to continue for a while yet particularly with more rate hikes than previously expected and a likely rise in distressed selling likely to add to listings, we are revising our expected fall to around 15%.

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. 

However, by the September 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 in the December quarter next year but a sharper than expected 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).

In terms of houses, Brisbane, Adelaide and Sydney are the most overvalued and vulnerable and so are likely to see bigger than average falls, ie in the range of 15-20%. 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.

Contrary to this analysis, Perth is already proving weaker than expected and so may end up with worse than average falls despite being relatively better value. 

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 over. This saw average property prices rise dramatically faster than their long-term trend and incomes since the mid-1990s and led to chronically poor housing affordability.

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!

That said, Coalition and One Nation policies for a sharp pull back in immigration levels imply sharply lower underlying demand for housing if they attain political power. In particular, One Nation’s immigration policies suggest that the housing shortfall could quickly be wiped out as its policies suggest that underlying demand for housing would run about 110,000 dwellings p.a. less than under Labor’s immigration targets for three years.

Falling home prices imply a significant hit to economic growth

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

• 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 as homeowners feel less wealthy. This is likely to be increasingly evident in the months ahead.
• Less new home building – as established dwelling prices fall relative to increasingly costly new dwellings it reduces the incentive to build new homes. Consistent with this new home sales and building approvals are now trending down.
• Increased negative equity – where a homeowner’s mortgage debt is worth more than their home. The proportion of homeowners in negative equity is 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 a bigger issue as unemployment rises forcing some to sell their property.
• 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 this year.

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 still 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 will be interest rates, consumer confidence, unemployment and investor demand. 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 15% fall we are now 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 crash in national average property prices (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 6.5% respectively compared to 4.7% currently in Australia. Of course, other factors also impacted both NZ and Canada as well.