Australian House Price Falls Accelerating

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July saw the biggest monthly fall in Australian house prices in 40 years. Just how much further will house prices fall?

-40-year fall in house prices
-More RBA pain to come
-Ongoing house price falls expected
-Which sectors are most at risk?

By Greg Peel

Since the GFC, Australian house prices have remained a difficult conundrum for the RBA. With the one blunt tool of cash rate setting, the RBA can rein in runaway house prices by hiking rates but in doing so risk adversely affecting the wider economy, or conversely cut rates to support the wider economy but thus risk runaway house prices.

To try to tackle this dilemma, the RBA has over past years called upon APRA to tighten lending rules, basically making it harder for property investors to obtain loans and harder for owner-occupiers to obtain loans they cannot afford.

Further complicating the issue is government fiscal policy over the period designed to make it easier for first home buyers to get into a market that is otherwise beyond them, which only serves to increase prices.

APRA’s tightening of various lending metrics has over the period worked to some extent, but not for long. When the RBA has hiked rates to cool housing, it has been quickly forced to cut again due to wider economic impacts.

Hence housing was the last thing on the RBA’s mind in 2020 when it slashed the cash rate straight to a record low 0.1% in response to the pandemic and it's possibly severe economic impact. Desperate not to lose all demand for loans, the banks cut their mortgage rates – variable and particularly fixed rates – to record lows. The result was, of course, a housing boom like no other.

There was not much APRA could do about it.

To be fair, today’s central bankers weren’t around the last time there was a global pandemic, and the global economy was a very different beast back then anyway.

Nor were they around when last there was a war in Europe. RBA governor Philip Lowe, like his US counterpart Jerome Powell, admits the board left it too long to start reversing the emergency rate cuts, believing at the time the pandemic-driven spike in inflation would prove transitory. And to be fair, they could not foresee the pandemic dragging on, China’s stubborn zero-covid policy or Putin’s invasion.

What Philip Lowe most regrets is his insistence for so long that the first rate rise would not come until 2024. The popular media is now awash with stories of Australians getting into the property market for the first time in 2021 assuming they had at least three years before their mortgage rates would rise.

The first rate rise came two years earlier, and there’s since been a total of four in consecutive months. Because three of those were of 50 basis points instead of the typical 25, effectively there’s been seven since May. From 0.10% in April, the cash rate is now 1.85% as of this month.

With more to come.

While the rate hikes are devised solely to attack inflation, given the RBA’s only other mandate – full employment – is for now locked in, surely Philip Lowe must be worried of the obvious counter-effect – a house price collapse.

No he’s not.

Lowe admits there will be mortgage holders who will go to the wall, and that is regrettable. But a buffer is provided by aforementioned low unemployment (3.5%), and house prices had simply run too far, which was in itself a problem. There is therefore a long way house prices can come back before the RBA starts to worry in the other direction. So rate hikes aren’t over yet.

How Far?

The average Australian house price fell -1.4% in July – the third consecutive monthly fall (which means prices began to fall immediately from the first rate hike) and the largest monthly fall in some 40 years. Prices are now down -2.6% from their April peak.

The falls were led by Sydney (-2.2%) and Melbourne (-1.5%), while Brisbane saw its first month of decline (-0.8%).

Note that in July, the RBA cash rate was 1.35%, and only this week it has risen to 1.85%. It may also rise by another 50 points in September.

It is not just a matter of sellers lining up. Not wishing to take the risk on still further rate hikes, buyers have also backed right off. In July last year auction clearance rates were running at 73%. Last month that figure was 52%.

Morgan Stanley points out this house price decline is in sharp contrast to other periods of house price declines, which the RBA hiked at most one time before pausing and reversing. Given the RBA has made it clear it will not pause tightening on house prices alone, Morgan Stanley now expects a cash rate of 3.1% by the end of this year.

There are four more RBA meetings this year and if Morgan Stanley is correct, that’s another 125 basis points. This suggests the September hike will have to be 50 points. The broker now expects house prices to decline by -10% by year-end, and -15% overall, but admits further downside risk if inflation cannot be tamed.

Jarden expects a peak-to-trough fall of -15-20%, which would represent the biggest correction since the 1980s. But since the release of the July data, Jarden has pulled forward its prior forecast of -5% in 2022 and -5-10% in 2023 to -10% in 2022 and -5-10% in 2023.

Morgan Stanley and Jarden are but two broker/economists who expect the year-end RBA cash rate to begin with a 3 and for house prices to fall by such a quantum.

Any Relief?

Consensus has it the RBA will be forced to pause in 2023 when the subsequent economic downturn becomes too severe and/or the house price correction become too precipitous.

And maybe even be forced to cut rates.

Another possibility is APRA responds to crashing house prices by cutting its “serviceability buffer” back to 2% from 3%. This is the additional rate on which mortgage providers must assess a borrower’s capacity to service a mortgage, on top of the prevailing mortgage rate, intended to prevent homebuyer aspirants from stretching their budgets too far and then getting caught out on a rate rise.

Of course at a 3% buffer, many still will.

Stock Market Impact

The higher the cash rate, the wider a bank can set its loan rates above its deposit rates, expanding their net interest margins and thus earnings. It’s all well and good, until higher rates lead to a drop in loan demand and banks are forced to cut their margins.

Jarden expects the banks to thus underperform over the next six to twelve months.

For real estate platforms, i.e. REA Group ((REA)), Domain Group ((DHG)) and Pexa Group ((PXA)), Jarden sees falling house prices as providing a headwind for earnings. That said, Jarden notes REA and Domain are trading at levels suggesting this headwind is already priced in.

The same is true in the consumer discretionary sector, where lower house prices will lead to lower consumer demand. A lot of that has also been priced in, Jarden suggests.

The building materials sector is also at risk, Jarden suggests, if falling prices deter new home construction.

The building industry has already suffered substantially, with some big-name construction companies hitting bankruptcy. But they were struggling ahead of this year’s rate rises on the soaring cost of building materials, supply chain problems and covid absenteeism. Falling demand for housing could be another nail.

This clearly also hits building materials producers.

One caveat here is that prior to the recent run of devastating floods on the east coast, builders were still dealing with construction backlogs in the wake of the devastating 2019-20 bushfires, and flood rebuilding has barely yet begun.

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