Arguments for and against a housing crash

Welcome to Finance and Fury. Arguments for and against a housing crash – in this episode, we will look at both sides of this and see what could happen

Is the property market going to see a decline – beyond what has already occurred? Or is it on the path to recovery.

To date – over the last 18 months or so – prices were on the rise up until the RBA started increasing interest rates –

1. Property values across Australia’s five major capital city markets started to decline from May when the first rate increase of 0.25% started.
   9. Data from CoreLogic – Sydney saw a drop of about 14% from May to Feb, Melbourne saw a drop of 9.5%, Brisbane was a bit of an exemption, which saw prices increase from May 2022 to Aug 2022 – but then have dropped around 11% from their peak – this is an aggregate – some areas haven’t seen this, some have seen more
2. Over the month of March – Property prices have been resilient – picking up a little bit even through this rebound has occurred despite two consecutive 0.25% interest rate hikes from the Reserve Bank of Australia (RBA) in early February and March
   1. This is probably due to the Australia’s property market suffering from a shortage of listings
      1. The 28-day rolling new listings is 17% below the same time last year and 12% below the 5 year average – these listings are seasonal and have very low new listings in Jan and Dec of every year as the building industry shutting down
      2. But this similar trend is reflected in total listings – which is around 20% lower than the 5-year average
   2. The other factor is the increased level of immigration that occurred over the past few months that helps increase demand
   3. There is a lot of seasonality in housing. What that means is that prices statistically tend to rise over February, March, April, May. That’s because there is a strong seasonal rise in demand

Factors that may cause property prices to crash –

1. Mortgage growth has slowed down with no signs of reversing –
   1. The Reserve Bank of Australia (RBA) has released data on the value of mortgages outstanding, which shows that mortgage growth fell to just 1.0% over the February quarter
   2. At the start of Feb 22 it was around 2.1%, so had more than halved – what comes as no surprise is that from the middle of 2020 when rates started being aggressively cut – mortgage growth sky rocketed from 0.8% to 2.1% – which was fuelled by low rates leading to both affordability to cover larger loans (in the short term) but banks being able to lend more under their servicing assessment
   3. Mortgage growth has tanked across both owner-occupiers (1.2%) and investors (0.6%)
      1. Since 2017 to 2020 investor mortgage growth turned from 1.5% to negative – but then sky rocketed – it is the most volatile
      2. Annual mortgage growth has also fallen to 5.8% and looks to continue to decline

• Mortgage credit growth has always been pretty volatile based around interest rate policies
  1. Spikes and troughs between the 1980 to 2000s – going from over 20% to 10% back to 20%, then down to 10% 8 times – but it has started to slow as a % as the size of the loans increased – in the 80s – if the average size of a mortgage is $60k and the growth is 20%, it is now $72k – but if the average mortgage is $700k and it grows by 5%, now $735k

1. But the slowdown in mortgage credit growth makes sense since it captures the first nine interest rate hikes from the RBA, which reduced borrowing capacity by around 30%

1. This data on the decline in mortgage growth mirrors that of the price declines in property
   1. Mortgage credit growth measures the addition to the mortgage pool from new mortgages taken out by borrowers – i.e. a growth in the size of all mortgages held
      1. the repayment of mortgage debt by existing borrowers actually slows this growth
   2. Only the first factor — new mortgages — has any real effect on home value

• So it is hard to get a gauge on the portion that is growth from new loans in real terms – i.e. before repayments are made – it could be that growth of mortgages has stayed the same, but as interest rates increased, we are seeing mortgage holders increase the amounts they are paying above their minimums – this would mean that property prices would be unaffected whilst seeing a decline in the mortgage growth – however what is likely is that the additional repayments people can afford to make has declined as interest rates increased

2. Mortgage holders may be in trouble – with increasing interest rates,
   3. According to an analysis by the RBA – almost 15% of mortgage holders now find themselves with negative spare cashflow after paying their loans based on a 3.6% – this means that after they pay their mortgage, they have nothing left in spare cashflow to pay for food, bills, etc.
      1. At the time this was released, it was a hypothetical impact of increasing the rates, but as of last month this was the reality
      2. At the current interest rate, a further 3% of households have less than 20% of their cashflow spare, 5% have between 80% to 60% and 10% have 40% to 60%

• So at current rates, 15% cannot afford their mortgage before they pay for anything else, then a further 8% can pay for their mortgage but would struggle to cover any additional lifestyle expenses – then another 10% would need to tighten their lifestyle expenses significantly

1. Looking at past property price collapses – this was a similar margin in the US during the GFC with the subprime lending
   1. There is a chance of mass foreclosures – but in reality this is pretty unlikely to happen – this segment of the population will fall further and further behind on repayments – which is an unpleasant experience
   2. But it will be years before any legally enforced sale can occur –
2. This begs the question where rates will end up – The RBA may have one or two hikes left in them – but at this stage it is becoming less likely than it was predicted 3 months ago
3. But even if they don’t materialise – there is still one in four home loans between now and the end of the year switching from their 2% fixed rates to 6% variable rates

3. This reduction in consumer spending means that a slowing economy is likely
   1. Since the end of our last recession in October 1991, Australia hasn’t experienced a normal recession – whilst government policy during 2020 did technically see the nation’s economy experience two quarters of negative growth, it wasn’t recognised as a recession
   2. During this time period – rather than seeing consumer consumption drop off, retail spending continued as normal and even had a little spike – but by the end of 2020 – retail spending was up massively, by around 13.7% compared to the same time the previous year
   3. Between government stimulus, access to superannuation eased and higher levels of savings due to low interest rates, the economy continued on
   4. Fast forward to today – any further measures given an inflationary environment should all be done with
      1. the options for stimulus are minimal depending on how serious the Government is about not influencing any inflationary pressures
   5. Regardless – shutting down small business domestically and supply chains and the capacity for production has created a deteriorating economic conditions – and with inflation, resulting in the largest falls in real household incomes since at least the 1980s
   6. So a combination of cashflow is affecting the average home owner – higher interest costs increasing cashflow towards debt repayments, higher inflation leading to higher costs of living, and decades low real wage growth – meaning that wages aren’t keeping pace with the shock of inflation – hence creating a worse economic condition for the average person

What could stop a housing crash

1. The power of Australian housing policy – known as extend and pretend – To explain this, looking at the last major housing crisis in the US – during the GFC or as they refer to it as a credit crunch, the number of American homes facing foreclosure rose from 0.6% in 2006 to 2.2% at the peak in 2010
   1. As a comparison to Australia, this would be an equivalent of 242,000 homes facing foreclosure
   2. But this is extremely unlikely to happen in Australia, despite the similarities of a sizeable proportion of households coming off cheaper fixed rates to higher cost loans along with the forecasts from the RBA
   3. Unlike in the US – Australian banks and policymakers are highly likely to pursue a strategy of ‘extend and pretend’ rather than one of mass foreclosures should mortgage holders get into serious trouble
   4. They can amortise the missed repayments onto the size of the loan – where they draw equity out of the property for an extended period of time
   5. In addition, Australia doesn’t have the same ‘walk away’ laws the US had, where in the US in the GFC they had jingle mail – with keys being mailed back – you simply can’t walk away from a property at a loss, the banks will come after you to recoup their lost earnings
2. Sentiment and the belief that property in Australia always goes up
   1. It may seem strange to include something because this is an abstract concept – but there is a belief that in Australia, property prices always go up and you should buy property due to this – regardless of how unaffordable it may seem
   2. This in part relates to the wealth effect – and due to this, the Government has an apprehension around allowing prices to go down as there is the belief that this will further impact consumption spending – the less wealthy you feel, the less you spent
   3. In addition, banks don’t want prices to go down – they want the collateral there if lenders default – so there is pressure on both the government’s fiscal policy but also monetary policy to not allow property prices to collapse
   4. But there is also the myopic aspect of property that many people have – those that focus on property prices in certain short timeframes – where since banking regulations changed in the 90s and interest rates have been on a long term downwards tend – property prices have gone up – ignoring the past 60 years of property price data prior to the 2000s
      1. in the end, sentiment – or the belief that property markets never go down and are a good investment, or are cheap at the moment and are a bargain could be what ultimately saves it
   5. With faith for many that prices will bounce back and eventually soar to new heights, the recent drops in prices are seen as an opportunity to ‘buy the dip’ before the next property boom sends prices to even greater heights.
   6. This sentiment could also be helping maintain property prices as those who were looking to sell are holding off, hoping prices recover and selling at a later date – reducing the supply
3. The last and probably most important – interest rates – if interest rates go down, this could help prices increase

In Summary –

1. While capital city house price fell and are reversing – will it reverse course or continue to rise?
   1. Cases for the market to tank – if the RBA has any new evidence of accelerating inflation, they’ll have to keep lifting rates and that’s where the [housing] market enters into a danger zone of a double-dip downturn.
   2. After the recent pause – there is a pretty good chance that the RBA start cutting rates later in the year – but even with reduced interest rates – once home loans come off fixed rates between now and the end of the year this could put further negative pressures on property prices
2. What is shaping up for property prices to increase –
   1. The RBA is likely to cut rates, which would lift borrowing capacity.
   2. The Australian Prudential Regulatory Authority is likely to follow suit by reducing the 3% mortgage buffer, which would further boost borrowing capacity.
3. Whether the house price correction is genuinely over remains to be seen – but at this stage the factors are looking like a 20% drop may be out of the question.