Welcome to Finance and Fury, the Say What Wednesday edition. This week’s question is from Martin.

Paraphrasing the question – but the crux of it is – What is happening in the property market and will property prices decline from here or were the original bank forecasts overestimated?

Great question – Today What is going on in the property market – Did an episode a few months back covering the economic forecasts – went through worst and best cases – said that it wouldn’t be the worst – probably some where in the middle – so where does the market currently stand

To start with – looking back on the Aus house price index – was growing strongly since the late 90s – had ups and downs along the way – but on average – the prices have mostly moved sideways over the past 3 years – rising or falling by around 10% per year across major cities like Syd and Melb

  1. Back in 2018 when prices started to fall – not much to be concerned about – affordability remained strong, unemployment was low and interest rates had room to fall
  2. Today’s landscape is different – Unemployment is now at a 20-year high, immigration is non-existent and interest rates have hit the lower bound
  3. However – current housing figures have been resilient given the circumstances –
    1. On average – house prices have fallen by about 1% over the past three months – all occurring through some of the worst economic conditions Australia has seen in the past 70 years

 

Short Term indicators – showing forwards price estimates

  1. Auction clearance rates – indicator of sentiment – if it is high – people are snapping up property in a competitive market
    1. When the Australian economy was in total lockdown during April 2020 – clearance rates dropped heavily but since have recovered into the mid-60% range – Victoria being the outlier – being much lower
  2. Mortgage finance – The level of mortgage finance going through the economy reflects the volume of borrowing – this has been historically a major driver of property price movements –
    1. the most recent data point is from May – so lagging behind – however – this was highly impacted by the lockdowns showed some of the largest declines in finance of the past 20 years – due to banks lending around uncertainty of individuals and their employment
    2. Price estimates – pointing to be slightly negative year-on-year for 2020 – potentially in the 5 to 10% per cent range over the next 12 months
  3. Building permits for new homes – the new supply of properties – indicator typically moves in the same manner as house prices
    1. recent figures for building permits show there’s been a quick decline in the intention to build – might show expectations that sales will be lower in the near future
  4. Properties listed for sale – supply of existing properties –
    1. Even though buyers are returning to the market, overall the number of properties listed for sale is down between 22% to 16% on average over the last 12 months
    2. The lack of good properties for sale at a time when there are still many interested buyers, is one of the reasons our property prices have, in general, held up in the current economic conditions –
    3. Around major cities – there still exists buyers – especially if people have been able to get $40k out of super and get the first home owner grants – lots of new available funds
  5. In total for the forward indicators – In the short term – if the number of sales returns to normal – house prices may decline on average by a further 5 to 10%

 

Longer term – looking at the big picture of property price drivers

  1. On average – Australian has done well for a few reasons – and people can still justify it even though it is the some of the most expensive in the world
    1. we have strong migration, good affordability due to lowering interest rates and constricted supply based around desired places to live – 1 of 5 major cities – so how does this hold up in the current climate
  2. Unemployment – one of the larger risks to the property market at this stage – due to Australia faces a historic level of job losses
    1. Gone through unemployment stats in the past and how they are calculated – however – 3.5% to 4% of the working-age population lost their jobs since March – 700,000 jobs and is two times larger than that seen in the early 1990s recession and four times larger than the 2008 recession
    2. this stat does not include those who are currently on the JobKeeper program which is around 3 million people
    3. All of this has brought about economic hardship for many households – which created a situation where banks brought in loan deferrals – or bank holidays – almost 500,000 borrowers have been granted loan deferrals
      1. About 1 in 5 of these – or 100,000 are considered to be in deep stress
      2. APRA states that deferrals across home loans account for about 10% of all loans
    4. These bank holidays were originally given for 6 months – but each application will be renewed in September – with the ability to continual the deferral process for another 6 months – until March 2021
      1. But this can only be applied – APRA stated “Where the ADI has undertaken an appropriate credit assessment of the borrower and is satisfied that they have a reasonable prospect of being able to repay the loan…when the repayment deferral period ends”
      2. APRA also stated that “in some cases, banks will need to recognise that loans are permanently impaired”.
  • So those in most financial stress- some 100,000 households will likely be forced to foreclose in September if things don’t turn around
  1. Compared to the average stats – around 30k to 40k properties sell each month – so there might be a spike in the market after this date – but banks may be unlikely to do this – a lot of bad PR involved
  1. Flow on effect – as 700k people have lost their jobs, and 3m are facing some uncertainty with JobKeeper running out next year fully – if unemployment persists – lower demand going forward over the next number of years
  2. Changes to employment – if people are working from home or online – could increase the sprawl of property and reduce demand for properties around cities
  1. Population growth – lack of immigration at the moment
    1. Population growth – coupled with the limited supply or viable options for the working age population to live has been one factor to create property price growth – through additional housing demand
    2. Over the past 5 years – the Australian population has been increasing by approximately 350,000 people per year – 220,000 or 63% of that is coming from overseas
    3. With immigration being put on pause for not – the short term growth of population for the year may be reduced by around 100,000 to 150,000 people – so a decent reduction when compared to the past 5 years
    4. Population growth is one major driving factor for new builds however – on average the number of new dwellings increasing by around 2% – between 170k and 200k –
    5. With the population immigration capped for the short term – new builds may slow down as well – buy a factor of 80,000
    6. But on the other side – looking at investment properties and rent – lack of immigration should manifest itself here on a larger scale – most people who immigrate rent – until they become residents – so rental markets may become weaker – even with no international tourism or students – rental markets may have an oversupply situation which creates either lowering rents – or a sell off of properties that are costing the owners too much to cover if no rents are coming in
  2. Interest rates – affordability of debt due to lower interest costs
    1. IMO – Interest rates have been one of the biggest factors of property price growth – as they are correlated to borrowing capacity – which in turn is correlated to the average price of property –
    2. Interest rates have consistently fallen for more than a decade – creating a situation where the amount people can borrow increases
    3. Historically – the RBA response when property price may go into the negative growth territory has been to cut rates –
      1. 2008, 2011, 2015 and 2019, the house price declines were slowed or reversed as the cash rate fell
      2. Occurred again over the past few months – even before – October – saw a cut to 0.75% – then Feb and March saw two more cuts by 0.5% in total – where the cash rate is now 0.25%
  • Now – the RBA is at a lower bound with not much room to move down from here – unless they consider moving into negative territory
  1. So the strategy of cutting rates to keep prices rising as has been the norm over the past decade plus may be coming to an end
  1. To explain how much rate cuts go towards benefiting prices of property – lets look at some examples
    1. First – the magnitude of rate cuts on house prices was explained by RBA research in early 2019 – they equated the price of a house as “the rental benefit divided by the cost of owning the property (includes the average real variable mortgage rate, running costs, transactions costs and depreciation)”
    2. Ironically – this is similar to pricing an annuity: the rent is your income stream and the user cost the discount rate
  • Example in the RBA paper – If the user cost is 6% a 1% drop in interest rates would have the potential to boost housing prices by 17% – assuming everything else remains equal
  1. So with the RBA cutting rates by 0.50% over the past few months – would work out to around 8.5% lift in prices – with everything being equal
  2. But not everything has been equal – as rents have the potential and in some cases have fallen – so not the best economic model to work with at this stage
  1. Other way to look at the effects of interest rates on house prices is by looking at how the average borrowing size is affected by falling mortgage rates – and how repayments in turn are affected
    1. If there is a 1% reduction in interest rates – would potentially to about a 14% increase in borrowing capacity – not dissimilar to the estimate made by the RBA above – due to the rate being cut by 0.5% – average household could take on at least $30,000 more debt – assuming employment is the same
    2. However – mortgage rates in some cases have fallen by more – especially over 12 months – by about 1.50% over the past year – or about $90k in affordability – all else being equal – but not everything is equal – but limited room to continue this strategy of dropping rates to boost prices

In Summary – there are some good, bad and uncertain factors for property price

  1. good – has been interest rates falling a little over 1% in the past 12 months – and lower supply of properties for sale – keeping properties higher in price
  2. bad – high unemployment and a lack of immigration – creates weaker demand
  3. Uncertain – related to fiscal support like jobkeeper and loan deferrals – in addition – unemployment benefits are two to three times higher normal – so the fact that Gov benefits and loan deferrals have been extended means some of the downsides may be been avoided or delayed
  4. When we come back to Martin’s question of how worried should we be about prices going down –
  5. There is the potential for prices to continue to decline in the next 12 months – limited additional government supports or ability for RBA to continue to lower rates without getting us into a liquidity trap
  6. If I were a betting man – good reason to believe that the number of negatives may start to overshadow the positives over the next 12 months as the support polices are slowly unwound – would mean that house prices could fall further than the forecast 5 to 15% in most major cities over the medium term  

Thanks for the question martin

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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