Has the housing market bottomed?

Negative bond yields, Trump’s Trade War, and protests in Hong Kong have stolen all the headlines in recent months, but (relatively) quietly, a bottom has been forming in the Australian residential property market… or has it? Several positive surprises have acted to support prices, such as the return of the Liberal-coalition, and the removal of APRA’s 7% serviceability buffer for assessing mortgages, but risks to the downside have not disappeared.

To make sense of the situation, we reached out to three Livewire contributors to get their take on one of the most important questions for the Australian economy today. Each of the respondents had a distinctly different take (not by design), with the responses below arranged from most bullish to most bearish. Responses come from Angela Ashton, Evergreen Consultants; Dr Shane Oliver, AMP Capital; and Damien Klassen, Nucleus Wealth.

2019 set to end on a higher note

Angela Ashton, Evergreen Consultants

We think that the housing market has bottomed, and we see modest improvements in residential housing over the next twelve months. This bottoming is already showing up in the most recent house price data supplied by CoreLogic, which at the end of July showed a small monthly increase in most capital cities, including the large Sydney and Melbourne markets. In about a month from now the ABS will release its June quarter Residential Property Price Indexes, which we expect will show a small fall across the nation. But we expect this series to ultimately see 2019 ending on a higher note as improved demand dynamics and looser credit supply conditions continue to emerge.

At the end of 2018 and in the lead-up to the May federal election some buyers had been delaying housing purchases with a view that prices could continue to fall, particularly market segments that were typically well above the first home buyer cohort. Property was taking longer to sell, and auction clearance rates were falling. Despite this, we consistently said that if lending and unemployment rates stay low, a huge crash would be unlikely. Our population growth rate remains solid and the aspiration of home ownership remains intact.

The Coalition’s unlikely victory immediately boosted sentiment, and for housing positives flowed from the continuation of the 50% CGT discount and negative gearing on investment properties. A stable jobs market, personal income tax relief along and ongoing moderate earnings growth should prevent any collapse in disposable income. Combined will falling home lending rates, loan serviceability does not look stretched. ‘Animal spirits’ were also bolstered when APRA removed the 7% serviceability buffer on home loans, removed the investor home loan 10% growth cap and the scrapped the 30% threshold on new interest-only lending. Finally, with two interest rate cuts by the Reserve Bank and more the way, a modest recovery looks set to continue.

Prices have probably bottomed, but don’t expect a new boom

Shane Oliver, AMP Capital

The housing market has probably bottomed, but given the threats to the economic outlook it’s a low confidence call. Even if it has bottomed house price gains are likely to be soft. The boost from the election result, which removed the threats to negative gearing and the capital gains tax discount, RBA rate cuts, and positive headlines around the relaxation of APRA’s interest rate serviceability test and tax cuts have helped provide a bounce in home buyer demand. This is clearly evident in a rebound in auction clearance rates. While this has come on very low volumes its usually the case that improved clearances lead a pick-up in volumes and this normally leads to higher house prices as evident in the next two charts.

Source: Domain, CoreLogic, AMP Capital

However, while home prices have probably bottomed, there are significant reasons for caution. It’s doubtful that annual price gains are on their way to 10% or so as implied by the past relationship with clearances and prices. The situation today is very different today compared to past cyclical upswings. In particular, household debt to income ratios are much higher, bank lending standards are much tighter, such that a return to rapid growth in interest-only and investor loans is most unlikely, the supply of units has surged pushing Sydney’s rental vacancy rate well above normal levels and unemployment is likely to drift up as overall economic growth remains weak with the added threat posed by the escalating US/China trade war. So, we don’t see a return to boom time conditions and expect constrained low single digit price gains through 2020. See the next chart.

Source: CoreLogic, AMP Capital

This should make for a more buyer friendly market than seen over the 2012-17 period. They should have time to make sure they have got the right property and are not taking on too much debt. But investors still need to look for investments that provide decent net rental yields as capital growth probably won’t be what it was in the last cycle.

Risks skewed to the downside

Damien Klassen, Nucleus Wealth

For the short term, yes, the housing market has bottomed. But the risks going forward are not even – the potential downside far exceeds the potential upside.

Short term support

In the short term there is a lot of both government and regulator policy support being thrown at the housing market to stop the downturn:

1. First home buyers (the key group not already over-leveraged) is being encouraged to borrow up to 95% of the value of a house.
2. APRA has lifted or mooted the lifting of restrictions on lending growth.
3. We have had two interest rate cuts and with the Federal government refusing fiscal support for a slowing economy, there are likely to be more.
4. Record population growth is being planned, as new housing approvals crash.

This means that the key factors affecting house price are being pulled in different directions:

The current federal government has (largely) compliant regulators and lots of scope to increase government debt to try novel ways to deliver on Scott Morrison’s “higher house prices under a Liberal government” election slogan.

Mid-term risks

Taking a step back, the federal government, in concert with regulators, is trying to convince the world’s second most indebted consumer to borrow more:

This caps the upside. Without the ability for consumers to continue increasing debt and with very few interest rate cuts left, the upside is limited.

Australian housing prices are still historically (and globally) expensive relative to rents and income. You can fix affordability three ways:

• rising wages
• falling interest rates
• falling house prices

The first looks unlikely – a mix of secular stagnation, inequality, falling union membership, increased automation and high levels of immigration mean wages are likely going to remain weak.

The Reserve Bank will work on the second, but interest rates are already at record lows.

The government is trying desperately to stop the third – but if there is to be any return to affordability, prices are most likely of the three factors to change significantly.

The risk is some sort of global shock, or increasing unemployment as the construction boom ends, or broader economic downturn. Australia has already “broken glass in case of emergency” to prop up the housing market and many of the policies that could be employed in a crisis have already been employed – meaning that in the event of a genuine crisis the downside is going to be more pronounced.

In conclusion

The housing market stands at an important crossroads; in one direction, credit availability and low interest rates push the market higher, while in the other direction, global instability, high debt levels, and the end of the construction boom look to drag the market lower.

Only with hindsight will we know the correct answer, but there are several indicators and data series that investors can keep an eye on to stay ahead of the curve. Those will be the subject of the next entry in this series, so make sure you hit 'follow' below so you're notified when it's published.