House prices slump: The Straw that breaks the economy’s back?

Will a slump in house prices be the straw that breaks the economy’s back and be the trigger for an economic hard landing in Australia? Probably no, but it is a question that will likely dominate the news over the remainder of 2017 and into 2018.

Australia has gone 25 glorious years without a recession, but the risks are building that late 2017 and 2018 will be glum ones for the economy. The extent to which the economy is stuck in the mud will depend on the extent of the housing slowdown, the impact this has on already fragile consumer demand and the policy response of the RBA and possibly the government.

A slump in house prices will damage consumer wealth and with that consumer spending, investment and employment. Wages growth, which is already at a record low, will stay low which will further compound the lack of traction in the economy and feed into the fragile growth outlook. Already retail sales are flat or falling and consumer sentiment shows more people are pessimistic than optimistic.

This is not good news.

In terms of house prices, there is a growing wall of worry that the boom in the Eastern States is ending, possibly in a bust. The admittedly erratic and somewhat volatile Corelogic house price data shows prices in both Sydney and Melbourne having fallen by 2 per cent from their peaks a little over a month ago. Perth house prices are down 11 per cent from their 2015 peak.

Adding to the risks, the regulators are instructing the banks to constrain their lending, especially for investors and interest only loans, and this is happening when the banks have been lifting mortgage lending rates independently of RBA moves in official interest rates. These factors will undoubtedly crimp demand for housing at a time when it is already of the cusp of a slowdown.

At the same time, it is strikingly clear that the financial strategy behind investing in property is turning sour – gross rents are actually falling in some cities and nation wide, rental growth is at its lowest in two decades. According to SQM Research, the gross rental yield is also falling which for highly indebted investors, cannot be sustained for very long. It is all very well for investors to have negatively geared properties, but there does need to be a reasonable cash flow from the rental property to help validate the investment decision.

What is also apparent is the oversupply of apartments in several cities where there has been a record building boom over the past few years is about to unleash an oversupply of property.

Economics 101 shows that when supply increases relative to demand, prices moderate – or fall. It is increasingly common to hear of anecdotes where apartment prices are being offered at marked discounts.

Lessons from the global financial crisis show that house price busts trigger widespread economic hardship and recession. Look at the housing busts and recessions in the US, Spain, Ireland and the UK, among others. What happens is that many home buyers capitulate and default on making payments on their properties if prices fall too much, and this leads to an economic slump as these losses impact on banks.

When banks have a rush of loan arrears on mortgages and actual defaults, they restrict lending which further compounds the slow down and the economy enters into a cycle of weakness.

This is still unlikely in Australia, but the risks are building. At best, house price growth is slowing. At worst, house prices are at the cusp of a decline. This will have significant consequences for home owners, investors, banks and of course, the overall performance of the economy.

The debate will revolve around the severity of the downturn and whether it spills over the broader economy.

Fasten your seatbelts and think about the possibility of Australian interest rates falling below 1.0 per cent and the Aussie dollar cascading.

Contirbuted by Stephen Koukolas: (VIEW LINK)