A housing correction, not a crash

Paul Bloxham, Chief Economist, Australia, New Zealand and Global Commodities, HSBC

So far, the cooling has been orderly, with few signs of distressed sales‎, and while there is considerable uncertainty, our central case is that the housing market will have a soft landing. We expect Sydney and Melbourne housing prices to have a peak-to-trough decline of 12-16%.

Of course, the astute observer would note that what is happening now in the housing market, and the economy more generally, is the solution to the affordability problem that was on everybody’s lips as recently as the middle of 2017. After all, there are two main ways to improve housing affordability - either household incomes can rise faster, or housing prices can fall.

What is happening right now is a combination of both of these forces. Household income growth is picking up, due to a strengthening economy, which is supporting solid jobs growth and starting to drive a pick-up in wage growth.

At the same time, housing prices are falling. After a 46% rise between mid-2012 and mid-2017, national housing prices have now fallen by 5% from the peak. Most of the cycle has been driven by Sydney and Melbourne, where prices rose by 75% and 58% during the boom and have now come down 8% and 5%, respectively.

Why are housing prices falling? A combination of factors has been at work. First, a construction boom has added a lot more supply, particularly of apartments, such that supply is finally catching up with strong population growth-fuelled demand. Second, foreign demand has weakened due to stricter capital controls in China, local restrictions in Australia, and higher taxes on foreign purchases. Finally, credit availability has tightened, largely reflecting moves by the authorities to constrain lending to investors in recent years, given concerns about excessive investor exuberance.

All of these factors are combining to see housing prices fall relative to incomes, and housing to become more affordable. In addition, because the cooling of the housing market is happening at a time when jobs growth is strong and mortgage rates are historically low, it has so far been quite orderly, with very little evidence of forced sales and loan arrears still low.

Importantly, there is also considerable variation in housing markets across the country. Housing markets outside Sydney and Melbourne have generally been more stable. Following the end of the mining boom, weaker economic conditions in Western Australia and Queensland meant that, despite the falling interest rates, Perth and Brisbane did not see big house price booms. For Perth, a boost to housing supply that came just after the mining boom ended left the market somewhat oversupplied, so housing prices have been falling and are now back at levels seen in 2009. In Brisbane, detached house prices have been rising, reflecting lowered interest rates, but an oversupply of inner city apartments has seen unit prices fall modestly. Adelaide, Canberra and Hobart have all seen solid and persistent housing price gains in recent years.

These other cities are now also starting to see stronger housing demand driven by internal migration. As has been typical in previous housing cycles, price rises in Sydney and Melbourne have made them less affordable and are encouraging internal migration to Australia’s smaller and more affordable cities. As conditions improve in the mining industry after a long period of decline, this is also supporting job creation in the mining states which, in turn, should underpin housing demand in these regions.

The key is that this adjustment process remains orderly. However, there is a risk that it does not, driving a harder landing.

Key concerns include credit availability and the possibility of changes to the tax treatment of investment properties. If credit availability were to tighten significantly from here, perhaps as the result of recommendations from the Royal Commission, this would weigh on the housing market. Possible changes to the negative gearing tax arrangements could also affect the housing market, although if the existing scheme is ‘grandfathered’, as is being proposed, this would reduce the effect of any changes.

Another risk, which is perennial, is of an economic downturn. This is not our central case but it is clear that with households carrying much more debt than in the past, a weakening in growth that saw the unemployment rate rise would do more damage than in the past, particularly to the housing market.

Given our positive outlook for economic growth, job creation and the fact that mortgage rates are still low, we expect the housing market to have a soft landing. ‎It is worth keeping in mind that the current combination of forces is also helping to make housing more affordable.

This article first appeared in The Australian on Monday, 26 November 2018.